The short answer is: “yes”, initially the government can do whatever they want to do. The long answer is “no”, it’s not that easy.
On Friday the Treasury Department announced what is amounting to effectively a government takeover of the two mortgage guarantor giants, Fannie Mae and Freddie Mac. This sent shock waves through the investor community because it would also effectively wipe-out any equity shareholders of Fannie and Freddie have, but guarantee the borrowers rights.
Will this happen? It could, but it could also spell big trouble for the U.S. Government if they do. Here’s why:
Fannie Mae and Freddie Mac are GSE‘s, Government Sponsored Enterprises. The government in reality does not guarantee the assets of these entities, but the idea that they were set-up by the Federal Government to enhance credit flow to targeted segments of the economy gives investors the warm-fuzzies that the investments are safer because the government could guarantee them in times of trouble, which Congress did earlier this summer when it gave the Treasury permission to inject $25 billion into Fannie and Freddie to help shore-up security of the two entities.
Fannie Mae and Freddie Mac guarantee over 50% of all the mortgage in the United States. If they were to fail the repercussions of such would be very devastating to the American homeowner and the economy.
But now there is talk of a government take-over and that has investors running, not walking away from Fannie and Freddie, right at the time that they needed to raise $225 billion to refinance short-term debt. Not a wise move the the Feds… Not wise at all. In my opinion, what the Feds have done is effectively guaranteed the demise of Fannie Mae and Freddie Mac.
Can the Feds do this?
No, not really. Well, not without problems that is. The Federal Government, and the Treasury in particular, do not have the authority to wipe-out stockholders equity in these two private companies. Both Fannie Mae and Freddie Mac are presently above statutory capital requirements, the amount of liquid reserves that are placed upon them by governing bodies. Any shareholder equity taken by the Treasury has to be approved by Fannie Mae/Freddie Mac. The Treasury may be given permission to purchase stock and change board members or management, but they do not have any legal method upon which to take-over and wipe-out shareholder equity.
An actual takeover attempt of Fannie Mae and Freddie Mac would be illegal and would have the potential for legal action against the Federal Government by defrauded investors. It could turn into a big mess for the Federal Government.