Lombard Street Research consultant Leigh Skene in the Financial Times:
Fannie (FNM) and Freddie (FRE) have severe solvency problems. Their combined balance sheets were 65 times levered at the end of 2007. They have raised $20bn in new capital in recent months, yet their fair value tangible net worth is negative according to recent estimates.
The history of government recapitalisations is replete with stories of too little, too late, leading to much bigger recapitalisations later. The recent, oft-repeated assertions that Fannie and Freddie were adequately capitalised (when they obviously were not) indicate the Treasury capital injections will be neither timely nor adequate.
This bail-out should lower the spreads on Fannie and Freddie credit default swaps back to the normal triple A range. Their debt spreads to Treasuries should also fall to more normal levels. However, the bail-out has solved no problems. All it has done is transfer risk from Fannie’s and Freddie’s debt holders and counterparties to US taxpayers who will fund the money they lose until the housing market recovers, which may be a long time.
A World Bank study in 2002 entitled Managing the Real & Fiscal Costs of Banking Crises studied 30 years of systemic banking crises across 94 countries. It shows bail-outs cost a lot of money but they neither solve problems nor alleviate the slowdowns the crises cause. The bail-out of Fannie and Freddie is no exception. This credit liquidation will continue for a lot longer than most people think regardless of what the authorities do.
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