Monday, August 11, 2008

Hank Paulson Lies

From Bloomberg:

U.S. Treasury Secretary Henry Paulson said there are no plans to use his new authority to inject capital into mortgage companies Fannie Mae and Freddie Mac, which both posted worse-than-expected earnings last week.

``We have no plans to insert money into either of those two institutions,'' Paulson said in an interview with NBC's ``Meet the Press'' broadcast today from Beijing. He added that their earnings results were ``not a surprise.''

Paulson and Congress last month brokered a plan to bolster the two government-sponsored enterprises that includes giving Treasury the right to buy their shares. Fannie and Freddie, which account for almost half of the $12 trillion mortgage market, reported losses three times worse than estimated, prompting some analysts to predict that Paulson will have to act.

First, Paulson has continually made statements that his later actions directly contradicted. Before he asked for the line of credit for the GSE's he said they were in fine shape and there was nothing to worry about. According to him, the US has had a strong dollar policy for the duration of his tenure at Treasury. In other words, his credibility is a bit lacking in these matters.

Basically, the bail-out bill allows the Treasury to inject funds directly or provide a backstop for the GSE's stock:

First, as a liquidity backstop, the plan includes an 18-month temporary increase in Treasury's existing authority to make credit available for the GSEs. Given the difficulty in determining the appropriate size of the credit line we are not proposing a particular dollar amount. Flexibility is the best means of increasing market confidence in the GSEs, and also the best means of minimizing taxpayer risk.

Second, to ensure the GSEs have access to sufficient capital to continue to fulfill their mission, the plan gives Treasury an 18-month temporary authority to purchase – only if necessary – equity in either of the two GSEs.

Let's look at Freddie and Fannie's balance sheet.

Fannie has lost money for four straight quarters. Here is a link to the last three at Reuter's. They're not pretty. But here's the real problem. According to Reuter's, Fannie has total long term investments of $780 million. The real question is what are those investments really worth. Considering the degree of writedowns we've seen over the last year, I seriously doubt those are really worth that much. The question is how off are the official valuations on the balance sheet?

Freddie has the same problem. According to Reuter's, they had $672 billion in long term assets on their balance sheet at the end of last year. But again -- what are they really worth?

These institutions touch 70% of the mortgage market. In other words, they are vital to out economy -- now more than ever. But just how solid are their balance sheet statements? Considering the mammoth amount of writedowns we've seen so far, I seriously doubt their latest statements are accurate.

And therein lies the problem for Hank Paulson. My guess is he knows there are serious problems lurking under the hood which is why he asked for such massive bail-out provisions which literally amount to a blank check. And that's why his happy talk is patently absurd.