Fannie-Freddie and Paulson’s ‘Bazooka’

Amid the recent Fannie Mae (FNM) and Freddie Mac (FRE) fiasco, Secretary of the Treasury Hank Paulson was called before Congress to help stabilize the situation. His plan, backed by the full faith and credit of the Bush Administration, was to extend a blank check to both government sponsored entities (GSEs).

His idea was to restore confidence in these banks so lenders, creditors and stockholders would not panic. Speaking to the U.S. Senate on July 15, Paulson said “If you have a bazooka in your pocket and people know it, you probably won’t have to use it.” It’s been over 5 weeks since Secretary Paulson spoke those fateful words – plenty of time for the market to digest his comments.

Did they work?

Let’s look at the GSE stocks. On 7/15/08, FNM closed at $7.07 and FRE closed at $5.26. As of today’s close, FNM is trading -30% lower and FRE is trading -40% lower. Hmmm. I don’t think we need a seven-figure consultant to figure this one out. Paulson’s jawboning failed to prop up the stocks.

The problem was Paulson’s lack of specificity. What exactly would the Feds support? Stockholders, bondholders, or just foreign interests? It’s hard to tell. Uncertainty is one thing investors can’t stand. Right now, the market is betting against Fannie and Freddie. It’s looking more and more likely Fannie and Freddie will not survive in the end.

My wife sometimes says my analogies don’t work. I wonder if Hank Paulson’s wife said the same thing after her husband testified before Congress. When he called his Bush-Multi-Billion-Dollar-Blank-Check-Plan a ‘bazooka’ was he just trying his pen at alliteration? Or was it just a poor analogy for what the Feds did?

I vote for the latter. Whereas rocket-propelled devices tend to help combatants win skirmishes, blank checks tend to reward risky investing. What works in geopolitical standoffs — or back-alley brawls, doesn’t translate the same on Wall Street. Bazookas can be a great deterrent in certain conflicts, but we’re not dealing with street thugs. Some would say we’re dealing with much worse – bankers.