Geithner retaliates against Demarco ( FHFA Head who refused to comply with Treasury's proposal for mortgage pricipal reduction ) by accelerating wind down of GSE Treasury backing - what could go wrong ?

http://ftalphaville.ft.com/blog/2012/08/17/1123731/frannie-est-mort-vive-le-frannie/

Frannie est mort, vive le Frannie

Posted by Joseph Cotterill on Aug 17 17:27.

So farewell then, 10 per cent Fannie and Freddie senior pref dividends.

You were very complicated.

The US Treasury announced on Friday that it will instead use all the profits generated by Fannie Mae and Freddie Mac in order to pay off their taxpayer bailouts. It’s supposed to replace a 10 per cent ceiling on the dividend paid on Treasury-held preferred shares in both GSEs.

The adjustment also speeds up Fannie and Freddie’s wind-down of their investment portfolios from 10 per cent to 15 per cent annually, though it’s not clear if the wind-down would have reached this pace anyway.

That might not sound like very much but, crucially for the GSEs’ credit risk, the latest amendment will waive the dividend when the GSEs make net losses. It also achieves the effect of making certain that the GSEs’ fate will be uncertain for some time to come.

Right, so, the Treasury is selling this as a plan to “make sure that every dollar of earnings each firm generates is used to benefit taxpayers”.

Is it?

Well, it certainly comes at a funny time for serious reform of the US housing market, which is also of some interest to taxpayers.

Now, a combined total of $190bn in preferred stock means (meant) $19bn of annual dividend payments for the two agencies together.

Fannie and Freddie earned $5.1bn and $3bn in net income respectively last quarter, which (unusually) allowed them to pay dividends to the US Treasury without drawing funds from the US Treasury, in that famous little circular arrangement. This could be part of a housing turnaround; Fannie’s numbers were boosted by a reversal in provisions for mortgage credit losses, for example, which had caused it to haemorrhage billions over the years.

But while Fannie said it “does not expect total loss reserves to increase above $76.9 billion in the foreseeable future”, nor has it expected “to generate net income or comprehensive income in excess of our annual dividend obligation to Treasury over the long term.”

So the recent profits were really a no man’s land for the agencies’ ultimate fate — whether they could be viable as private companies, or whether the government should end the charade of conservatorship, tackle the looming cash-flow problem, and take them over.

Witness the budding trade in GSE junior preferred shares for instance, betting on the tail event of the GSEs returning to sufficient, independently-managed profit to reinstate payments on them. Not just the senior. “Some of the smartest funds in the world are very long Freddie prefs in a very big way on a notional basis, and have been for some time,” as Distressed Debt Investing put it.

Well, the bet had blown up spectacularly on Friday – which to be fair was the “lottery ticket” nature of the trade.

But it shows where Friday’s dividend switch has taken the debate — towards longer-term conservatorship, shading on government direction of the GSEs, without much light on the desired end-state.

Some thoughts from Barclays’ rates team:

With the change in support, we see virtually no chance of the post-YE12 capital supports being exhausted over a multi-decade period. This is primarily because of the high quality of the post-conservatorship guarantee book, coupled with our view that provisioning for legacy credit losses is essentially complete (also in line with the Q2 results).

In our view, this puts to rest any worries about GSE credit risk even in intermediate/longer maturities. Thus, we expect the agency-Treasury spread curve to flatten sharply and can envision 10s trading at T+15-20bp. By accelerating the pace of portfolio shrinkage to 15%, this should also boost the positive supply technical for agency debt, further buoying valuation.

…the GSEs are now, more than ever, dependent on the government. By removing virtually all concerns about standalone credit and appropriating all profits, the government is signaling what most market participants already know: that FNM/FRE are essentially off-balance-sheet government entities. The question remains whether this move will be enough to change perceptions of investors (typically overseas) that have previously differentiated between Treasury/GNMA and FNM/FRE securities.

We think that over time, the answer to this question is an unambiguous yes. Any signal that the Fed/OCC is considering reducing FNM/FRE risk weights as a result of this dividend change would increase investor appetite for agency debt/MBS; however, this would also further entrench FNM/FRE securitization, complicating any transition to another housing finance model.

and.... 

http://www.zerohedge.com/news/socialism-strikes-back-geithner-retaliates-against-demarco-accelerates-wind-down-gse-treasury-b

Crony Socialism Strikes Back: Geithner Retaliates Against DeMarco; Accelerates Wind Down Of GSE Treasury Backing

Submitted by Tyler Durden on 08/17/2012 08:41 -0400

• Bank of America
 
• Bank of America
 
• Department of the Treasury
 
• Fannie Mae
• Freddie Mac
 
• Housing Market
 
• recovery
 
• Tim Geithner
 
• Treasury Department

Two weeks ago we reported in Geithner To DeMarco: "I Do Not Believe [Un-Socialism] Is The Best Decision For The Country" that TurboTax Tim did not take lightly to FHFA head Ed DeMarco's snubbing of the worst treasury secretary ever, when DeMarco refused to comply with Tim Geithner's "proposal" for mortgage principal reduction in effect forcing responsible taxpayers to bail out irresponsible ones. Lots of media posturing and free-market bashing ensued. Today, Tim has once again taken the offensive, and is announcing plans that the Treasury is accelerating the winddown of its backing of Fannie and Freddie and that going forward instead of a 10% dividend, the Treasury will be entitled to a "full income sweep" of the GSEs on behalf of the US Treasury. One can only hope that the loan loss reserve reduction which was the sole source of Fannie and Freddie "profit" (see Bank of America) will continue. And since it won't, it is once again Tim Geithner who ends up with the short end of the stick in his idiotic attempt to escalate a matter which is far beyond his meager comprehension skills. And here is the kicker: "The agreements require an accelerated reduction of Fannie Mae and Freddie Mac’s investment portfolios. Those portfolios will now be wound down at an annual rate of 15 percent – an increase from the 10 percent annual reduction required in the previous agreements. As a result of this change, the GSEs’ investment portfolios must be reduced to the $250 billion target set in the previous agreements four years earlier than previously scheduled." Oops MBS market, unless of course there is someone who will miraculous step up and buy the "excess investment portfolio"... who could that be... who could that be? Ah yes: Giethner just greenlighted the MBS purchases (sorry MBS twist - no cookie for you) portfion of QE3. And finally, following today's unambiguous renationalization of the GSEs, does this mean that US debt is now $16+6 trillion or over $22 trillion courtesy of the GSEs which are now on the US balance sheet?

From Bloomberg:

The U.S. Treasury Department today announced plans to accelerate its winddown of its backing of Fannie Mae and Freddie Mac.

Treasury amended its terms as conservator of the government-sponsored-enterprises. Treasury said the plan also includes a “full income sweep” for Fannie and Freddie.

The GSEs have been under conservatorship since 2008. Both Fannie Mae and Freddie Mac reported second quarter profits earlier this month.

Republicans in Congress have called for an end to the two taxpayer-owned companies, which now own or guarantee about 60 percent of U.S. home loans. Treasury Secretary Timothy F. Geithner has said he will propose a plan to overhaul housing finance that could include dismantling or altering Fannie Mae and McLean, Virginia-based Freddie Mac.

From the official statement:

The U.S. Department of the Treasury today announced a set of modifications to the Preferred Stock Purchase Agreements (PSPAs) between the Treasury Department and the Federal Housing Finance Agency (FHFA) as conservator of Fannie Mae and Freddie Mac (the Government Sponsored Enterprises or GSEs) that will help expedite the wind down of Fannie Mae and Freddie Mac, make sure that every dollar of earnings each firm generates is used to benefit taxpayers, and support the continued flow of mortgage credit during a responsible transition to a reformed housing finance market.

“With today’s announcement, we are taking the next step toward responsibly winding down Fannie Mae and Freddie Mac, while continuing to support the necessary process of repair and recovery in the housing market,” said Michael Stegman, Counselor to the Secretary of the Treasury for Housing Finance Policy.  “As we continue to work toward bi-partisan housing finance reform, we are committed to putting in place measures right now that support continued access to mortgage credit for American families, promote a responsible transition, and protect taxpayer interests.”

The modifications to the PSPAs announced today are consistent with FHFA’s strategic plan for the conservatorship of Fannie Mae and Freddie Mac that it released in February 2012. The modifications include the following key components:

Accelerated Wind Down of the Retained Mortgage Investment Portfolios at Fannie Mae and Freddie Mac

The agreements require an accelerated reduction of Fannie Mae and Freddie Mac’s investment portfolios. Those portfolios will now be wound down at an annual rate of 15 percent – an increase from the 10 percent annual reduction required in the previous agreements. As a result of this change, the GSEs’ investment portfolios must be reduced to the $250 billion target set in the previous agreements four years earlier than previously scheduled.

Annual Taxpayer Protection Plan

To support a thoughtfully managed wind down, the agreements require that on an annual basis, each GSE will – under the direction of their conservator, the Federal Housing Finance Agency – submit a plan to Treasury on its actions to reduce taxpayer exposure to mortgage credit risk for both its guarantee book of business and retained investment portfolio.

Full Income Sweep of All Future Fannie Mae and Freddie Mac Earnings to Benefit Taxpayers for Their Investment

The agreements will replace the 10 percent dividend payments made to Treasury on its preferred stock investments in Fannie Mae and Freddie Mac with a quarterly sweep of every dollar of profit that each firm earns going forward.

This will help achieve several important objectives, including:

·        Making sure that every dollar of earnings that Fannie Mae and Freddie Mac generate will be used to benefit taxpayers for their investment in those firms.

·        Ending the circular practice of the Treasury advancing funds to the GSEs simply to pay dividends back to Treasury.

·        Acting upon the commitment made in the Administration’s 2011 White Paper that the GSEs will be wound down and will not be allowed to retain profits, rebuild capital, and return to the market in their prior form.

·        Supporting the continued flow of mortgage credit by providing borrowers, market participants, and taxpayers with additional confidence in the ability of the GSEs to meet their commitments while operating under conservatorship.

·        Providing greater market certainty regarding the financial strength of the GSEs.

* * *

This means that the offloading of GSE inventory has just increased by 50%. Goodbye housing market.

But more importantly, today's news brings up an interesting question: with the Treasury in effect announcing it is the beneficiary of the entire Fannie and Freddie's Income Statement, does that mean the Treasury is also on the hook for their $6+ trillion in debt?

Inquiring minds want to know.