Fannie Mae and Freddie Mac are in full retreat today, taking the market with them. Jaret Seiberg at the Stanford Group outlines in a note what Uncle Sam might do if the situation worsens for the "companies":
1) If failure were imminent, [the Fed would agree to buy] debt issued by the troubled enterprise. This would address short-term liquidity problems that would occur if investors refused to buy the debt of an insolvent or nearly insolvent [government-sponsored enterprise].... Congress would pass legislation to inject capital into the troubled enterprise in exchange for warrants or equity. This would heavily dilute existing shareholders. As the troubled GSE recovers, the government would sell its equity stake.
2) Less likely in our view is a Bear Stearns-like rescue. Were one to unfold, we expect it could look like this: Private equity firm or other buyer agrees to purchase insolvent enterprise for minimal amount. Firm also agrees to recapitalize the firm up to a level that regulators feel is necessary to provide an adequate cushion against losses. Federal Reserve agrees it would buy the troubled GSE's debt to ensure firm does not suffer liquidity squeeze if private investors do not step up. Federal Reserve role reassures investors about the implicit government guarantee, which means they start buying the GSE's debt.
3) Another option would be to nationalize the troubled GSE. We see many problems with this option—both practical and political. But [we] cannot rule it out. Troubled enterprise declares bankruptcy. Federal Reserve steps in to buy GSE debt. Congress enacts legislation to provide full faith-and-credit guarantee on troubled GSE's debt. This brings private investors back to the market. In exchange, equity holders are wiped out and government owns the enterprise. Could either keep it independent or bring it under Department of Housing and Urban Development, which means it would be treated the same as Ginnie Mae.
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of CA 4:29PM July 11, 2008