Tuesday, August 19, 2008

Fannie Mae and Freddie Mac Article Moves The Market

Monday's move in the stock markets were at some level spurred on by an article in Barron's over the weekend regarding Fannie Mae (FNM) and Freddie Mac (FRE).

The article cited an anonymous Bush administration source that said the government is trying to have each respective company raise more capital to safeguard against losses, but the administration thinks they will fail. The article continued by saying that the government was likely to buy preferred stock in both companies which would wipe out common shareholders.

This single article spooked investors in both mortgage giants and sent the stocks down more than 22% each. The movement in these two stocks spilled over to the rest of the financials which pushed the Dow and S&P lower with the NASDAQ following suit.

Most analysts disagree with the article though and believe that if the companies were in dire need of capital, The Fed or U.S. Treasury would give them emergency loans instead of buying preferred stock. If necessary, the purchase of preferred stock in either or both companies is seen as the ultimate final step to nationalize them. Few analysts believe the situation would ever come to that since the Fed and Treasury have the ability to lend money to the companies, so the need to purchase stock would be unnecessary.

A Fannie Mae spokesman said the company "continues to exceed our regulatory capital requirements ... We continue to provide stability and liquidity to the housing market and we will continue to play a key role as the market recovers from this cycle."

Then a Freddie Mac spokeswoman commented directly on the Barron's article by stating that the article "significantly overstates Freddie Mac's financial situation" and the company is "financially sound."

Finally, since July, the U.S. Treasury has the ability to lend to the companies and the Fed decided to open the "discount window" to Fannie and Freddie if they needed to strengthen their balance sheet. The Fed also made a previous move in March to open the discount window to investment banks. These moves by the Treasury and Fed just prove the point that this government/administration and Fed are working to stabilize the monetary system and minimize any major impact. While they are not trying to step in to control the situation, they are on the scene to "backstop" the companies.

As with most previous events, these events will be used to analyze what was done right and wrong for future decisions. The Fed and Treasury will look back to analyze if they could have handled anything differently. This has been the procedure of both institutions in the past, and it will be almost assuredly done now.

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