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"Treasury Secretary Hank Paulson swatted back reports of government nationalization of Fannie and Freddie, which would mean making explicit what, has long been an implicit taxpayer guarantee of their liabilities. This would instantly add $5 trillion in liabilities to the federal balance sheet, doubling the U.S. public debt burden and putting America’s AAA credit rating at risk. This is a nightmare scenario for taxpayers." Think about the long-term implications of the statement above, which references a doubling of the already off the charts U.S. debt burden and a mention of America possibly losing our AAA credit rating. While yesterday’s government intervention into the Fannie and Freddie (GSEs) situation may be good for traders and short-term market conditions, it is most definitely bad news for the long-term outlook for the United States and U.S. investors. While our government is claiming to let Fannie and Freddie “operate in their current form”, the facts are this is another example of interference with the free market system. Mr. Paulson wants the ability to take an “equity stake” in the GSEs if needed. Taking an equity stake is a form of nationalization. Taking an equity stake means using taxpayer money to buy newly issued shares of Fannie and Freddie. The key is newly issued shares. Newly issued shares are bad news for stockholders in Fannie and Freddie. Why? Because newly issued shares dilute the value of existing shares.
"But if the companies try to raise massive sums of new capital by issuing stock, they will severely dilute the ownership of their current shareholders - that’s a big reason the stocks have nosedived." Assume for illustrative purposes that Fannie had one million shares of common stock outstanding. Assume the government invests our money into one million newly created shares. As an existing shareholder, the book value of your shares gets cut by 50% instantly.
"As part of the plan (to help Fannie & Freddie), the administration will also call on Congress to raise the national debt limit, people briefed on the plan said." Pushing aside this morning's initial reaction and taking a long-term perspective:
Chris Ciovacco
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