Fannie Mae-No Politics (FNMA)

[NeoSunTzu]

... Treasury choosing to write off the seniors rather than exchange them for commons a la AIG is just them writing an enormous check to shareholders for no reason at all. Mnuchin said that it would both be illegal and would result in a lot of political fallout, according to Calabria’s book.

While a writedown of the LP would be seen as “fair” by shareholders (though certainly not by people like Senator Warner), I don’t see any reason to expect it to ever happen given all the evidence we have.

-- Midas 79 post on Tim Howard's blog

Tim's reply:
... As I’ve said on other occasions, I think a decision by Treasury on what to do with the senior preferred–convert it to commons, cancel it, or leave it on Fannie and Freddie’s balance sheets–will depend of what its objectives are. If it wants to enable the companies to recapitalize via new equity issues, it has to eliminate both the senior preferred and its liquidation preference; otherwise new issues of equity will be unsalable. And Treasury’s choice between converting the seniors to common and canceling them also will depend on its objectives. If its goal is to maximize the value of its ownership in the companies, I contend that it is much more likely to do that by canceling the seniors–which if converted to common only would allow it to increase its ownership in Fannie and Freddie from the 79.9 percent it currently has because of the warrants to a percentage somewhere in the high 90s (depending on the price at which the seniors are converted). Today, Fannie and Freddie’s $25 billion of annual earnings are accorded a minuscule P/E ratio (and an extremely low stock price) precisely because investors are so uncertain about how Treasury will treat their private shareholders going forward. If it converts the seniors to common (boosting its ownership in the companies by less than 20 percent), I believe it is highly likely that Fannie’s and Freddie’s P/Es will remain severely depressed, keeping the prices of their equity (and Treasury’s potential gains from its near-total ownership of them) very low. In contrast, canceling the seniors very probably would lead to a significant repricing of the companies’ $25 billion annual earnings stream, in the form of a greatly increased P/E. Yes, that would benefit existing shareholders, but it would benefit Treasury even more, and thus would not be a giveaway “for no reason at all.”