Shareholders' Woes

The infamous phase of the year if not for years or decades, "If you’ve got a bazooka and people know you’ve got it, you may not have to take it out.” ("As Crisis Grew, a Few Options Shrank to One" by Charles Duhigg, Stephen Labaton and Andrew Ross Sorkin, 07 Sep 2008, New York Times) In the end, he still had to use it. Who is he? Treasury Secretary Henry M. Paulson Jr. is him.

At the time of implementation of the bazooka, which is simply to give officials the power to inject billions of dollars into the Freddie Mac and Fannie Mae through investments and loans("Scramble Led to Rescue Plan on Mortgages", Stephen Labaton, 15 Jul 2008, New York Times), Treasury Secretary Paulson only wanted an instrument to calm the market. He was able to calm the markets with the bazooka. But it was only for a short duration.

The market became even more jittery after that, which can be seen from the stock prices of Fannie Mae and Freddie Mac. With each passing day, the market was worried. Should the bazooka be used, who would be the ones affected? Would it be the shareholders, bondholders or both? What would be the repercussion for any of them?

Shareholders would lose the worth of the shares. Bondholders would lose not only their interest paydowns but their principals as well. But who is the group that the Treasury Department is willing to bear the losses? The shareholders or the bondholders? Note that most bondholders are foreign central banks, financial institutions and others ("In Rescue to Stabilize Lending, U.S. Takes Over Mortgage Finance Titans", Stephen Labaton and Edmund L. Andrews, 7 Sep 2008, New York Times) and if the bonds are defaulted, it would mean that the US has defaulted payments. No country would want this, not especially the United States of America. As such, the only logical group to bear the cost would be the shareholders.

Finally the bazooka was fired. Mainly due to Freddic Mac being unable to rise the USD5.5billion which was needed. Fannie Mae was considered as being too close with Freddie Mac and since Freddie needed help, Fannie should be helped too. ("As Crisis Grew, a Few Options Shrank to One" by Charles Duhigg, Stephen Labaton and Andrew Ross Sorkin, 07 Sep 2008, New York Times)

However, with shareholders bearing the blunt of this explosion. One will begin to wonder who are the shareholders of these GSEs? Are they the financial institutions who are facing the sub-prime crisis, like Citigroup, Lehman Brothers, Morgan Stanleyand UBS just to name a few. If the closing stock price of Fannie and Freddie being USD 0.99 and USD 0.8834 respectively as of 09 Sep 2008, what would this mean to the books of these financial institutions who are holders of these 2 GSEs? Surely, there is a need to mark-to-market. Further losses from financial institutions can be expected due to this conservatorship done by the Treasury Department.

There is one consolation prize from all of this. The market seems to be reacting well to the usage of the bazooka with the Dow Jones and Nasdaq rising. However, only time will tell if this is just a short term bullrun based on feel good sentiment from the bazooka.