a public-private hybrid doesn’t work

TO BE NOTED: From Bloomberg:

"Fannie, Freddie Face Pressure to Revamp as U.S. Aid Increases

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By Dawn Kopecki

April 15 (Bloomberg) -- Fannie Mae and Freddie Mac are under pressure from lawmakers to revamp their operations as the mortgage-finance companies tap more government money to survive.

Among the options under discussion are combining the companies, breaking them up or reshaping their missions.

“It’s highly unlikely that they would return to the way they used to be,” said Ira Jersey, the head of U.S. interest rate strategy at RBC Capital Markets in New York.

Regulators seized Fannie and Freddie in September amid a rise in mortgage delinquencies that led to a combined net loss of $108.8 billion last year at the companies, the largest sources of financing for new U.S. home loans. The Treasury Department has injected $59.8 billion in emergency funds into the companies, including $46 billion issued two weeks ago.

Executives at Washington-based Fannie have discussed internally the possibility of taking over McLean, Virginia-based Freddie’s operations, according to people familiar with the matter. A formal approach isn’t imminent, said the people, who asked not to be named because the discussions are private.

The Treasury has agreed to give the two government- sponsored enterprises, or GSEs, as much as $400 billion through Dec. 31. That agreement probably will need to be extended by Congress before year-end, said Karen Shaw Petrou, a managing partner of Federal Financial Analytics Inc., a Washington-based research firm.

‘New Structure’

“There will be a massive re-write of the GSEs into some new structure,” though probably not this year, Petrou said.

House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, is exploring ways to separate the companies’ private and public missions, said Steve Adamske, a Frank spokesman.

A merger would be the quickest way for regulators to cut costs by reducing Fannie and Freddie’s combined 11,000-person workforce, shedding underperforming mortgage assets and reducing the bureaucracy of running two companies with identical functions, said Christopher Whalen, co-founder of Institutional Risk Analytics in Torrance, California.

Substantial movement toward a merger may not come quickly. James Lockhart, who oversees the companies as director of the Federal Housing Finance Agency, has said they will remain under government control until the housing market recovers, and the Obama administration has ordered Fannie and Freddie to focus on helping homeowners meet their mortgage payments.

Public Mission

“It’s got to happen; we’re not going to put them back the way they were,” Whalen said of a merger. “The only way we’re going to be able to manage them is if we squeeze every last ounce of savings out of the administrative side and just focus on trying to keep the loss number under control.”

Brian Faith, a Fannie spokesman, and Michael Cosgrove, a spokesman for Freddie, declined to comment on the possibility of a merger or other restructuring.

Fannie, created by the government in 1938, and Freddie, formed in 1970 to be a competitor, ensure that banks have cash available to make loans by buying mortgages or guaranteeing securities they help create from the debt. Together they own or guarantee about 56 percent of all U.S. home loans.

Freddie has received $44.6 billion in federal aid, about three times as much as Fannie. Freddie’s tab at the Treasury will cost it at least $4.6 billion in annual interest payments, almost triple what Fannie owes.

“With both of them as wards of the state, do you need two of them?” said Joshua Rosner, an analyst with Graham Fisher & Co. in New York.

Ousted Management

Lockhart’s agency put Fannie and Freddie under its control and forced out executives after examiners said the two may be at risk of failing, threatening further damage to the housing market.

Top management of the companies remains in flux. Freddie Chief Executive Officer David Moffett unexpectedly quit last month. Fannie CEO Herb Allison emerged this week as the leading candidate to run the $700 billion U.S. bank-rescue program, according to a person familiar with the matter.

Under Frank’s plan, a government trust fund would assume the companies’ responsibilities to subsidize rental housing and a remaining company would continue to do business in the private mortgage market, according to Adamske, the lawmaker’s spokesman. He said it’s too soon to say what the final structure would look like.

To make Frank’s proposal work, regulators may need to put one company into receivership, a process similar to bankruptcy, said Armando Falcon, who was Fannie and Freddie’s government supervisor from 1999 through mid-2005. The fastest way would be for “one to buy all the assets and assume all the liabilities of the other, place the rest of it into receivership and wind it down,” he said.

Home Loan Banks

The solution is to “break them up,” said Representative Spencer Bachus of Alabama, the top Republican on the House Financial Services Committee. “One possibility that I’ve looked at is letting the Federal Home Loan Banks take over some of their obligations and operations.”

The Federal Home Loan Banks are 12 government-chartered cooperatives that lend money for mortgages at below-market rates to their membership of more than 8,100 thrifts, commercial banks, insurance companies and credit unions.

Daniel Mudd, ousted as Fannie’s CEO after the government’s Sept. 6 takeover, said too much is being demanded of the companies, and that lawmakers should rethink the idea of shareholder-owned firms with public missions.

‘Robust’ Debate

“We need to have a robust policy debate,” Mudd, 50, said in an interview. “Do you want large companies to be focused exclusively on housing finance, albeit prone to produce the result -- just like we’ve seen recently -- that when the housing market goes down, there will be blood?”

Falcon, now an industry consultant at Canonbury Advisors in Alexandria, Virginia, said a public-private hybrid doesn’t work. He has advised other nations to avoid following the Fannie and Freddie example in developing their secondary mortgage markets, he said.

“There are just too many inherent risks in following the U.S. model,” he said. “All that has been proven out.”

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net."

Their basic implied threat is to withhold any further capital investment in big banks, which example would be followed by foreigners.

TO BE NOTED: From the FT:

"Who can afford the next recovery plan?

By John Dizard

Published: April 12 2009 11:45 | Last updated: April 12 2009 11:45

“That piece of shit up there, I never liked him. I never trusted him... But that’s history, I’m here, he ain’t.” Tony Montana (Al Pacino), watching a colleague hanged from a helicopter.

Scarface (1981)

It’s nearly time for some Washington careers to get the helicopter-noose treatment, particularly among the crowd of unvetted advisers and the tiny group of confirmed appointees at the Treasury Department. Politicos and policy hustlers have a style that differs slightly from Tony’s, but they’re about as sentimental. Secretary Timothy Geithner, not a bad or dishonest person, just a mediocrity who picked the wrong friends and trusted them for too long, can probably hear the rotor blades in the distance. Sadly, the prospective compensation packages for his next career are more modest than they would have been even a year ago…

For the rest of us, the question is who can be the next to take the lead on the national workout. That is probably Sheila Bair, chairman of the Federal Deposit Insurance Corp. But the FDIC needs serious reinforcement of its talent, and a different capital structure, for this to work.

You can pick out the likely geographical spot where the present bail-out wave will recede: 399 Park Avenue, the Citigroup HQ. Already, the Federal Deposit Insurance Corp’s resolution planners are circling the holding company’s shareholders, bondholders, and – at last! – top management.

Even other Tarp financed Wall Streeters are getting tired of the pretence that the Treasury and its advisers are brilliant or that their schemes make sense. Vishwanath Tirupattur, a Morgan Stanley credit strategist, said on a conference call last week that “The policymakers think lack of liquidity and leverage is the main problem…they think prices are depressed more for technical than underlying reasons. There are clearly several asset classes where current prices are better explained by collateral performance.”

“Collateral performance” means that the banking system’s real losses, not temporary mark to market losses, are overwhelming the capital injections finance-able by Federal bail-out appropriations. Congress won’t vote for any more, because they want to safely return home to their districts and maybe get re-elected.

So who’s left? The receivers at the FDIC. They’re sort of like the Internal Revenue Service, though without the Service’s easygoing institutional nature and its agents’ good sense of humour.

When there is a seizure, or “resolution”, of a bank, they take over as owner, guarantee deposits, and fight to take control of any assets. They are not customer-centric, relationship lenders. The FDIC is a corporation owned by the US government, but its costs are paid through levies on member banks.

Before Sheila Bair puts up government buildings colour swatches on the wall of Mr Geithner’s office, though, she will want to decide whether it might make more sense to stay in her current position. Senate confirmation would not be a challenge for her. Maybe, though, having some other punching bag at the Treasury would be better, especially since the FDIC faces staff shortages. Managing that, as well as a leadership transition and a raft of resolutions, would be difficult.

Also, while the Wall Streeters in Mr Geithner’s corner are demoralised enough to be brushed aside, and the big bank shareholders are either playing some derivative arb or totally out of it, the bondholders of the banks aren’t going to run away crying like little girls. Their basic implied threat is to withhold any further capital investment in big banks, which example would be followed by foreigners. That is less scary than it was before Hank Paulson’s crash.

Chris Whalen of Institutional Risk Analytics, which, among other activities, profiles bank credit quality, says “The administration has said that all the senior debt of the banks is money good, but they don’t have the money to back that up. The fight with the bondholders is the political issue we face. Before the end of the second quarter, we have to come to a decision on Citibank. Government cannot write a cheque for $200bn, $300bn or $400bn to bail out the bondholders.” Mr Whalen, a Bair fan, has been right so far in his bearish calls on the bail-out.

Citi might buy some time with writeups on assets formerly marked to market. And even with bank bondholders sliced up and turned into mere stockholders, and with the FDIC backed with a $500bn (£341bn, €377bn) (or bigger) line of credit with the Treasury, a systemic workout will eventually need new law.

The key problem is this: if the cash the FDIC uses for big bank resolutions really is a loan from the Treasury, then it will have to be repaid with a usurious assessment on the rest of the insured banks. That would not leave sufficient operating cash flow, or capital accumulation, for the banks to finance recovery. So the loan must turn into an equity capital contribution from the taxpayers.

However, since the FDIC is owned by the same taxpayers, and insures their deposits, that will be an easier sell than any more capital “investments” in the banks or dealers. Also, FDIC managers have modest houses in the suburbs, and drive minivans rather than limos. Better optics.

johndizaard@hotmail.com"

No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis

TO BE NOTED: From The Big Picture:

"AIG: Before CDS, There Was Reinsurance

Posted By Chris Whalen On April 2, 2009 @ 5:38 am In Markets | 51 Comments

Updated!!

Below is the latest issue of [1] The Institutional Risk Analyst. We did a lot of work on this one. Look forward to your comments.

Also, check out the earlier writings of Lucy Komisar on offshore shenanigans of AIG and the offshore transaction set:

[2] http://www.ritholtz.com/blog/2009/04/aig-before-cds-there-was-reinsurance-part-2/

– Chris

“What do many corporate buyers of insurance have in common with American International Group? Perhaps more than they would like to admit. Like AIG, many companies in the past few years have bought finite insurance, which transfers a prescribed amount of risk for a particular liability. What regulators now want to know is, how many companies, like AIG, have used finite insurance to artificially inflate their financial results?”

Infinite Risk?

CFO Magazine

June 1, 2005

“In the regulatory world, a ’side letter’ is perhaps the most insidious and destructive weapon in the white-collar criminal’s arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless.”
Fraud Magazine

July/August 2006

PRMIA Event: Market & Liquidity Risk Management for Financial Institutions

First, a housekeeping item. On Monday, May 4, 2009, in partnership with the Federal Deposit Insurance Corporation (FDIC) & the Office of Thrift Supervision (OTS), the Washington DC chapter of Professional Risk Managers’ International Association (PRMIA) is presenting an important day-long conference on managing liquidity and market risk for financial institutions. Speakers include some of the leading risk practitioners, investors, researchers, bank executives and regulators in the US financial community. [3] PRMIA free and sustaining members may register on the PRMIA web site. Members of the regulatory community may register via the FDIC University. IRA co-founder Christopher Whalen will participate in the conference and serve as MC. See the PRMIA web site for more information on the program and speakers.

And yes, our favorite bank regulator is making the opening remarks.

For some time now, we have been trying to reconcile the apparent paradox of American International Group (NYSE:AIG) walking away from the highly profitable, double-digit RAROC business of underwriting property and casualty (P&C) risk and diving into the rancid cesspool of credit default swaps (”CDS”) contracts and other types of “high beta” risks, business lines that are highly correlated with the financial markets.

In our interview with Robert Arvanitis last year, [4] “‘Bailout: It’s About Capital, Not Liquidity; Seeking Beta: Interview with Robert Arvanitis’, September 29, 2008,” we discussed the difference between high and low beta. We also learned from Arvanitis, who worked for AIG during much of the relevant period, that the decision by Hank Greenberg and the AIG board to enter the CDS market was, at best, chasing revenue. No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis, could have resulted in a favorable decision to pursue CDS and other “high beta” risks, at least from our perspective. ( NB DON )

In an effort to resolve this conundrum, over the past several months The IRA has interviewed a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem. Below we present our preliminary findings and invite your comments.

One of the first things we learned about the insurance world is that the concept of “shifting risk” for a variety of business and regulatory reasons has been ongoing in the insurance world for decades. Finite insurance and other scams have been at least visible to the investment community for years and have been documented in the media, but what is less understood is that firms like AIG took the risk shifting shell game to a whole new level long before the firm’s entry into the CDS market.

In fact, our investigation suggests that by the time AIG had entered the CDS fray in a serious way more than five years ago, the firm was already doomed. No longer able to prop up its earnings using reinsurance because of growing scrutiny from state insurance regulators and federal law enforcement agencies, AIG’s foray into CDS was really the grand finale. AIG was a Ponzi scheme plain and simple, yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community.