Fannie and Freddie Can't Sell Their Debt

by: REIT Wrecks August 24, 2008 | about stocks: FNM / FRE    

REIT Wrecks

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A few days ago, I was talking with a friend who until very recenty had been in charge of capital markets at a privately-held "hard money" lender.  Hard money is a rough and tumble world of last resort, where borrowers who are out of both time and luck go for quick cash, priced at prime plus ten and three points on closing. 

My friend left the firm because he refused to participate in a quiet, back-room shell game designed to conceal the true health of the firm's loan book from their accountants and lenders.  The scheme basically involved trading bad loans back and forth with competitors, then disguising the trades as repayments and refinancings. All they did was replace one piece of illiquid, rotting swamp sludge with another, but it made the companies and their portfolios look much healthier than they actually were.

While I found what he told me to be pretty disturbing, I dismissed the practice as a product of that particular environment, excacerbated by the fact that this firm was privately held.  After all, Sarbanes-Oxley was written specifically to increase disclosure at public companies, and didn't Andy Fastow and Jeff Skilling go to prison for falsifying financial records?  And then Phil Bennett at REFCO after them?

So imagine my alarm when I read of similar financial contortions going on over at Fannie Mae, (FNM) and Freddie Mac (FRE).  Foreign investors, particularly Asian central banks that had been huge buyers of Fannie and Freddie debt have pulled back in recent weeks, and that left Fannie and Freddie with no resort but to play "let's make believe" with their debt sales last week.

In its online edition, The Economist wrote in "Fannie, Freddie and Lehman ensure August is anything but quiet" that a five-year issue by Freddie Mac on August 19th sold for 1.13 percentage points over treasury bonds, the highest spread for at least a decade, and almost double what Freddie had to pay just a few months earlier.  But extraordinarily high yields are only part what Fannie and Freddie had to offer.

According to The Economist, the banks that manage the agencies' debt issues are pulling out all the stops to ensure their success, even to the point of artificially boosting demand through deals known as "switches". In such an arrangement, an investor agrees to buy into a new issue in return for being able to sell back to the banks an equal amount of an old one, thus ensuring its net exposure does not rise.

If enough of these deals are struck, large amounts of debt can be shifted even when demand is thin. A recent $3.5 billion issue by Fannie was helped along by "very significant" amounts of switching, said one banker involved in it. With $223 billion, or one-seventh, of the agencies' debt falling due before the end of September, those peddling it will have their work cut out for them, especially if the Asian investors continue to be put off by unkind headlines.

Fannie Mae and Freddie Mac are now clearly out of time and luck, and it looks like we taxpayers will soon become the hard money lenders of last resort.  Bernanke signaled just such an outcome last week in Jackson Hole, and both common and preferred equity holders will soon be completely wiped out.  Unfortunately, we have no choice.  As The Economist wrote: "loss of faith in the firms' equity is one thing, ebbing confidence in their vast pile of debt is altogether scarier."

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This article has 13 comments:

  •  
    Aug 24 08:16 AM
    Do Nothing it will correct on it own, just give it time.
    Reply | Link to Comment
  •  
    Aug 24 08:35 AM
    Many of us believe that somehow the sacred american investor, shopper and taxpayer, will be spared any real discomfort , and this has been true to an extent for 75 years or more.
    I think now may be the time to get ready for something different.
    This would be a good time not to be in charge of the congress and the white house and to stay away from securities of all kinds.
    Reply | Link to Comment
  •  
    Aug 24 09:27 AM
    Ho hum, another day, another scare story to keep small investors from buying FRE and FNM at firesale prices. The conspiracy of the year.
    Reply | Link to Comment
  •  
    Aug 24 10:45 AM
    "switches" or swaps are pretty common - an investor who already owns the debt picks up a little yield for the new issue over the old. Same credit and interest rate risk, more yield. The old debt that they swapped out of still has to be sold by the bank anyway - not like it just vanishes. So who's the bank selling the old issue to? Fannie and Freddie are not redeeming and the bank is likely not taking the risk on its balance sheet so stands to reason someone is buying the old debt as well.
    Reply | Link to Comment
  •  
    Aug 24 10:58 AM
    Human psychology tends to magnify recent events or the most readily available data; and it discounts past factors or quieter events; let's not forget the following: 2% fed rate; 300 billion dollar housing rescue bill with anther four billion dedicated to sprucing up foreclosed homes; higher lending standards; a securitizing industry cleared out but for the GSE's; home affordability not seen in 10 years; two presidential candidates vowing to devote fed resources to aiding homeowners in trouble; Paulson's assurances that not action is yet needed; Greenspan's , Zell's and other forecasting a housing bottom before 2010; no subprime lending for over a year; a new baby boom happening now in U.S; ..... did I forget something...
    Reply | Link to Comment
  •  
    Aug 24 05:04 PM
    Dwb makes the right point in that the debt is not extinguished so real progress, deleveraging, is not accomplished. This is a shell game period.
    Reply | Link to Comment
  •  
    Aug 24 08:36 PM
    It is starting to get amusing watching these dumb hacks make up stupi stories.

    A question to the author: if "Fannie and Freddie Can't Sell Their Debt", then why is their debt trading at a premium to par"?

    Who do you think you are fooling?
    Reply | Link to Comment
  •  
    Aug 24 08:40 PM
    Someone wrote "Dwb makes the right point in that the debt is not extinguished so real progress, deleveraging, is not accomplished. This is a shell game period. "

    It's like if someone wrote in wondering why they have to keep putting gas in their car. "The automobile is a shell game because it keeps needing gas to operate"
    Reply | Link to Comment
  •  
    Aug 24 10:10 PM
    This article will be reported to the SEC
    Reply | Link to Comment
  •  
    Aug 24 11:40 PM
    "Did I forget something". You speak as though a 2% artificial rate is a good thing. "300 billion housing bill. " That's a bill to the tax payer, who must work to pay it off or sell assets, lowering prices. "Home affordability". With what income? With what job? "Paulson's assurances" Is that a sick joke?

    Here are some "past factors" you've "discounted"... Argentina, Zimbabwe, Russia, the Ottoman Empire, Rome. Here's some "readily available data: US debt: $9,620,000,000,000. Private debt:$43,000,000,000,0... Report me if you think I've added a zero.
    Reply | Link to Comment
  •  
    Aug 25 10:08 AM
    Since you need Buffet to do your thinking for you ask him what this means: " NEW YORK, Aug 25 (Reuters) - Shares of Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) were up 5 percent on Monday after solid demand for its $2 billion sale of 3-month and 6-month bills, easing some worries about its ability to raise cash. [ID:nN25422818]

    Freddie's stock was last up 15 cents, or 5.3 percent, at $2.96, erasing an earlier loss of 9 percent.

    (Reporting by Richard Leong, Editing by Chizu Nomiyama) "

    Ask uncle Warren if this means "Fannie and Freddie Can't Sell Their Debt"
    Reply | Link to Comment
  •  
    Aug 25 01:41 PM
    What exactly does selling debt mean? Is it like getting a loan? Why would you buy debt? It seems like this does not actually change the net value of the company and merely delays the financial consequences. Now, these companies were able to sell off a couple billion dollars worth of debt, but they have a couple hundred billion dollars worth of debt coming due next month. Does that mean they have to sell 100 fold more debt than they just did?
    Reply | Link to Comment
  •  
    Aug 25 08:32 PM
    Selling debt is just a cute way to describe rolling over your loans. It used to be called borrowing from Peter to pay Paul. The US Government is the biggest player in this shell game, but maybe not for much longer.
    Reply | Link to Comment
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