Global No-Confidence Vote: Fannie And Freddie Fallout

Things are looking increasingly dim for Fannie Mae and Freddie Mac. Analysts foresee both companies being unable to raise the capital they need to continue sometime in the next 45 days.

Fannie Mae and Freddie Mac tumbled to about 18-year lows in New York trading on concern the government will be forced to bail out the mortgage-finance companies, wiping out common stockholders.

Fannie slid as much as 18 percent, and Freddie fell 19 percent after Barron's said the Bush administration anticipates the government-chartered companies will fail to raise the equity capital they need, prompting the U.S. Treasury to step in. Fannie is down 84 percent this year. Freddie has fallen 86 percent.

``It is very, very likely to happen before the end of the third quarter,'' Ajay Rajadhyaksha, the head of fixed income strategy for Barclays Capital Inc., said in an interview. ``Without government help, we think there is very little chance of Freddie completing a significant capital raising.''

A rescue of the companies, which own or guarantee 42 percent of the $12 trillion in U.S. home loans outstanding, would include preferred stock with a seniority, dividend preference and convertibility that would wipe out common stockholders, Barron's reported, citing an unidentified source in the Bush administration.

Treasury Secretary Henry Paulson, who on July 31 received the unprecedented authority he requested from Congress to help the companies, has said a bailout won't be needed.

``We aren't going to comment on speculation,'' said a Treasury spokeswoman, Jennifer Zuccarelli. ``As the Secretary has said, we have no plans to use these authorities.''

Fannie Mae was down $1.40, or 18 percent, to $6.51, at 12:02 p.m. in New York Stock Exchange composite trading. Freddie fell $1.07, or 18 percent, to $4.78.

The bailout of Fannie and Freddie is coming. It's just a matter of time now. The Fed will have no choice, or $5 trillion in mortgages collapse overnight, wiping out the real estate market, the US economy and the global economy.

Both companies will need to raise as much as $15 billion, Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Virginia, said earlier this month.

Fannie paid a record high yield in a $3.5 billion sale of three-year benchmark notes last week that drew less demand from Asia, the second-biggest buyer of Fannie's debt and mortgage- backed securities. Asian investors bought 22 percent of the issue, almost half the demand of three months ago and about two- thirds of Asia's usual buying.

Treasury data show that private and government investors in Japan slowed purchases of their debt to $770 million in June, from $4.5 billion a month earlier. China bought $9.6 billion in Fannie Mae and Freddie Mac debt, down from $14.9 billion in May.

There's no choice. With the rest of the world seeing increased effects from global recession, the market for Fannie and Freddie's debt is drying up. They can't afford it anymore...because there's no chance they will be paid back.

Standard & Poor's cut Fannie and Freddie's preferred stock and subordinated debt ratings by three levels last week to A- from AA-. S&P affirmed the companies' AAA senior debt rating, reflecting perceived government support.

A rule that made it harder for investors to bet against Fannie and Freddie's shares also expired last week. The Securities and Exchange Commission on July 21 imposed a temporary order that tightened rules for 19 stocks, including Fannie and Freddie, prohibiting firms from so-called naked short selling, where they sell shares without actually borrowing them.

The cost to protect the subordinated debt of Fannie Mae and Freddie Mac from default climbed to a record. Credit-default swaps on Fannie's subordinated debt increased 18 basis points to 296 basis points, while contracts on Freddie Mac jumped 23 basis points to 300, according to CMA Datavision.

Wall Street is convinced the bailout is happening and happening soon. When it does happen, taxpayers will be out billions...and the Fed is running out of money on its balance sheet to shore up the faltering US economy. The Fed will have to make some tough choices soon about who gets saved and who goes under. Not everyone is Too Big To Fail.

Ben S. Bernanke is still trying to define which financial institutions it's safe to let fail. The longer it takes him to decide, the tougher the decision becomes.

In the year since credit markets seized up, the 54-year- old Federal Reserve chairman has repeatedly expanded the central bank's protective role, turning its balance sheet into a parking lot for Wall Street's hard-to-finance bonds and offering loans through its discount window to investment banks and mortgage firms Fannie Mae and Freddie Mac.

The lack of clearly defined limits may put the Fed's independence at risk as Congress discovers that its $900 billion portfolio can be used for emergency bailouts that might otherwise require politically sensitive appropriations and taxes.

``There is some hard thinking that needs to be done,'' Philadelphia Federal Reserve Bank President Charles Plosser said in an interview last week. ``The Fed has a terrific reputation as a credible institution. We have to be cautious not to undertake things that put that credibility at risk.''

The expanding role of central banks will be the hottest topic in the room when Bernanke addresses his counterparts from around the world at the Kansas City Fed's Jackson Hole, Wyoming, symposium Aug. 22.

Since taking on $29 billion in Bear Stearns Cos. assets to facilitate the failing firm's takeover by JPMorgan Chase & Co., Bernanke has made several moves that imply further expansion of the central bank's mission.

The Fed has already spent more than half of its balance sheet on bailouts so far. Fannie and Freddie would certainly require billions more, and that means other institutions like smaller banks, hedge funds, and insurance companies may be next on the list to bail out...and the Fed may not have the cash. Of course, the financial houses aren't done yet. Goldman Sachs is always a prime target of speculation, but a strong bearish outlook is shared by many involving the very survival of Wachovia and Merrill Lynch.

The year-old financial crisis is not only far from over but could actually get much worse, bringing more big shocks to the US economy and stock market, a host of experts said Monday.

Among the predictions: the failure of some of the country's biggest financial institutions, the collapse of 1,000 banks and a possible government bailout of mortgage giants Fannie Mae and Freddie Mac .

"I think the financial problem is halfway through the cycle," David Kotok, chairman and chief investment officer from Cumberland Advisors, told CNBC. "There's another shoe to drop ahead of us and it could be more severe."

Kotok thinks Merrill Lynch , Wachovia and other financial companies are at risk of failure as the cost of raising capital soars at a time when the banks need to pay settlements over auction rate securities.

The cash companies need to shore up bad investments, "is up to about $50 billion and will probably top $100 billion before it's over," he added.

"Those firms—Merrill, Wachovia and others—are going to have to raise that cash," he said. "They are either going to have to get it from the Federal Reserve, through some direct or indirect means, which means more leverage, more Fed balance sheet, more regularly oversight or they're going to have to get it in the capital markets."

Everybody needs Federal handouts these days, and the Fed is tapped out. Somebody's going to have to pay for these hundreds of billions in bailouts. If you want a hint who, look in the mirror.

And be prepared.