This week's selloff was spurred by an article in Barron's over the weekend:
IT MAY BE CURTAINS SOON FOR THE MANAGEMENTS and shareholders of beleaguered housing giants Fannie Mae and Freddie Mac . It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer's dime, availing itself of powers granted it under the new housing bill signed into law last month. Such a move almost certainly would wipe out existing holders of the agencies' common stock, with preferred shareholders and even holders of the two entities' $19 billion of subordinated debt also suffering losses. Barron's first raised the possibility of a government takeover of Fannie and Freddie in a March 10 cover story, "Is Fannie Mae Toast?"
As the Barrons article points out, the shareholders will likely be wiped out by any bailout - or at least they should be. The board of directors and managers will also likely get the axe. While that is necessary, it is not enough if taxpayers are asked to fund these two. The companies should not be operated as government agencies and allowed to just keep expanding their book of business.
Fannie and Freddie, if taken over, should be broken up and privatized. Even as semi-private companies Fannie and Freddie greased a lot of palms in DC. Imagine the potential for corruption if they become protected government entities. They are already the dominant players in the industry and if allowed to continue operating under the umbrella of explicit government guarantees, the number of competitors will just shrink further.
Furthermore, if taxpayer funds are used to prop these companies up now, then taxpayers should benefit when they are sold off. If we are to assume the downside of guaranteeing their existing mortgages, we should get the upside when they recover. The government should get some kind of equity kicker (warrants probably) when the companies are fully privatized. I would even go further and say that any equity retained by the government in these deals should be distributed to taxpayers rather than retained by the government. How can government be expected to regulate an industry in which it holds a stake?