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April 20th, 2009

How A Velvet Glove Can Become An Iron Fist



“Once the government gets its claws into an industry, it’s often hard to get them out,” said HSH Vice President Keith Gumbinger.

Certain scenarios which started out as sounding more like conspiracy theories for nationalization have, within a couple of months, begun to sound a lot more plausible. There are certainly a number of hot-button issues circulating through the financial world these days — “nationalization” being one of them.

One could argue that the transition of the once quasi-government controlled Fannie Mae and Freddie Mac to the government-run Fannie Mae and Freddie Mac could also be happening (in a roundabout way) to our nation’s largest banks. Many of these mounting scenarios are considered by critics, as the New York Times put it today, as “a back door to nationalization.”

These scenarios include the increased operating restrictions for TARP banks, bank stress tests which can result in the exchange of Federal dollars for banks’ equity shares, and the TARP repayment restrictions.

To review: Since being taken over, Fannie and Freddie have become a valuable tool for Washington to enact the vision of the Federal Reserve, Congress, and the White House vision for lower mortgage rates and national refinance and loan modification programs. The mechanism of Fannie Mae and Freddie Mac has been invaluable to accomplishing the housing reform goals of the U.S. government.

As the economic crisis came to a head last fall, Congress allotted $700 billion to the nation’s largest and most unstable banks with the hopes of unfreezing the credit markets. Recipients of the money grew increasingly frustrated with the excess baggage that accompanied the federal aid. Bankers argued that Washington was trying to tell them how to do business. Many smaller, healthier banks began refusing the money, and now others are working hard to pay it back.

As conditions began to improve, the Treasury announced a series of stress tests to determine the future liability of the nation’s 19 largest banks. The Treasury’s plan would provide the institutions with additional capital (if needed) in exchange for shares of the banks’ common stock. As fiscal situations at struggling institutions like Citi worsened, the government’s stake in the institutions grew. According to the Times, the Treasury now owns 36% of Citi’s common shares (which come with full voting rights — the Treasury is trying to decide what to do with it), becoming the bank’s largest shareholder.

Just this weekend, a U.S. official reiterated that the Treasury would allow healthy banks to repay their TARP loans, but only after they pass three new tests to determine if the institutions can operate safely and free of funding.

Here’s why those so-called “conspiracy theories” are feeling more factual everyday:

First, the added TARP restrictions indicated that banks would have to do business how the government saw fit, as long as they were operating with their money. Second, the stress tests allow the Treasury to have a controlling stake in several banks, if they deem the institutions to be under-capitalized. Lastly, the newly added repayment tests have seemingly become another roadblock preventing banks from moving out from under Washington’s control.

Some will say that what started out as a gesture of good faith has turned into a road of indebtedness. The same way in which Fannie and Freddie have been taken over and utilized solely for government programs is what seems to be developing in our banking system.

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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