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It’s the 'Three Amigos' to the Rescue of Fannie & Freddie

Or is it? Are the amigos up to the task? Are they even amigos?

By Fred Yager
ConsumerAffairs.com

July 16, 2008
They’re calling them “the three amigos” -- Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson and Securities and Exchange Commissioner Christopher Cox.

Each has stepped forward to offer their agency’s support to restore confidence in mortgage giants Fannie Mae and Freddie Mac. But did their support arrive in time? And how likely are they to do much good?

Paulson proposed an increase in the U.S. Treasury Department’s line of credit and an offer to buy equity in the companies if necessary. Keep in mind that Congress would still need to approve both proposals which may be why Paulson’s proposals did little to stop the stock prices of both companies to keep falling.

Naked Short selling

Then SEC Chairman Cox weighed by announcing restrictions on a somewhat dubious and quasi-legal trading strategy known as “naked short selling” of Fannie Mae, Freddie Mac and other large financial companies such as Merrill Lynch, Morgan Stanley and Goldman Sachs.

Short sellers make money by betting that a stock price will go down. They’re supposed to do this by first borrowing the stock from another investor and then selling it. If the stock falls, the short seller can buy it back at the lower price and make a profit.

Naked short sellers complete their trades without actually borrowing any stock. Starting Monday and for the next 30 days, the SEC will require traders to own or borrow shares in these companies before completing a short sale.

This kicked off an instant debate over whether this move was even warranted or whether the SEC should reinstate something called the “Up-tick” rule that was repealed last year. That rule allowed shorting of a stock only when the last sale or “tick” on the ticker tape was an up or positive move in the stock.

It was put in place a decade after the stock market crash of 1929, ostensibly to curb an escalation in declining share prices that could be caused by shorting a stock.

The potential consequences of this restriction could impact stock options trading on the Chicago Board Options Exchange and traders there are divided over whether this will cause unwanted disruptions or whether it's a necessary step to calm the markets.

Fed Authorizes Loans

This followed a Fed statement that said its Board of Governors had granted the Federal Reserve Bank of New York authority to lend to Fannie Mae and Freddie Mac "should such lending prove necessary." The statement went on to say any loans would be at the primary credit rate offered to investment firms and would be backed by US government and federal agency securities.

What it means to you

What does this mean to you? Fannie Mae and Freddie Mac hold or back one out of every two mortgages in this country, around $5.3 trillion worth. So there's a 50-50 chance that they hold yours. If your mortgage is under $417,000, you have a three out of four chance.

Although they’re owned by investors, they’re known as government-sponsored enterprises -- GSEs, to use the usual jargon. And the debt securities that finance their operations are owned by foreign governments such as China, pension funds and other large influential investors.

Crisis of confidence

Many experts say the primary issue plaguing these two mortgage giants has been a lack of confidence over whether they have the money to survive all the problems in the mortgage industry. This crisis of confidence has resulted in a sell-off of Freddie Mac and Fannie Mae to the tune of 80% over the past few months.

Some of the confidence was restored Wednesday, but it didn’t have much to do with our “Three Amigos.” In fact nothing any of them said or did had any impact in stopping the downward spiral of Fannie and Freddie stock prices.

It was the market responding to Wells Fargo reporting better than expected earnings and falling oil prices that turned the tide and pushed the market upward. Shares of Fannie Mae and Freddie Mac went up along with most financial stocks.

Critics of government intervention and the possibility of taxpayers footing the bill for reckless lending maintain that it’s confidence in our free market system that is the only confidence that really matters.

At this point, a little confidence in anything at all would be helpful.

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