Pershing Square Capital Management sent the following letter to the U.S. Treasury Department Regarding Fannie Mae and Freddie Mac.
I have not had time to analyze it fully, and it is simply too late at this point to do so. There will be a solution this weekend. Nonetheless, it is interesting to see all this last minute posturing. I have more posturing from Bill Gross following this letter.
Dear Secretary Paulson:
We understand that a Treasury plan for Fannie/Freddie (“the GSEs”) may be announced this weekend. We thought you might find useful some further thoughts on potential GSE solutions.
As you are likely aware, we had previously distributed a proposed restructuring plan for the GSEs. In that plan, under a prepackaged conservatorship, equity interests would be extinguished, subordinated debt would be exchanged for warrants, and senior debt would be exchanged for new senior debt and common equity in the newly recapitalized entities. The government would write a put to the new common equity holders which would expire in three years.
It appears, however, that the GSEs may need help more quickly, and conservatorship may not be triggered until the GSEs are formally determined to be undercapitalized. As such, in the event the government needs to inject capital immediately, we suggest you consider the following transaction (“the Transaction”).
In order to minimize risk to tax payers while being equitable to other constituents, we suggest that the Treasury consider purchasing senior subordinate debt in the two companies in an amount sufficient to address their capital needs in the short to intermediate term. This senior sub debt would be junior in right of payment to the outstanding senior unsecured debt and senior to the outstanding sub debt, preferred stock, and common equity. We refer to the outstanding sub debt, preferred and common stock as “the Subordinate Securities.”
The issuance of senior sub debt is permitted under the GSE legislation and under the existing terms of the outstanding debt and equity securities of the two entities (please see the attached memo for further details). As a condition of Treasury’s purchase of senior sub debt, the GSEs would defer the interest payments on the outstanding sub debt (which can be deferred for as much as five years), and the dividend payments on preferred and common stock. All of the Subordinate Securities would continue to remain outstanding according to their existing terms.
The new senior sub debt should have a market-based coupon and Treasury should receive low-strike price warrants (penny warrants) for a substantial portion, i.e., 49% of the two companies. The coupon and warrant structure should be as close to fair-market-value terms as possible. The ultimate determination of fairness would be the willingness of non-government investors to purchase the Transaction securities on the same basis as Treasury. As part of the Transaction, the GSEs would deleverage their capital structures by paying down senior debt from the free cash flow generated by their core businesses further improving the position of the new senior sub debt.
The benefits of the Transaction are as follows:
Most importantly, we believe there are serious negative implications for other large financial institutions in the event the Treasury were to bail out Subordinate Security holders. The Treasury and OFHEO have done substantial research on the benefits to capital market discipline from large financial institutions’ issuance of subordinate debt, and the destructiveness of the government implicitly or explicitly guaranteeing such obligations.
More Gross Posturing
More Gross posturing can be found in Paulson Plans to Take Control of Fannie, Freddie.
Paulson met with Fannie Mae Chief Executive Officer Daniel Mudd and Freddie Mac CEO Richard Syron yesterday to tell them of the decision to put the companies into a conservatorship, where they would be removed from their jobs, according to a person briefed on the discussions. A public announcement is expected this weekend, the person said.
The decision follows the Treasury chief’s repeated comments to lawmakers in July that he wasn’t likely to use taxpayer funds to prop up the federally chartered, shareholder-owned firms hit by $14.9 billion in losses the past year. The shares of both companies slid since Paulson won powers to inject unlimited funds in the companies, and their borrowing costs rose.
Pacific Investment Management Co., manager of the world’s biggest bond fund, and other large investors may put in their own money once the Treasury decides to inject government funds, Bill Gross, co-chief investment officer at Newport Beach, California-based Pimco, said yesterday in a Bloomberg Television interview.
“They have to open their wallet,” Gross said, predicting that the Treasury will act this weekend before the Federal Housing Finance Agency releases an assessment of Fannie’s and Freddie’s capital. About 61 percent of Gross’s holdings were mortgage-backed securities as of June 30, mostly debt guaranteed by Fannie, Freddie or government agency Ginnie Mae, according to data on Pimco’s Web site.
Bill Gross Is Already In
Bill Gross made his bet in advance and bragged about it. So what’s up with the statement “PIMCO and other large investors may put in their own money once the Treasury decides to inject government funds.”
Bill Gross is already in, 61% in to be precise. Is he going to load up more? How much more? 2%? 5%? any%?
I hope Gross is punished. A quick look at the Pershing plan shows that PIMCO might take some kind of hit if that is how it is structured. This is hard to say. What we can say is that all these nuances are being worked out now and all of this last minute posturing is taking place for a reason.
The disgusting reality is that everyone is looking to be rescued, and at taxpayer expense to boot.
Oh take me in your ARMs
I want your tender charms
‘Coz I’m lonely and I’m blue
I need you and your love too
Come on and rescue me
Come on baby, take me baby, hold me baby, love me baby
Can’t you see that I need you baby
Can’t you see that I’m lonely
Mike “Mish” Shedlock
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