Saturday, September 06, 2008

US Treasury to Officially Merge with Fannie and Freddie

WASHINGTON -- The U.S. Treasury today announced its intention to take a majority stake in two formerly "private" institutions, Fannie Mae and Freddie Mac.

Secretary of the Treasury, Henry "Hammerin' Hank" Paulson said of the merger, "this is an exciting day for taxpayers. We arbitrarily decided to nationalize two companies that had not failed and had maintained capital at ratios that we had mandated for them to maintain. While some people, particularly the companies' existing shareholder base, may believe this is at best an inappropriate use of The Treasury's power and at worst illegal, we believe that nationalizing valuable assets at cheap prices is GRRRRRR-EATT! for tax payers, of which I have been and expect to continue to be a large one."

CEOs Danny Mudd and Dick Syron released a joint statement on the matter. "We are really excited for the new shareholders - US Taxpayers. While we both will be fired for no apparent reason, we think it is totally appropriate that Fed. Chairman Ben S. Bernanke is the person who actually gave us our pink slips. It is appropriate because of the embedded irony given his heavy involvement in the Fed's inflationary policy that led to the speculative bubble in housing in the first place. In some sense, he is a genius, albeit an evil genius, for his ability to avoid all the blame that he is rightfully due and actually end up with substantial control over the entire "private" US Financial system. He fascinates us. Oh, and f*$% you Hank."

Here's the WSJ's take on the Treasury's plan.

Now that the US Treasury controls the entities responsible for keeping the domestic housing market from collapsing, I am sure that a profit motive will continue to guide the businesses. I'm sure that our government will make nothing but rational economic decisions with regards to who will receive financing and the terms on which they will receive it.

I have, since July 23rd, owned Dec. 08 $6 puts on Freddie given the Treasury was basically telling us that equity holders were going to eventually be wiped out (or massively diluted). Despite my sarcasm above, I actually think this is a creative solution to the problem as the dilution will only occur on an "as needed" basis. It appears that Hammerin' Hank will only add capital as holes appear, so the ultimate dilution/ownership by the Treasury is TBD. However, I strongly suspect that the market is going to crush the shares as people come to the realization that persistent dilution is a near certainty. The problem is, the lower the stock price, the greater the dilution will be as the Trerasury will acquire more shares per dollar injected as the share price declines. Due to this self fulfilling dilutionary death spiral, I think most equity holders will choose not to take the risk of being diluted into oblivion.

Really, my biggest issue with this entire plan is that the government appears ready to protect the preferreds and sub-debt holders.

As I discussed a few weeks ago, a huge portion of the preferreds is in the hands of regional banks and foreign governments/Sovereign Wealth Funds. The Treasury depends on those same foreignors to continue to fund our government's profligate spending and many banks that own these securities are already suffering from capital shortages. So, the Treasury is understandably concerned about wiping those securities out. HOWEVER, that means that you and I, John Q. Taxpayer are going to take the hit. In order to protect these idiots from their own stupid capital allocation decisions, we will yet again subsidize their existence. We already subsidize them through underpriced FDIC insurance, artificially low interest rates (this basically takes money from savers and uses it to line the pockets of banks), and a Federal lending backstop. Well, these preferreds are only a mere $36 billion and the sub-debt is Lord knows how many tens of billions more. I mean, what's $50 to $100 billion amongst friends? It's just money that our citizenry is giving to foreign governments and private companies.

Happy Birthday China! Merry Christmas Regions Financial!

On another note, these preferreds have been popular shorts amongst hedge funds. Sucks to be those shorters! The preferreds, in broad strokes, have been trading at 50% of face. If the Fed is going to take them out at par (I can't imagine they guarantee them, or else they'll trade way past par), then that's an up 100% move which will sting a little tiny bit. If, for some reason, the Fed doesn't actually call them at par but instead guarantees them, they should trade through par until the dividend begins to converge with Treasuries, which would be much more than a 100% move (closer to a 300% move!).

Of course, some hedge funds almost certainly have on long preferred/short equity paired trades. For those with that combo on, this will be an epic homerun of an investment. This should be fascinating.

Strap your boots on.

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