Saving Fannie and Freddie
Can’t take credit for this. This comes from someone much smarter than I am. Bill Ackman, a Fannie and Freddie short, who runs Pershing Square Capital put out a really interesting presentation to demonstrate a method that could save Freddie and Fannie through some create recapitalizing. You can see it for yourself by clicking the following link – Saving Fannie and Freddie.
The presentation only deals with Fannie but Ackman believes it could work for Freddie as well. Basically, the plan calls for extinguishing current equity, recapitalizing the firm by exchanging subordinated debt for warrants, and, most importantly, taking the current $750 billion in unsecured debt and exchanging it for $675 billion in new senior debt or $75 billion in new common stock where these particular shares are backed by a commitment by the U.S. government to repurchase at the original price if financial conditions continue further. Basically, it would free up $131 billion currently tied in debt and allow Fannie to absorb continued mortgage fallout.
To me, this is a nearly perfect solution which will not put too many of our hard earned tax dollars at risk and doesn’t put unecessary pressure on Treasury securities. What about the current shareholders? Well, ultimately, equity ownership implies the risk of the firm failing. Without a significant deleveraging, Fannie and Freddie will fail and current equity owners will lose their stakes anyway. Going down the line, sub debt holders will likely see little or no return should these firms fail, so they ought to be at least somewhat willing to consider exchanging their loans for equity. And, finally, in order to lighten some of the senior debt load, the senior lenders receive a US Treasury guarantee on the principal they allow to be converted to equity and a properly capitalized Fannie/Freddie will offer a better chance of paying interest on the remaining senior debt.
The plan is appropriate, fair, and ought to be considered seriously especially in relation to Secretary Paulson’s current plan to simply bail out current equity holders by allowing the Treasury to buy equity in Fannie and Freddie.
If you enjoyed this post, please consider to leave a comment or subscribe to the feed and get future articles delivered to your feed reader.
