As most of you know, the government just introduced a huge bailout plan for Fannie Mae & Freddie Mac. Here’s my input on the situation:

Fannie & Freddie were getting dangerously close to their regulator’s definition of insolvency & the fed knew that if the situation continued to deteriorate there would be huge repercussions in the bond-market which would lead to a collapse of global markets as we know them.

Several months ago a rumor circulated that IndyMac was illiquid & in less than a week so many depositors withdrew their cash (several billion $$) that they truly became illiquid. Yes, they were struggling, but not near to the point of bankruptcy; however perception became reality & they collapsed in a very short amount of time – This is what the fed was trying to prevent.

The fed did not completely take over the GSE’s, they more stepped in as a big piggy bank – The current structure & general business practices of the GSE’s will remain largely unchanged. They also tried to come up with a solution that would not put the complete burden of a bailout on the taxpayers.

Following is a brief detailing of the agreement:

-          Fannie Mae and Freddie Mac (GSEs) give the Treasury each 80% of their stock and $1B (each).

-          The Treasury promises to keep the GSEs solvent by lending it money at 10% per year. If the fed determines that a GSE’s liabilities have exceeded its assets, the Treasury will contribute cash capital to the GSE in an amount equal to the difference between liabilities and assets. An amount equal to each such contribution will be added to the stock held by Treasury. The agreements are contracts between the Treasury and each GSE. They are indefinite in duration and have a capacity of $100 billion each.

-          The Treasury promises to keep the GSEs liquid by buying its Mortgage Backed Securities (Where all home loans ultimately end up), financing the purchase by selling more Treasury bonds, and then holding the MBSs to maturity.

-          The regulating agencies will agree on an additional amount--a "commitment fee"—the GSEs must pay to the Treasury starting in March of 2010. This gives them an opening for future negotiations should they deem that the current agreement is not profitable & needs adjusting.

Interest rates should improve for the following reason: The yield on Mortgage Backed Securities & the 10yr treasury bond have historically been comparable & MBSs have typically risen & fallen along with the 10yr bond. Recently though, investors have been less inclined to place their money in the MBSs & have preferred the safety of the 10yr bonds, so the MBS’s have been forced to increase their yield’s to attract investors from 10yr bonds This has created a much larger than normal spread in the yields & although 10yr bonds are at record lows rates have remained fairly high because of the yield imbalance. Because of the bailout, traditional wisdom would say that the yields should go back to normal, thereby lowering interest rates.

I hope this information is helpful.