Sunday, September 7, 2008

Some Highlights from Paulson's Statement to Takeover GSEs

1.To support the stability of financial market and support the availability of mortgage financing, GSEs will purchase MBS portfolio and gradually reduce them, largely through natural run off, to contain system risk.
2.To avoid triggering the recervirship of debt holders and serve the market discipline, risk and rewards, Treasury will establish Preferred Stock Purchase Agreements which guarantee debt holders and put common shareholders and preferred stock investors on the front of losses.
3.To boost GSE's liquidity backstop, Treasury will establish new secured lending credit facility
4.Treasury will increased the MBS portoflio to compliment GSE's moves.
Objectives of Takeover
Since this difficult period for the GSEs began, I have clearly stated three critical objectives: providing stability to financial markets(secondary market), supporting the availability of mortgage finance, and protecting taxpayers - both by minimizing the near term costs to the taxpayer and by setting policymakers on a course to resolve the systemic risk created by the inherentconflict in the GSE structure.
The importance of Taking Over GSEs
...the housing correction poses the biggest risk to our economy. It is a drag on our economicgrowth, and at the heart of the turmoil and stress for ourfinancial markets and financial institutions. Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing. Therefore, the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance, including by examining the guaranty fee structure with an eye toward mortgage affordability.
What will Treasury do?
To promote stability in the secondary mortgage market and lower the cost of funding, the GSEs will modestly increase their MBS portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size. Treasury has taken three additional steps to complement FHFA's decision to place both enterprises in conservatorship. First, Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities. Under these agreements, Treasury will ensure that each company maintains a positive net worth. These agreements support market stability by providing additional security and clarity to GSE debt holders - senior and subordinated - and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities. This commitment will eliminate any mandatory triggering of receivership and will ensure that the conserved entities have the ability to fulfill their financial obligations. It is more efficient than a one-time equity injection, because it will be used only as needed and on terms that Treasury has set. With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers. Additionally, under the terms of the agreement, common and preferred shareholders bear losses ahead of the new government senior preferred shares... Market discipline is best served when shareholders bear both the risk and the reward of their investment. While conservatorship does not eliminate the common stock, it does place common shareholders last in terms of claims on the assets of the enterprise. Similarly, conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses. The federal banking agencies are assessing the exposures of banks and thrifts to Fannie Mae and Freddie Mac. The agencies believe that, while many institutions hold common or preferred shares of these two GSEs, only a limited number of smaller institutions have holdings that are significant compared to their capital. The second step Treasury is taking today is the establishment of a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. This facility is intended to serve as an ultimate liquidity backstop, in essence, implementing the temporary liquidity backstop authority granted by Congress in July, and will be available until those authorities expire in December 2009. Finally, to further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS. ..During this ongoing housing correction, the GSE portfolios have been constrained, both by their own capital situation and by regulatory efforts to address systemic risk. As the GSEs have grappled with their difficulties, we’ve seen mortgage rate spreads to Treasuries widen, making mortgages less affordable for homebuyers.

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