Second Anniversary: Fannie & Freddie Government Protection Program

It's hard to believe, given the incompatible realities of the anemic economy and the stalwart insistence of the Federal Reserve, Treasury Department and Andrew Ross Sorkin that things would have been so much worse without the bailout, that it was exactly two years ago that the government first moved to subsidize the ailing government sponsored entities (GSE's), Fannie Mae and Freddie Mac, whose stock prices now hover at around 30 cents. 

Yet, today marks the second anniversary of that first step in what became a multi-trillion dollar bailout and subsidization of the entire financial sector. On Sunday, September 7, 2008, the government announced it would buy $200 in preferred stock in Fannie and Freddie (their stock prices subsequently plunged as trading opened on September 8, 2008), followed by another $200 billion round of purchasing in February, 2009. As a quiet Christmas Present last year, Treasury Secretary, Tim Geithner, raised the cap on how much stock the government could purchase to keep the entities afloat - from $200 billion a pop, to - ready for it? - an unlimited amount.

In the past two years, the Treasury Department has explicitly purchased $220 billion of mortgage-backed securities (MBS). It has increased guarantees for the Government National Mortgage Association (GNMA) to $398.4 billion and for the Federal Housing Authority to $365.9 billion. The Fed has bought another $1.4 trillion of GSE mortgage backed securities. And, according to the July Sigtarp report, the government is providing an implicit guarantee of $5.5 trillion for Fannie/Freddie and $1.3 trillion for the Federal Home Loan Bank (FHLB).

Considering that the balance of sub-prime loans at these agencies was only about half a trillion dollars worth, it would seem that this method of excessive, strategy-devoid subsidizing remains - well - haphazard, expensive, and reckless. Far more efficient and economical would be extracting the non-performing loans from their securitized container and forcing their restructuring to benefit the borrower and thus, the related security in which that loan lives, rather than throwing a whole pile of money at the general entity without pinpointing and separating of the worst loans, and thus, providing a more cost-effective remedy to the problem.

Since almost everyone's mortgage lives somewhere within the GSE framework, it's in all of our best-interests to find a solution. This kind of bottom up approach to bailing out and subsidizing has always made more financial sense - to me, anyway. 

Goldman's Private Equity Spin-off - For Rules? or Profits?

Banks aren't boy scouts. So, I tend to be skeptical about banks proactively doing things deigned simply to adhere to new rules, like spinning off their private equity arms  - especially when it's years before those actions are necessary. Yet, despite my general cynicism, I was surprised that even my hero, Tyler Durden, considered the possible spin-off of Goldman's prop desk a positive sign. Now, Andrew Ross Sorkin considering anything Goldman does in a positive light, I expect - but Tyler?

It made me think maybe I was wrong this time. So I took a look at some numbers.

In the last quarter (Q2/2010), Goldman's net revenues were $8.84 billion. Trading (of the Non-Volcker Rule or NVR - type) comprised $5.6 billion (or 63%) of that total. Principal Investments (PI: the area that Goldman considers to be its private equity leg) were $943 million (or 10%.) Compare that to the second quarter of 2009 (q2/2010), in which net revenues were $13.8 billion, trading (NVR) was $10.78 billion (or 78%) and principal investments were $811 million (5.9%).

First, either way -  in good and less good trading quarters - PI comes in at, or below, 10% of total net revenues, not tiny of course, but nothing particularly huge either. 

Second, this is what Goldman's CFO, David Viniar said about that PI's contribution this past quarter:

"Let me now review our Principal Investments, which produced net revenues of $943 million in the second quarter. Our investment in ICBC generated $905 million, largely driven by the recognition of our liquidity valuation adjustment as the transfer restrictions on our investments expired during the quarter. Our corporate and real estate investment portfolios were not meaningful contributors during the quarter."

He basically said that a key part of the business that he considers to be principal investing or private equity (which mostly represents a stake in China's ICBC) came to the end of its investment period. When Goldman bought its stake in ICBC, partners and other investors had to stay parked for three years. Those years are over and they made a killing. Shifting out of that investment because of a US law, rather than just to take profits, might look a whole lot better to China. The rest, as Viniar says - is 'not meaningful.'

Separately, many of the news reports say Goldman may spin off its prop trading desk (others say its private equity arm): yet, nowhere does Viniar mention the prop desk as a separate earnings category, nor is it delineated separately in the firm's earnings report, so it remains to be seen how that would look in practice, and it's unclear why these news reports don't differentiate - or use the earnings statements to do so.

True, Goldman wouldn't be the only bank spinning off a private equity arm: there's Bank of America, Citigroup, and Morgan Stanley, too. But, for all the 'adhering to rules' spin of the spin, these moves aren't particularly meaningful in altering the Wall Street landscape, as the areas aren't significant contributers to the bottom line in revenue or risk, compared to 'customer-driven' or 'market-making' trading. If they were, they wouldn't be happening before the potential 7 years grace-period written into the financial reform bill. Plus, the 'spun-off' entities wouldn't be comprised of shifted investments from the main bank, and run by former employees of the main bank either into the asset management arm or a newly created entity - that's about as close to an overlap as you can get.