Freddie Overstated Capital Cushion / Bailout Imminent

Posted by urbandigs

Sat Sep 6th, 2008 06:52 PM

A: First week of football, bailout of Fannie & Freddie, ahhhh the excitement. And man, how pathetic am I. Anyway, here is the latest and its not surprising. Both Fannie & Freddie for whatever reason have been marking their assets to model, not to market. When Merrill sold off their distressed assets at a reported 22 cents on the dollar, arguably 5 cents on the dollar, it issued in price discovery for what these distressed assets were currently worth on the open market. The ricochet of mark downs were not occuring at the GSE's, making their books appear at first glance to be stronger than they really were. I wish I had an intern to help me research all this for more visual discussions on these very important topics.

Via NY Times, "Loan Giant Overstated the Size of Its Capital Base":

The government’s planned takeover of Fannie Mae and Freddie Mac, expected to be announced as early as this weekend, came together hurriedly after advisers poring over the companies’ books for the Treasury Department concluded that Freddie’s accounting methods had overstated its capital cushion, according to regulatory officials briefed on the matter.

The details of the deal have not fully emerged, but it appears that investors who own the companies’ common stock will be virtually wiped out; preferred shareholders, who have priority over other shareholders, may also wind up with little. Holders of debt, including many foreign central banks, are expected to receive government backing. Top executives of both companies will be pushed out, according to those briefed on the plan.
Just amazing. Price discovery continues, mark to market write downs will continue, as the cycle progresses to the next stage. As I stated July 28th:
"This is how the cycle goes. A frozen secondary mortgage market leads to forced sales of assets that would not otherwise be sold. As firms stack their toxic holdings into the imaginary accounting blanket of Level 3 assets (which I told you back in NOVEMBER of 2007 would become a household phrase), some firm has to ruin the party and forcibly sell their bad holdings for a bad price in the bad open market that is not really very open anymore. And then, have the audacity to sell more shares and dilute current shareholder value. How dare they! And now, we get a fresh new glimpse at the price that the frozen marketplace will currently pay for assets that I both don't want to own or sell. Sweet, thanks, great job Merrill Lynch. Now I need to MARK DOWN my bad assets to the low level that you just sold them at! Damn bastards."
Freddie's capital cushion appeared better and was overstated because the marks on their toxic holdings were not updated as of the latest discovery trade. When you update them to the new value of the bad assets, the capital cushion becomes too low.

Welcome to free market capitalism, or lack thereof. The full details on the bailout is imminent. If market is to rally on this announcement, we probably will NOT get any event rate cut. An event rate cut is my phrase for the fed acting to sooth the markets that are reacting to a very negative event. You would think this would classify, but financials will likely surge and credit spreads likely will tighten significantly on this news without any cut. We'll see.

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