Fannie Mae - Freddie Mac (1)

Freddie mac receivership would likely have involved

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Freddie Mac, receivership would likely have involved some losses being borne by senior creditors (that is, holders of agency debt and mortgage-backed securities) and a breach of the implicit government guarantee. Conditional on Treasury financing, there were several reasons why the conservatorship was preferable to receivership. First, in the summer of 2008, there was significant uncertainty about the housing market and future losses at Fannie Mae and Freddie Mac. This meant that -- given the time frame allowed – restructuring the two firms via receivership would entail some risk that they could potentially fail again. Hence receivership might not have solved the critical near-term problem. Second, the business model of the government sponsored-enterprises had been the subject of intense debate in the years leading up to their failure. The structure of the conservatorship agreements essentially placed Fannie Mae and Freddie Mac in a “time-out”. Receivership, by contrast, would have reorganized and released the two firms (at least within five years). The thinking was that conservatorship would force Congress to address the problems of this business model, or else face the long-term prospect of government control of the U.S. housing finance system. Third, receivership raised an operational concern relating to the treatment of derivatives as “qualified financial contracts” (as discussed by Paulson 2010). Receivership required a determination within one business day about the status of individual counterparties: specifically, whether their claims would be transferred to the “good” entity or remain with the “bad” entity. Depending on that determination, counterparties held the option to terminate net positions. However, under law the conservatorship did not trigger these termination options in derivatives contracts (Federal Housing 20
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Finance Agency 2008). Thus, receivership would have created greater uncertainty about business continuity and derivatives counterparty actions. Finally, conservatorship still allowed for the receivership option to be chosen in the future, if a subsequent administration felt that it was a better course of action. Another alternative option was to nationalize Fannie Mae and Freddie Mac, by buying more than 80 percent of the firms’ equity and thereby taking a controlling interest. However, as Paulson (2010) describes in his book, the Bush administration was opposed to nationalization or anything that looked like open-ended government involvement. Relative to conservatorship, nationalization would have given the administration more direct control over Fannie Mae and Freddie Mac, but would have required the firms to be put on the government’s balance sheet. The 2012 “full income sweep” amendment discussed above effectively narrows the difference between conservatorship and nationalization, by transferring essentially all profits and losses from the firms to the Treasury.
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  • Fall '06
  • DLZahm
  • The Land, Mortgage loan, Subprime mortgage crisis

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