From Bronte Capital:
In Part VI of this series I came to the (non-consensus) conclusion that both Fannie and Freddie were long-term solvent and that the cost to the government of their conservatorship would be zero. I also suggested that the common stock had value and that the (non-cumulative) preferred shares (currently trading at 4c to 6c on the dollar) would one day receive par.
There are model sensitivities and economic sensitivities to this conclusion. In this post I want to (begin to) explore how robust those conclusions starting with the model in Part IV. I am conducting an “idiot check”. In the next two posts I will do idiot checks on Parts V and Part II.
I apologise in advance as these three posts will look a little disjointed compared to Parts I to VI. In this post I am using all sorts of anecdotal or practical data to test my hypotheses… this is a practical - not a theoretical exercise – and it is as a result messy....
...Sensitivity as to the income line
I am fairly confident about my estimate of credit losses at Fannie and Freddie. Those are manageable – and the end loss to taxpayers is very unlikely to be large. I am much less confident that the income line (which has expanded greatly) can remain so generous. And for the losses to taxpayers to be zero I need the companies to be able to earn their way out of their current predicament. I need the current large operating income to continue – or at least not to drop suddenly.
The sustainability of the operating income is the subject of the next post.
In between is a lot of stuff that we will be bookmarking.