Who Killed Frannie?

Andrew Ross Sorkin today says there’s a relatively simple reason why Fannie and Freddie were forced into conservatorship: they needed fresh capital, but Hank Paulson essentially prevented them from raising any.

According to this theory, Fannie and Freddie would have been capable of raising money on their own — but then Paulson went and announced that he might (possibly, maybe, hopefully not) intervene with government cash. And as anybody who saw what went down at Bear Stearns knows, when Paulson intervenes, he intervenes with a vengeance, and shareholders are left with essentially nothing.

So on top of the normal risks of injecting new capital into leveraged entities with trillions of dollars of housing exposure, there was an extra political risk that all that capital could be wiped out at any time by an executive decision at 1500 Pennsylvania Avenue.

Writes Sorkin:

For the last two months, Fannie and Freddie ran around Wall Street searching for a savior. Private equity? Sovereign wealth funds? Anyone?

But Wall Street was never really sure what Mr. Paulson would do — and that was a problem. “He never laid out a roadmap and how he would use the power. Because of the uncertainty nobody was willing to put in money” into Fannie or Freddie, said Doug A. Dachille, the chief executive of First Principles Capital Management.

Sorkin for one is skeptical that there was any real emergency, and even hints that Paulson’s decision was political in nature:

Many people in financial circles can’t quite figure out why Mr. Paulson, the former chairman of Goldman Sachs, pulled the trigger when he did. He insisted politics had nothing to do with it. Never mind that the news broke just after the Democratic and Republican conventions, but as far away as possible from the November election.

But as of last week, Fannie and Freddie, for all their troubles, seemed to be bumbling along O.K.

I’m a bit more well-disposed towards Paulson. Clearly, if you are going to intervene, it’s better to do it sooner rather than later. Equally clearly, the management at both companies was something of a shambles, led by lobbying efforts rather than internal strength. And in any case the equity in Frannie was so tiny that it just didn’t make sense any more to run the companies for the benefit of shareholders.

Sure, Paulson might have held off on intervening while the conventions were going on. But the neither-one-thing-nor-the-other status of the GSEs was untenable, and he ultimately simply did the necessary thing. What’s more, I’m glad that it was Paulson doing it, rather than someone like John Snow, who would probably have let things deteriorate much further before pulling out his bazooka.

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