"to ultimately stop this asset/debt deflation, a fresh and substantial new source of buying power is required. This became all too obvious as the Treasury’s attempt to entice additional capital into Freddie and Fannie came up empty. Yet this same dilemma is and will continue to confront all highly levered institutions in the throes of asset liquidation. Without a new balance sheet, their only resort is to sell assets, which in many cases leads to further price declines, or ultimately debt liquidation/default." -Bill Gross
"The Bush administration on Saturday formally proposed a vast bailout of financial institutions in the United States, requesting unfettered authority for the Treasury Department to buy up to $700 billion in distressed mortgage-related assets from the private firms. NYTimes"
Now I want to show how billion dollar hedge fund manager William Ackman thought he could save Fannie Mae and Freddie Mac with a pre-packaged bankruptcy WITHOUT risking taxpayers money. The Treasury actually did use taxpayers money to buy up senior preferred stock with warrants (for up to 80% of common stock) that actually exposes the taxpayer to future upside in the American housing market. So if the upside outweighs the inflation risk, the temporary cost could work out very well for the tax payer.
"Because the GSEs are in conservatorship, they will no longer be managed with a strategy to maximize common shareholder returns, a strategy which historically encouraged risk-taking. The Preferred Stock Purchase Agreements minimize current cash outlays, and give taxpayers a large stake in the future value of these entities. In the end, the ultimate cost to the taxpayer will depend on the business results of the GSEs going forward. To that end, the steps we have taken to support the GSE debt and to support the mortgage market will together improve the housing market, the US economy and the GSEs' business outlook." Treasury.gov
Of course Bill Ackman was openly short the securities he thought should be wiped out or reorganized. He came on CNBC and explained his detailed strategy not too long before Fannie and Freddie was nationalized by the US Government and the common equity went to 40 cents.
Will this new Government balance sheet save our economy? I'd like to see the treasury's analysis of the after affects of this huge Government intervention. It probably all depends on how quickly the bailout repairs bank balance sheets. With the Government making the market in toxic mortgage debt it will ease forced liquidations which has been pushing down prices, like Bill Gross said. Once bank balance sheets are repaired it will ease the liquidity squeeze on the consumer allowing capital to freely flow to a new business start up or good standing home buyer, which will in turn bring employment, income and confidence to the system. So from here it really all depends on how resilient the consumer is. If there's no need for credit because of a recession it would definitely delay the recovery, and inflation could also be a concern with the Government printing out billions of new paper rectangles we call currency.