Pearlstein: Government Takes Control of Fannie Mae and Freddie Mac

Steven Pearlstein
Washington Post Columnist
Monday, September 8, 2008; 11:00 AM

Washington Post columnist Steven Pearlstein was online Monday, Sept. 8 at 11 a.m. ET to discuss the federal bailout plan for mortgage finance giants Fannie Mae and Freddie Mac.

On Sunday morning, the Treasury Department and Federal Housing Finance Agency announced that the FHFA will become a conservator of the two publicly traded firms.

Read today's column: In Crisis, Paulson's Stunning Use of Federal Power

And click here for complete coverage of the government's take over of Fannie Mae and Feddie Mac.

A transcript follows.

About Pearlstein: Steven Pearlstein writes about business and the economy for The Washington Post. His journalism career includes editing roles at The Post and Inc. magazine. He was founding publisher and editor of The Boston Observer, a monthly journal of liberal opinion. He got his start in journalism reporting for two New Hampshire newspapers -- the Concord Monitor and the Foster's Daily Democrat. Pearlstein has also worked as a television news reporter and a congressional staffer.

Pearlstein was honored with the Pulitzer Prize for commentary for his columns about mounting problems in the financial markets. His award was one of six Pulitzer Prizes won by The Washington Post this year.

Read Pearlstein's latest columns.


Riverton, Utah: Please explain the difference between the Feds role with Bear Stearns, Fannie Mae, and Freddy Mac and fascist corporatism?

And the benefit to each and every American whose hard earned cash funds these bailouts?

How will this effect the lives of our children and grandchildren?

Steven Pearlstein: Ah, someone with a practical bent writing in from a practical western state!

Look, there are differences between Bear Stearns and Fred and Fan rescues, but I suspect that's not what you are looking at. And there are differences between all of these rescues and state socialism that are pretty obvious on their face, putting aside the fascist swipe.

The benefit to each and every American is that (1) they probably will get back any cash they put in, and then some, when all this is over, because the Treasury has been pretty tough in setting considitions for government intervention and (2) each and every American will get the benefit of having a financial system that doesn't collapse and the continued availability of mortgages at a time when banks and investors don't want to hold them (and can't be forced to hold them except in fascist states!).

Your problem is that you are forgetting to consider what would happen if nothing were done. You think you'll be fine because you have your mortgage. But if you or your children needed to move and wanted a mortgage, that would be an issue. And it would be an issue if your pension money was invested in stuff that suddenly cratered because the financial system froze up as a result of a Fannie and Freddie bankruptcy. And the company you work for might suddenly have its lines of credit pulled and have to close down some operations, which wouldn't be exactly the best thing for your household, or the Greater Riverton economy.

So please, let's get beyond the simplistic slogans and bring some western practicality to this conversation and we'll all be better off.


Washington, D.C.: I own the old preferred stock which I bought in 2006 that will no longer be paying a dividend. I bought it because it was paying a decent dividend. How will the market now value that stock as the new preferred stock will pay a dividend?

Steven Pearlstein: I haven't checked the markets yet but my guess is that the value of these shares will be significantly diminished, since most of the people who invested cared most about the dividend. Until the company is making enough money that is can pay a dividend, the shares won't be worth much. When and if that situation changes, they could be worth more than they are now. So it is going to be a game of waiting or taking a big loss and moving on.

_______________________ Market information can be found here: Fannie Mae| Freddie Mac


Richardson, Texas: Hi Steve. Why should the government (... which means us, but we're not asked to approve... just ordered to pay the bill) bail out failures which are the result of unbridled greed? It seems to me that capitalism has somewhat deviated from its original philosophy, in that in cases like this one, it's a "no risk" game for the "big" stockholders. Let them face the pragmatic reality: you fail, you lose! It will bruise their greed-driven egos but, hey, that's life. If this means that some other corporate financial entities will fail as a result, well let the dominos fall and good riddance. Others, with perhaps better intentions and social integrity, will take their place.

Steven Pearlstein: First, let's stop this unbridled greed business. All business is based on greed (I have yet to be able to distinguish when greed is bridled and when it is unbridled, so maybe you can help me on that one). Those who most benefited from the risk-taking of the past, the shareholders, are pretty much wiped out for the moment, so they have received what you would consider their just dessert. The people who were bailed out are institutions and individuals that bond Fan and Fred bonds -- they, in effect, agreed to lend money. And they will get their money back with interest. They did on the assumption that the government stood behind these entities, which were unique and special and did have a government charter and a public purpose (so that's not traditional capitalism, as you defined it). And now that assumption is being made good: the government is standing behind these debts.

You don't know, I don't know, Hank Paulson doesn't know whether, in fact, these businesses have failed, in the sense that they are insolvent. It is not knowable. They have plenty of cash. They even still have access to borrow more money. But there was a growing risk that their operations could not continue and that was such a big risk to the global financial system and the US economy that the government decided to step in now and foreclose that possibility. If you don't like that solution, then tell me what yours would be, because one thing I can tell you is nobody, including you, would like how if felt if the financial markets began to suspect that Fannie and Freddie would not be able to honor all their outstanding debt. It would be a financial and economic calamity.

You can be judgmental all you want about that. But this isn't, as I've written before, a morality play. Its very serious, real life situation where the well-being of people all around the world are at stake. And it requires the practical, sound judgment of policy makers like Hank Paulson and Ben Bernanke and their crews, which are doing, frankly, a damn good job at managing a very bad crisis. Did they and other policy makers contribute to that crisis. Yes. But that's water over the dam, as they say. What matters now is what's best for the public going forward.


Toronto, Canada: What will happen to the shares that I have of these two companies. Have I lost all my money?

Steven Pearlstein: For the moment, those share have been badly diluted, so the percentage share of the company you own is now a lot less, even though the company may not be worth more. At this point, the best thing is probably to be very patient and hope the shares rise in value after the housing markets settles down and the company comes out of conservatorship and Congress rewrites its charter. There probably isn't much to be gained by selling now. You won't get much.


Arden Hills, Minn.: I hear Sen. McCain discuss the bailout of Fannie-Freddie as necessary "to keep Americans in their homes." I can see how it keeps the mortgage system running (though continuing to distort asset values) by providing a free flow of mortgage money. However, in what way does it keep current home owners "in their homes"? How does this help someone over their head on their mortgage?

Go Trin!

Steven Pearlstein: It doesn't do much to keep most mortgage holders in their home, you are right. But it does keep the mortgage market open for new loans and refinancings, and will almost certainly result in a reduction in rates from current levels.


Tuckahoe, N.Y.: By not protecting Preferred shareholders could the Treasury actually be trying to pressure some banks into mergers?

Steven Pearlstein: Yes. There are several dozen banks that will be dramatically affected, and the regulators and Congress will have to deal with that fallout. But to have fully protected the preferred shareholders would have caused even more problems with those people unhappy about the fact that the government was bailing out. A preferred share is a bit of a hybrid -- a share of stock (equity, risk capital, ownership) that operates a lot like a bond. So there was a question of where to draw the line in terms of the government protection. Paulson decided to give the preferred shareholders a slightly better deal than the common shareholders by not diluting their interest as much. But that will only have value to them if they hang on and the company recovers enough to begin paying dividends again.


Morrisville, N.C.: I probably have the same question as everyone else does. It looks like the U.S. has decided it prefers the Chinese model to the traditional American one: state owned companies with publicly traded stocks. Is private enterprise one of the casualities of globalization?

Steven Pearlstein: No, that is a gross overstatement. 99.99 percent of the US economy remains the same as it has been.


Moscow: Whatever happened to the free market? We now have the United States Socialist Republic (1)making up to $200 billion in investments in mismanaged institutions that are too humongous to fail and (2)intervening directly in (or propping up) the GSEs' mortgage backed securities market. Will Mudd and Syron get nice parachutes as well? And, surely, other senior managers were also responsible for the mess since these CEOs weren't apparently exactly hands-on. What happens to them? A free ride with a raise? What about the lawsuits that have been filed against Fan and Fred? Looks like an admission by the U.S. Gov't that something was rotten.

Steven Pearlstein: Ah, yes, those terrible, greedy CEOs. Look, they made mistakes. They won't get the full amount they are due under their employment contract because they are smarter than that -- and anyway, most of the goodies in that package have to do with stock and stock options which are pretty much worthless. But let's not blame this situation on the executives making off with all the loot. It's really a very small amount relative to the size of these companies and the size of the hoel they are in. Let's focus on what really matters, shall we?


San Francisco, Calif.: I'm heated with Paulson's move to suspend Preferred shares Dividend, so much for investing in GSE pfds and supporting Uncle Sam. All they do is turn around and rob you of your money. With Regular Pfd shares, they are issued with a par value, then after "x" of years, the par value will then be given back to their shareholders. Will the FNM's pfd shares be treated the same, where the original par value given back to their investor?

Steven Pearlstein: I'm not an expert in these things, but in the event the company is sold or liquidated, yes the preferred shareholders would get all their money back once all the debtors are paid and after the government is paid back for anything it invests. That's probably as far as I ought to go.


Kansas City, Mo.: How long do you think it will be before interest rates increase due to increased borrowing by the US to cover Fannie and Freddie's fannies? And is there quiet concern that our relatively low interest rates could be the next bubble to burst?

Steven Pearlstein: Right now, investors from around the world are still pretty comfortable with US Treasuries. The rates rose a bit this morning, to reflect the very concerns you espouse. But they are still quite low by historical standards, particularly considering the inflation rate. The real, inflation adjusted rate on a 10 year treasury right now is probably less than 1 percent.


Wheaton, Md.: Any chance that the two CEO's of Freddie Mac and Fannie May wil be returning any of their commbined 30 million dollar paychecks to help out in the current crisis?

Steven Pearlstein: That 30 million you cite was the value of their compensation package at the time, including stock and stock options that now have a very much lower value. That said, they received milliosn of dollars in cash salary and bonus, refleting what chief executives of large companies get these days. That cash won't and can't be clawed back, nor should it, really. They worked hard, did the best they could and made some mistakes in a very bad situation. If you run the country's two dominant housing finance companies, and the housing market craters, it really doesnt matter how smart you are -- your companies were going to lose lots of money.


Salt Lake City, Utah: The GSE's were not failing nor was their failure imminent, exactly because of the explicit unlimited guarantee of the US Government which was issued in July. So why this move now? If this causes the yields on their debt to fall, the immediate beneficiaries of this will be the investors who own those securities. Pimco is one of these investors who have very recently been loudly arguing for this action by the treasury. Alan Greenspan who is a paid "consultant" of Pimco, has also been arguing for this.

In the case of the Bear Stearns "rescue", it was the investors who held the debt of Bear Stearns who made out, along with the short sellers of the stock, who trashed them through rumors and innuendo. This looks to be the same with the GSEs at this point. Will there be a JP Morgan type beneficiary of this as well?

Steven Pearlstein: The JP Morgan beneficiary will be the US taxpayer.


Franconia, Va.: Wow Steven,

You are really kissing some major Federal regulator butt on today's live chat. Unfortunately for you, by now the taxpayers know they are complicit and just a bunch of Wall Street cronies so your credibility is dropping with every response you post.


Steven Pearlstein: How about I don't question your motives and you don't question mine.


Miami, Fla.: Does the 79.9 percent dilution up-front represent the final dilution of the common stock?

Steven Pearlstein: Actually, the dilution, technically, has not happened. But the government has warrants to buy 80 percent of the common stock at less than $1 a share, and the Treasury has indicated it would exercise those warrants if it were in the best interest of taxpayers, which it will be when and if the companies stabilize and come out of conservatorship.


Annandale, Va.: How is the takeover expected to affect housing prices?

Steven Pearlstein: Hard to say. If it lowers prevailing interest rates from where they otherwise would have been, some of that benefits will get shifted over to the current properry owners (the sellers) in the form of higher prices for the homes. So, if anything, it will help slow the decline in house prices.


Annandale, Va.: Why not just form Fannie2 and Freddie2 and let the originals go their own way?

Steven Pearlstein: That's the old good bank-bad bank rescue model. But it assumes that there is concesnsus that the Fan and Fred model is worth replicating in the future. One thing we know is that there is no such consensus right now.


Tampa, Fla.: Please clarify what is going to happen to the preferred stock holders. I understand that dividends have been suspended, but since the companies are not in receivership it would seem that they would have to restart dividends once they are considered financially sound and out of conservator-ship, or call the stock at par on the call dates. I am also assuming that the stock warrants the Treasury is receiving are for common shares and any dilution should only effect the common share holders. Is there a call date for the preferred stock the Treasury is being issued? If so would it not make sense for the GFEs to retire that debt as soon as possible because of the high dividend rate?

Steven Pearlstein: You have it right about the dividends. What I don't know is what happens on the call dates if there is no money available to pay back principal. There is probably some default procedure in the wording of the offering but I'm not familiar with it and I"m not a securities lawyer, so I better stop there.


Arlington, Va.: Hi Steven,

My question regards the current employees of Freddie Mac. Do you know if they will be negatively affected? Will the takeover result in layoffs? If so, do you have any idea of how many?


Steven Pearlstein: I suspect there will be little effect on most employees, other than that their stock and stock options are not likely to be worth much.


St. Pete, Fla.: Why does this latest bailout make me think of the rich guy who is on his second lung, liver and heart transplant, but still insists on a pint of single-malt, two packs of cigarettes and toast points with fois gras at every meal?

Where's the conservative uproar about "nationalizing" a publicly traded business or three? Isn't that what "Communists" and "socialists" do?

Also, does it seem to anyone else so nicely piquant that the sidebar ad on the Post's main story page was for the latest personal bizjet.

Steven Pearlstein: Yes, its socialist. But when I last checked, that was not venal sin.


Washington, D.C.: As an employee of Fannie Mae, I have seen first hand Dan Mudd's smart, conscientious leadership and management of the company. For example, the company has incurred credit losses NOW, as a loan loss reserves, rather than when the losses actually occur. Additionally, the company has opened several offices around the country to facilitate foreclosure prevention. Furthermore, several senior management positions were overhauled by Mudd, as another measure for positioning the company to successfully weather the credit crunch. And finally, Fannie Mae WAS able to raise capital despite the rickety market, signifying the confidence in the company's management.

I am absolutely appalled that the media and market analysts have ignored these facts and have created the perception that Fannie Mae is on it's last legs. The company is not, I repeat, NOT on it's last legs and is 100 percent solvent.

My question to you. What do you think is the primary cause for this premature, unnecessary "takeover" by the government? The media? Uneducated market analyst reports? Or simply Freddie Mac's inability to raise additional capital?

Steven Pearlstein: The market has been losing faith in Fan and Fred for some time, as reflected in the bond spreads and the stock price and the inability of Fred to raise new equity capital. It is a judgment call as to whether the companies could have muddled through or not, but Paulson & Co. looked at their books, looked at the prospect of tens of billions of additional losses (on a GAAP accounting basis) and concluded that they would very soon get to the point where they would have to classify the companies as "undercapitlized." And since they really can't raise new capital, that would have driven spreads even higher and the stock price even lower. So they figured it was best to act now, before everyone was put through that process, which would have been very destabilizing for the wider financial markets.

I know you feel this was unnecessary. Let me say that I am not one of those journalists who thought badly of the companies or thought they had a terrible business model or that they should be privatized and sold off in pieces. And even I concluded several weeks ago that the jig was up. So for what its worth, I think you have to accept the possibility that this was what was best for the country, even if it might not have been the best for Fan and Fred employees and shareholders.


San Diego, Calif.: Can the FNM and FRE world wide preferred and common share holders trigger a major class action law suit for the sudden, ruthless take over without consulting the major share holders with voting right prior to today 9/7/2008? Is this a major case of human, SEC and corporation rights violation? How does this play out under our constitutions and SEC and corporation laws? What happens if it fails because of simply lack of confidence? Can they guarantee to succeed?

Steven Pearlstein: I'm sure the lawyers have gamed all this out pretty carefully, and I suspect a judge will be very reluctant to step in the way here.


Grossed out and completely disgusted: Journalists should flood the zone and investigate how Bill Gross and PIMCO loaded up on GSE debt, making the political bet that it would become the equivalent of Treasury bonds.

Alan Greenspan's role in helping PIMCO make this killing deserves a proctologist level of scrutiny. He's debased the status of a Federal Reserve chairman even more than he debased our currency.

I understand the need for the Fannie and Freddie bailout, but PIMCO shouldn't be allowed to use its sheer size and rhetoric to make a killing.

Steven Pearlstein: Excuse me, but predicting that Fannie and Freddie would get an explicit government backing for its bond wasn't exactly an out-of-the-box thought. You could have done the same thing, and maybe others did just that. Some even thought the preferred shareholders would be protected, but that turned out to have been a bad bet.

Let's stop looking for boogeymen here.


McLean, Va.: Is there any reason to believe that these actions will work any better than previous attempts by Paulson and Co.? Aren't they just prolonging the crisis by not allowing the free market to run its course? The market told us that housing was way too expensive and lending standards were way too lax. If the gov't would just stay out of this, housing prices could drop to their appropriate level and people could afford the required down payment.

Steven Pearlstein: Yes. The full faith and credit of the US government is now behind these companies. I have every reason to believe that will do the trick, as far as Fan and Fred are concerned.


Washington, D.C.: Roughly how many Americans are directly backed by Fannie and Freddie? Or, what percentage? 100 percent of home owners, etc?

Steven Pearlstein: I think they insure about half the mortgages outstanding in the US.


Anywhere, Virginia: Steven,

Great columns, very informative!

Would it be fair to say that the Fannie/Freddie takeover, while it may marginally reduce mortgage interest rates, doesn't actually have any impact on the fundamentals of the housing market and ecomony, namely that prices have to fall much further and banks have to start lending to each other again before we can say "bottom hit, crisis over"?

Steven Pearlstein: Yes, to the extent that housing prices got out of whack with demand and with the incomes of the people who live in them, there is nothing that today's actions will do to prevent that correction. When I say it will lower rates and therefore help boost prices, that is relative to where things are today. But in the long run, things have to get to a new sustainable equilibirum that comports with the fundamentals.


To San Diego: Purchasing shares of stock is an action with inherent risk. There is no contractual right to repay you. You accept the risk/reward analysis. For a GSE, part of that analysis should have been the risk of nationalization during times of financial turmoil.

Steven Pearlstein: Thanks.


Vatican City:"Yes, its socialist. But when I last checked, that was not venal sin."

Don't you mean "mortal"? Venal sins are the little ones -- littering, using bad language during the NCAA final four. Mortal ones are the big ones -- murder, heresy, standing to the left on the Metro.....

Steven Pearlstein: Sorry, I meant mortal.


Baltimore Md.: Well, you do seem to side with the big bucks guys, so let's just say you know who is reading your column.

To suggest that anyone should still receive compensation in the 8 digits or more when any company is having enough problems to be taken over is ludicrous. They should lose everything.

We should change the way this country works. Greed should be a pay off for success, not failure.

Steven Pearlstein: What do you mean lose everything? They lost their job. Under contract, they are entitled to certain severance pay which they will probably have to agree to reduce, for appearances sake. What more to you want? Capital punishment? Ten years in jail? Let's not criminalize bad business decisions.


Philadelphia, Pa.: Does this situation stem from another case of "capitalism without morals"? Do you believe that an economy based on "capitalism without morals" will eventually collapse upon itself?

Steven Pearlstein: Don't think there are big moral issues here. These companies operated, as far as I know, in a pretty ethical fashion and cared a lot about the communities in which they operated.


D.C.: People need someone or something to blame when bad things happen. It's a strong part of human nature. So...who or what is to blame? It's clear you think you think your readers are blaming the wrong people, but who are the right people to hold responsible?

Steven Pearlstein: There'a s a lot of blame to go around, as I tried to suggest this morning. Regulators, politicians, everyone in the mortgage industry to some extent. There aren't too many heroes in this story.


Dallas, Texas: You said earlier in this chat, "If you don't like that solution, then tell me what yours would be".

It seems to me that if the Treasury had just stated flat out that Fannie and Freddie would have access to as much capital as necessary from the Fed discount window, for as long as necessary to ride out the crisis, a takeover wouldn't have been necessary?

Your thoughts?

Steven Pearlstein: I'm not sure the Fed would have gone along with that, but they might have done the same with the Treasury. And, in effect, that is what they did, only they did it in a way that at least preserves the fig leaf of doing it through a well-capitalized intermediary that could emerge from conservatorship and be on its own.


McIntosh, Fla.: In a Q & A a few weeks back I asked you about the greed factor and you more or less demurred, saying you didn't like to look at things in those terms. But when I see that the two executives walking away with some $30m and taxpayers being liable for who knows what amount, I want to ask again.

You said today:

"By 2005, however, Fannie and Freddie found they were losing market share to private competitors offering new, highly profitable mortgage products that they had generally ignored... To varying degrees, Fannie and Freddie decided to jump into these markets... That decision, too, has now come back to haunt them.

It is fair to blame Fannie and Freddie executives for these misjudgments, although they were no more misguided than others in the industry. "

So, in the long view with taxpayers now liable, was excess greed a factor?

Steven Pearlstein: They made misjudgements. Not sure why you conclude that it was because of excess greed -- as I said before, I'm not sure I understand when greed gives way to excess greed. And I'm not sure $30 million is the right figure to use. But even if it is, what is the big deal? So somebody got something they didn't deserve. Happens all the time in life, in case you hadn't noticed. That $30 million in a drop in the bucket here. Do you care more about the fairness of those two transactions, or do you canre more about the fact that a risk to a financial meltdown has been averted. Let's get our priorities straight!


Great Falls, Va.: I suspect most of your comments today will be highly critical of the bailout, simply because it's a bailout. Philosophically, sure, who's to argue? But it certainly looks like something along these lines was necessary.

I guess the question is: what's next? I don't see the turmoil ending until massive amounts of debt get destroyed. That's happening slowly, but there are probably months and months left to play out. How much more can the government possibly do, and how much more will they want to do?

Steven Pearlstein: There's somebody with his or her eye on the ball. That is the big question, and it will be the subject of my column on Wednesday, I suspect.

Thanks all. That's all the time we have. We can pick up again on Wednesday.


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