Thursday, October 29, 2009

Fannie Mae, Freddie Mac "The new GSE as zero meme – laying the assumptions bare – and a modest plan for Obama" (FNM; FRE)

John Hempton has put together a lot of numbers as he looks at Keefe, Bruyette & Woods analyst Bose George's models and assumptions.
(see "KBW says Fannie, Freddie common shares worthless (FRE; FNM)" for the initial news).
This is definitely worth a bookmark.
From Bronte Capital:

There have been a few broker notes out suggesting that the GSE preferred stock is going to zero. The preferred stock itself has been dreadful lately – retreating almost to our original purchase price.

I think the broker notes are wrong – but lets do this formally because if you look at the assumptions in my model and the assumptions in the broker notes you can make up your own mind. [I will lay out their assumptions and my assumptions clearly – you decide.]

The first “GSEs are zero” broker note was produced by Keefe Bruyette & Woods (one of the few brokers left covering the stocks). I have reproduced the note here (and claim fair comment use for doing so).

The core assumption is that the GSEs are closed – and that they are put into very rapid run off – and that they do not earn much money during this run off period. Here is the revenue model for Freddie Mac....

He ends with:

...Winding down the GSEs right now runs the risk of killing the nascent recovery in the housing market.

The sensible course of action is to just wait. This is policy that can be delayed without any real additional risk to the government. (The government is already on the hook for the losses.)

If my math is right – and I think it is – then the GSEs will appear solvent in time for the 2012 election. The government can demand (and receive) almost 100 billion in capital to be repaid from them (which will make the budget look good and undermine the only viable Republican argument that the Democrats are irresponsible). It will make the government look like good conservators of key institutions. It will make Obama look like safe hands for running America.

The anti-GSE lobby knows this is a possibility and they are determined to capture as much GSE business as possible right now – so they are vociferous in their claims. Sensible people should ignore them.

In between those two exerpts are more facts and figures than any junky could hope for. This might be the definitive analysis of the former* GSE's.

Here's Bronte.

*Former because, with government ownership, they are no longer just "sponsored".