Monday, 8 September 2008

Secretary Paulson Jumps the Gun – and Fires His Bazooka

Treasury’s takeover of Fannie Mae and Freddie Mac over the weekend meant that Secretary Paulson’s bazooka strategy had failed – but only because he chose to fire without having to do so. Otherwise, following his own words that “government support needs to be either explicit or nonexistent,” he could have extended an explicit government guarantee to Fannie and Freddie and achieve the same results he got with the takeover with much less suspense and fanfare. But the point, of course, was not to save Freddie and Fannie, but to bury them.

The extensive coverage of the event that followed added nothing of substance to the subject. That was par for the course for the media, as the readers of this blog know from the Destruction of Fannie Mae and Freddie Mac. A few tidbits, though, I found interesting.

One was Secretary Paulson’s using a secure video link from a bunker to brief the president. I understand the show-off, the ego trip: look Ma, I am talking to the president from a bunker. But there could not have been anything confidential about the plan that required secure communications. The Treasury’s plan was a rehash of the “prescription” – castration, really – that The Wall Street Journal presented on its July 10 editorial. I quoted it in the Destruction series. So, a few lines on any message board, with a link perhaps to the Journal article, would have sufficed.

As if to confirm this point, the New York Times reported that Mr. Paulson had also briefed Warren Buffet. No explanation was offered for this private briefing of a private investor by the U.S. Treasury secretary – doubly inappropriate because it took place in the context of an issue that involved, as per Secretary Paulson himself, a “conflict between public and private purposes”.

The Sage of Omaha then had this to say:
Secretary Paulson has made exactly the right decision for the country. He is minimizing the problem of moral hazard and maximizing the benefits for the housing market and for the smooth functioning of financial markets.
And you thought drivel – pure, unadulterated, absolute drivel – was the purview of politicians only.

I also learned that Fannie Mae CEO, Daniel Mudd had pleaded with Paulson to spare his institution. He pointed to his success in raising capital and emphasized that Fannie was in much better shape than Freddie Mac. He must have been certain that Fannie Mae could survive on its own, else he would not have dared to press the point in an atmosphere of the crisis. But his reasoning went nowhere. Paulson told him that “Freddie was nearing a crisis and that, in the eyes of the markets, the companies were joined at the hip”.

And why was Freddie Mac nearing a crisis?

It needed capital. When the CEO, Richard Syron went to New York to seek investors, The New York Times reported, “potential investors told Mr. Syron there was too much uncertainty around the Treasury’s intentions; if investors acted now, and Freddie was later seized by regulators, they would lose everything they had invested.”

So the reason Freddie Mac could not get capital was the uncertainty about the actions of Treasury. And that – Freddie’s inability to raise capital because investors were unsure about the Treasury's actions – was the reason that Fannie Mae also had to go.

None of this is will surprise the readers of this blog who read the Destruction series. Unbeknown to the CEOs, the fate of Fannie Mae and Freddie Mac was sealed long before the first weekend in September 08. That is why the Treasury’s rescue plan now “bans [Fannie/Freddie] from lobbying the government, putting an end to their ability to use their political machine on Capitol Hill.”

This is the equivalent of creating a “no fly zone”, proof that opponents are in the driver's seat and the sign that they are planning to have their way with you.

A matter of a small indignity remained. The New York Times said:
The seizure of Fannie and Freddie is all the more surprising because, as recently as late March, Washington viewed the companies as saviors of the housing market and the economy, rather than as risks to them. Instead of requiring Fannie and Freddie to scale back, regulators gave then a green light to buy and guarantee more and bigger mortgages.

On March 19, James B. Lockhart, their chief regulator, dismissed swirling rumors about their financial health. “The actions we’re taking today,” Mr. Lockhart declared, referring to a decision to ease restrictions on how much capital they were required to hold, “make the idea of a bailout nonsense in my mind. The companies are safe and sound, and they will continue to be safe and sound.
This remembrance of the events past is hard on Paulson and Lockhart. It makes them look like fools who misread the situation even after the collapse of Bear Stearns.

Such characterization would be fine with both men, certainly with Lockhart. That is because the real story is even more damning.

The plan, you recall from the Destruction series, was to take out the agencies. The job had to be done in a “clean” and controlled manner; it would be foolish to do otherwise. But in the midst of the plot, the unpredictable intervened: the credit market froze. After the collapse of Bear Stearns in March, panic set in. In desperation, the attention turned to two healthy institutions that, up to that point, had been incessantly maligned. Suddenly, the tune changed, hence Lockhart's passionate declaration that “the companies are safe and sound, and they will continue to be safe and sound”. The second half of the statement is a wishful thinking, almost like a promise you know you could not keep. Anyway, by then it was too late.

I will have more to say on this subject in Vol. 5 of Speculative Capital.