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Tuesday, July 15, 2008 1:45 PM

SEC Panic - Shorting Curbs Placed on GSE Stocks

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The panic at the Fed, the SEC, and the Treasury department continues. In an emergency action the SEC Curbs Shorting of GSE Stocks, Considers Limits for Wider Market.

The Securities and Exchange Commission announced an emergency action aimed at reducing short-selling aimed at Wall Street brokerage firms, Fannie Mae and Freddie Mac, and will immediately begin considering new rules to extend new requirements to the rest of the market.

SEC Chairman Christopher Cox said at a Senate Banking Committee hearing that
the SEC would institute an emergency order requiring any traders to pre-borrow stock before shorting Fannie Mae and Freddie Mac, the embattled government-sponsored entities that own more than half the nation's mortgages.
Ackman Shorts Fannie, Freddie

Bloomberg is reporting Ackman Shorts Fannie, Freddie, Suggests Restructuring.
Hedge fund manager William Ackman, who is betting against shares of Fannie Mae and Freddie Mac, criticized any government plan to buy equity in the existing mortgage-finance companies and said shareholders should be wiped out.

"We've not yet heard Secretary Paulson's plan but it would be a grave error for the government to invest in the equity of Fannie Mae and Freddie Mac as they are currently capitalized," Ackman, 42, said in a telephone interview from his New York office.

Ackman said he had discussions last week with the Treasury, Federal Reserve and Senate Finance Committee about his plan for Fannie Mae and Freddie Mac, which guarantee or own almost half the $12 trillion in U.S. home loans outstanding.

Under Ackman's plan, Fannie Mae's senior unsecured debt would be reduced by 10 percent and the junior debt would be completely eliminated, adding $86 billion in equity capital to the company.

"The good news is that Fannie Mae has all the capital that it needs," Ackman said. "It just has the capital in the wrong form with too much debt and not enough equity."
Ackman's Plan To Save Fannie and Freddie

CNBC has two videos on Ackman's Plan To Save Fannie and Freddie.
Ackman, who runs the New York-based Pershing Square Capital Management, has a short position in both the junior debt and the equity of both Fannie Mae and Freddie Mac, and is critical of the federal plans to backstop the two companies if needed.

In a CNBC interview, Ackman laid out a plan he claims will reduce leverage at the two government sponsored enterprises. [Mish note: Two videos are present in this link and there is additional discussion about the plan in the Bloomberg link above]

Ackman has no position in the senior debt of the two mortgage lenders.

With his short position, Ackman stands to benefit if the value of the Fannie and Freddie Mac stock and junior debt deteriorates.

"Investors made a bet," Ackman said. "They received dividends, and so on...they allowed the institutions to become too levered, they chose these directors....The subordinated debt holders received an excess yield. This is not the senior debt of Fannie Mae - there is a relatively small amount of it outstanding....We believe the subordinated debt holders should get warrants."
Shorting Curbs Can't Help

Shorting curbs cannot possibly help when the problem is solvency not liquidity. In spite of the announcement, shares of Fannie and Freddie are down another 19% each as of 1:40 PM Central.

If the SEC intended to cause a short covering rally in the GSEs, it sure failed miserably. Indeed, the market response shows just how futile the actions of the SEC, the treasury department, and the Fed are.

Mike "Mish" Shedlock
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