Fannie and Freddie: Tragedy or Farce?

…oh to be a credit/bond trader again, if only for one month…

I’ve been watching the GSE train wreck unfold from afar over these past few months with some fascination, like a Hollywood remake of an old French movie: not the same, bigger, flashier, more. But the story is the same. Only in America the hero is well, a heroic character, while in the original it was more ambiguous, more of an ensemble cast. That’s the French for you. Enigmatic in their certainty.

The year was 1996. July even:

“Ruined by its commitments in real estate and a deficit of internal controls,” he said, the firm was faced with a negative cash flow and had failed to attract an outside investor, and the state had no choice but to step in…

…whose officers are appointed by the state and whose main line of business was government-backed loans, was considered a quasi-state institution and a haven for savings and retirement funds. Its decay and collapse over the past year surprised investors, many of whom thought that the shares were the equivalent of government-backed securities…

Eerily familiar? I remember. Vividly. I was in Paris. We were long their bonds. It was pretty much impossible not to be.

Euromarket veterans will know I am talking about none other than Credit Foncier de France… The IHT reported at the time:

Ending a year of uncertainty, the government said Friday it had failed to find a buyer for the nearly bankrupt property lender Crédit Foncier de France SA and would take the bank over and dismantle it.

Under a plan announced by Finance Minister Jean Arthuis, the state-run bank Caisse des Depots & des Consignations will buy more than two-thirds of Foncier’s shares at 70 francs ($13.99) each and transfer its assets to another state-run entity, which will liquidate them over 10 years.

Mr. Arthuis also said the state would guarantee as much as 270 billion francs of bonds issued by Crédit Foncier, which was France’s second-largest borrower after the state itself.

It certainly looks like the Americans are going to have to follow the French and engineer some sort of restructuring and government take-over of the debts of Fannie and Freddie. Buy the bonds and sell the equity…

Twelve years is a long time. My memory is a bit fuzzy around the edges. But I seem to recall CFF’s 10 year bonds trading down around 15-20 points at the very worst (we didn’t have CDS in those halcyon days…) That’s about 200-250 basis points. No real volume. Everyone (who cared) was long – so long there was no point trying to sell. So a few plucky outsiders with a clean ledger just kept offering lower into a vacuum. I know hindsight is 20/20 but believe me when I tell you that we knew that the government would step in. It was only a matter of when and figuring out how much to give, if anything to the CFF shareholders. And so it was that we (the bank – all CFF risk was brought together in the ALM book) kept our position, even added a bit more I think. Implicit becomes explicit: too big to default. Too big to even take a haircut. The goverment (and various linked agencies) knew it had a hell of a lot of debt to sell over the next few decades; blowing up their entire domestic underwriting and investor base was not an option. Not to mention the damage that would be done to the domestic mortgage market…

But CFF is tiny compared to Fannie and Freddie. 270 billion francs. c. $50 billion dollars. More than an order of magnitude smaller. And with very few international bond-holders. How do you think the various Asian central banks and Middle Eastern sovereign wealth funds who hold hundreds of billions of these securities would like it if they were to default. They are already down a fortune given the partial dollar default devaluation. The United States simply cannot afford to leave Fannie and Freddie to their own devices. I’m waaay too far away from the markets to get a sense of when might be the right time to buy Fannie or Freddie paper, CDS seems to be trading at around 75bp. Could go even wider if the decision on what to do drags on (which it well could), especially as an election is coming up. But at some point I suspect this will be a buy as Uncle Sam will need to follow the banks and take its own SIVs ‘back on balance sheet’.

Yes, history repeats itself…btw was thinking, how about Bruce Willis as Hank Paulson (the hero) in the movie?

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