Substantial Implicit Subsidy to GSE Shareholders “Unwinding”

I came across an interesting Fed paper the other day from 2005. It looked at how much subsidy was built into shareholder’s equity of Fannie Mae (FNM) and Freddie Mac (FRE) due to the government’s implicit backing.

Given today’s market action was blamed on the two GSEs, its apparent
that the previous "implicit subsidy to GSE shareholders" is not only
less implicit, but it may be evaporating altogether. 



charts via Divisions of Research & Statistics and Monetary Affairs, FRB   


Let’s go to some deep research on Fannie Mae (FNM) and Freddie Mac (FRE):

The housing-related government-sponsored enterprises Fannie Mae and Freddie Mac (the “GSEs”) have an ambiguous relationship with the federal government. Most purchasers of the GSEs’ debt securities believe that this debt is implicitly backed by the U.S. government despite the lack of a legal basis for such a belief. In this paper, I estimate how much GSE shareholders gain from this ambiguous government relationship.

I find that (1) the government’s ambiguous relationship with Fannie Mae and Freddie Mac imparts a substantial implicit subsidy to GSE shareholders, (2) the implicit government subsidy accounts for much of the GSEs’ market value, and (3) the GSEs would hold far fewer of their mortgage-backed securities in portfolio and their capital-to-asset ratios would be higher if they were purely private.

The calculation formulas used in this Fed research paper are beyond me, but the charts are rather self explanatory.



Why would a Barron’s article, with no new information in it, send Fannie down 22% and whack 2% off of the markets? 

Once again, we are forced to ask, What Efficient Markets?


Fannie and Freddie: Worth Negative $50 Billion Each (August 2008)

The GSE Implicit Subsidy and the Value  of Government Ambiguity 
Wayne Passmore
Federal Reserve, 2005-05   
Finance and Economics Discussion Series Research & Statistics and Monetary Affairs

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What's been said:

Discussions found on the web:
  1. Ugh commented on Aug 18

    “Why would a Barron’s article, with no new information in it, send Fannie down 22% and whack 2% off of the markets?”

    1. Because it was sourced from someone at the Treasury department.
    2. Because it mentioned prefered shareholders will also take a big hit. That’s new and bad news for the banks.
    3. Because delusional common equity holders don’t understand that a capital raise from the government will de facto wipeout their stakes.

  2. free markets! commented on Aug 18

    Collective market-maker greed; pre-options expiration run-up in all stocks over last two weeks; technical rebound; Willigness to ignore the bad news; fed’s intervention in Gold and commodities. It’s capitalism — everything will work itself out for the ultra-smart crooks at GS/on Wall Street.

    Real investors will keep cushioning the “efficient markets” for these felons.

  3. SR commented on Aug 18

    “And the Beat(down) Goes On……”

    Fannie, Freddie shares battered
    Fannie stock falls 22% and Freddie 25% to near two-decade lows.
    Media report suggests the Bush administration doubts mortgage giant firms will be able to raise needed capital.

    No mileage variation(s) here….

    -OR- “Go on and load the horses in the wagons boys, it’s all downhill from here.”

  4. Jim Haygood commented on Aug 18

    Fannie and Freddie’s “ambiguous relationship” with the federal government precisely mirrors a quote from a former House speaker:

    “Never write when you can speak. Never speak when you can nod. Never nod when you can wink.”

    Yeah, well, the “nod and wink” song and dance has come a cropper. “Hank the Skank” has an $800 billion blank check from the bozo taxpayer victims, and no one knows what the bill’s gonna be.

    Just don’t spend it all on wine, cakes and floozies, Hank. Or if you do, cut me in on the booty. Thanks in advance, pal!

  5. Pat G. commented on Aug 18

    The two GSEs will get bailed out with our money. Shareholders will get zip. But the government’s benefactors will be rewarded for their generous campaign constributions by keeping what they commited fraud to get. Another day in paradise.

  6. bloomberg terminal commented on Aug 18

    wonder if someone’s out there right now smartly (or stupidly) loading up on GSE debt and shorting Treasuries as a hedge.

    Who knows….maybe we’ll see LTCM II some day soon.

  7. Rich Preppyfag commented on Aug 18

    Hey – don’t you guys realize how goddamn hard it is to create these new and innovative products every year? You think CDO’s and CDPO’s and ARS just write themselves?

    No, of course not; it takes dedicated professionals, like me and my Wall Street buddies, to create these products and, by extension, give you bozos something to “blog” about. Let’s face it, deep down you want me – no, NEED me – on Wall St. because if my Hampton buddies and me weren’t looting the Trasury what would you have to complain about?

    Now you’ll have to excuse me, my chopper is about to leave for the Hamptons and I’m going to try and get the pilot to stop off at Stanford C.C. in Greenwich to pick up my new Titanium/Graphite TaylorMade Driver. It cost $14,000 but only weighs 3 oz. and can hit a golf ball into the Space Station.

    Ta Ta!

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