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Banks Slammed By Treasury’s Bailout
By Elizabeth MacDonald

The Treasury Department’s bailout of Fannie Mae and Freddie Mac could ignite a cascade of sizable writedowns and losses at up to 40 banks around the country, analysts say.

The reason is the Treasury did not adopt in its rescue of Fannie Mae (FNM: 0.86, +0.13, +17.80%) and Freddie Mac (FRE: 0.81, -0.07, -7.97%) a plan that would protect the value of the preferred shares, or the common stock, in the two mortgage giants.

Fannie and Freddie own or guarantee about $5.4 tn in home loans–half the nation’s total, and half the size of the US gross domestic product. Preferred shares are different than common stock, as they carry no voting rights, among other things.

As a result, the Treasury Department’s plan now threatens to blow open gaping potholes in dozens of bank balance sheets due to the resulting drops in value in Fannie and Freddie preferred shares.

Because of the bailout, the preferred stock in Fannie and Freddie could eventually be worth just pennies on the dollar, or even zero, according to some analysts.

And because of the looming losses, the regionals will be forced to either go hat in hand to, say, the private equity crowd, consolidate, merge, or go out of business–or, ironically, raise capital via more preferred share offerings.

The potential write-downs and losses come after the Treasury Department and the Federal Housing Finance Agency seized control of the mortgage giants, in what is expected to be the world’s biggest government bailout that effectively makes the US government the planet’s largest mortgage finance company.

Fannie And Freddie: What Next?
Steve Forbes, 09.08.08, 10:12 PM ET


Will the Bush administration in its remaining months continue policy by reaction, or will it take positive initiatives to end the credit crisis? Yes, Fannie Mae and Freddie Mac--or as wags call them, Fonie and Fraudie--were too big to fail. Defaulting on their bonds would have triggered the worst financial meltdown since the Great Depression. That’s why drastic action should be taken now.

Treasury Secretary Hank Paulson should finally do to these two corrupt, mismanaged monsters what he should have done months ago and unveil a plan to break them up into 12 new companies. They should be recapitalized, which will require an initial outlay of more than $300 billion. Current shareholders should be able to exchange their existing paper for shares in these new companies. They won’t likely recover what they lost on Fonie’s and Fraudie’s common stock, but they’ll end up with a lot more than what these shares were worth before the government takeover. Preferred shareholders should be able to exchange their paper for similar securities in these new entities, with warrants attached for conversion into common shares.

To help beleaguered regional banks, which owned much of this stuff, these preferred shares should be called in at par in, say, 20 years or so. That way banks and other financial institutions shouldn’t have to take a massive write-down. The federal government should also have warrants in these new outfits so that taxpayers can ultimately get a part or all of their money back. In this way you could have a dozen competitive companies with no ties to Washington.

These vigorous new entities would help revive the housing market.

Paulson, the president and the SEC should also give firm orders to bank regulators to start exercising common sense with regard to their mark-to-market mania. These forced write-downs on securities that are intended to be held to maturity exacerbate the crisis. The banks must then be recapitalized. The write-downs impede their ability to lend, thereby hurting the economy.

Most immediately, the Treasury and the Fed should explicitly strengthen the dollar. The White House must resoundingly put an end to the administration’s highly destructive weak-dollar policy. The instability of the buck hinders business investment. It undermines markets for dollar-denominated assets. If the dollar isn’t restored, this Fannie-Freddie fiasco won’t be the last horror of the credit crisis.

By the way, if big tax increases are enacted next year, the housing crisis will get far worse. We don’t need a weaker economy now.

Lehman sinks as much as 40 percent on capital worry