CC-Transcript

• 00:00They were founded many decades ago. Fannie Mae, first in the thirties. Freddie Mac later in the seventies. Actually, they were privatized in the past, in the late sixties, by a previous piece of legislation, which sort of has some some echoes of what’s happening today. And the companies basically guaranteed 70% of US mortgages. You know, their existence is unique globally and it makes the US homeownership model possible. And it’s the reason that we have a 30 year fixed rate mortgage available to homeowners today. So what do we need to know about what happened potentially during the financial crisis and the government oversight that we’ve seen over the last few years? And what could change? Given what we heard from the president, you guys are the companies are fundamentally changed since the financial crisis. It’s important to note that they were doing all kinds of of ancillary businesses. They were basically operating the world’s biggest hedge fund, as Warren Buffett once said. And they got over their skis, taking on a bunch of additional risk beyond just guaranteeing vanilla mortgages. So so the majority of the losses they suffered from 2008 to 2011 were were from those activities. Right. So they don’t do any of that anymore. But, you know, they exist in the sort of quasi governmental state where the FHA and the Treasury own and are in charge of the companies. And by and large, they function very well. They provide a huge amount of liquidity to the US housing markets every year. They make the 30 year mortgage possible and they earn about $30 billion a year for the Treasury Department. So the status quo is is is arguably working. But they’re in sort of a bankruptcy like process that was never meant to be permanent. And so there are a lot of observers who think that that process should now come to an end. All right. So you’ve got Fannie Mae up 40% in today’s session. Freddie Mac is up just about 39%. So if they do go public officially and their publicly held entities, what does it mean for them? What does it mean for their role in housing? How might that change things from what they’ve been? Well, it’s it’s really important to note that there are very few details on this. Right. So that, yeah, the president has been has been sort of saying what he said last night since 2017. So we don’t have anything new. And the really important detail will be how, if at all, the US government continues to back these companies after they exit conservatorship potentially and start to be treated like normal public companies. And everyone, by and large agrees that there will be some form of federal government guarantee. They hope it will be explicit, they hope it will be defined at a certain value, and they hope that it will be paid for. But by and large, the companies get a huge amount of benefits from being quasi governmental. You know, their credit rating is tied to the sovereign, for instance. So they they get very they get they get financing on par with the with the risk free rate, essentially, which allows their business model to function at the prices it does today. So if the companies were to exit conservatorship. You know, it’s not necessarily true that mortgage rates will rise, but there are plenty of ways in which they could. One is that the companies choose to or need to earn more profits to attract third party private capital, capital to replace the government’s current stake. And the other way is that agency and investors lose faith in in their backing and they start to see credit risk returning to the securities. And therefore, they demand a larger premium over treasuries, and that translates into higher mortgage rates. What does it mean exactly when you say that the US has a stake in these companies? Because, you know, I go to FDS on the Bloomberg terminal to look at these equities to see who the holders are. It doesn’t say the US government owns X percentage of these firms. Yes, actually at Bloomberg we do an interesting thing, which is that we display the share count as though the Treasury had already executed its warrants. It holds warrants to buy 79.9% of the common stock, but they’re not actually exercised yet. So the federal government is not reflected as an owner of the common shares, but they do own something called the senior preferred shares, which obviously, as the name implies, are senior to the common shares and and the valuation. There is something called the liquidation preference, which is growing each quarter equal to the amount that the companies earn, and it’s approaching $400 billion. So that’s kind of the biggest impediment to this recap and release process that you hear about is what does the federal government do with this gigantic stake in the companies and how does it get paid back? Yeah, because I wonder, like if the government is still somehow involved, is it kind of a sure thing for investors? Maybe not a high flyer, but a sure thing? And I also do think about like moral hazard. They give something goes a strike. Like do we just assume the government’s going to be there to protect them? Okay. Yeah, I think I think there’s the biggest risk is obviously moral hazard, right? Right. If they leave conservatorship and there is a defined dollar amount that the that the Treasury agrees to backstop the companies and they pay for it, I think even then bond markets will assume that if worst comes to worst, the federal government is going to write a blank check. The companies are absolutely fundamental to the U.S. economy. And, you know, if they were private enterprises, there’s just no way that they could, you know, go into bankruptcy and be resolved simply. And the evidence of that is 2008. Right. Staring us right in the face. So it does seem as though there’s some circular logic, like we’ll be going right back to where we were.