Friday Afternoon Is Bad News Time

If you’ve been paying attention, the Fed likes to release bad news after the markets close on friday afternoon. The past couple weeks, they’ve announced the failures of small regional banks.

Well today, they announced something just a little bit bigger – the government bailout/takeover of Fannie Mae and Freddie Mac, the two large mortgage finance guarantors. The markets have been expecting this for a while, but obviously not everyone was expecting it as their stock prices were $5.50 and $4 respectively when the market closed today. If everyone was expecting this, then those prices would have been a lot closer to zero.

This means the US taxpayers are now the guarantors of many of the mortgages that have been issued in recent years. Nobody really knows how much liability that the government/us taxpayers have taken on, but it’s certainly a huge number, way more than the savings and loan bailout of the late 80s.

I’ve been reading The Black Swan which talks about the impact of highly improbable events and how often they actually happen. Two years ago, if you had asked wall street insiders what the probability was of a bankruptcy of Fannie Mae and Freddie Mac, they’d have most certainly said less than 1%. And yet that is basically what we’ve just witnessed. It’s not technically a bankruptcy, but the equity has been wiped out and the company has been taken over by the only entity that can guaranty the debt – the US govt/taxpayers.

Some will argue that this is really good news, that this marks the bottom of the bear market in real estate and the final capitulation from which we can now start moving higher. I don’t think so. The small regional banks that the Fed’s been letting go under the past couple weeks will continue to go under and I think we’ve got at least another six months to a year of bad news in the real estate/mortgage business before it’s all over.

However, I’ve also heard that the smart money that was short real estate and mortgages for the past couple years has mostly closed out those shorts and is starting to put together significant capital to buy mortgages (maybe from the us, the taxpayers, via Fannie Mae and Freddie Mac – just as smart money did after the S&L bailout).

So, we are closer to the bottom than the top and although we’ve got more pain to work through, the smart money is starting to shift their posture.

How does this impact startup land and venture capital? Well from my vantage point, we’ve been largely spared for the past year. And I think we’ll muddle through this period better than many other sectors. But the capital markets are a mess and we should not expect a rosy exit environment any time soon. And we should expect to continue to get bad news on fridays after the market closes for a little while longer too.


Comments (Archived):

  1. Ed

    I appreciate your perspective.I also agree that the bad news will continue. And I think some sizable banks, and other entities will be included.

  2. arjunram

    Whats your take on this impacting the international market? More importantly the international VC market..Would you be more interested in the companies catering to international markets? or international companies catering locally?Thoughts?

    1. fredwilson

      The uk and parts of western europe are experiencing similar things. I hope their situation is not as bad as ours. It seems that euro vc investing is down a lot this year. Not sure its related but it could be

  3. howardlindzon

    Good post. As I tweeted, It’s bullshhit though. How is this SMALL government and how is Bill Gross able to bull his way around if he’s a mutual fund manager and act like a government insider.I am for the greater good, but Bill Gross is not the greater good.Another sad day for capitalism and free markets, but time will hopefully heal it.

    1. fredwilson

      I’ve got one word for the bush administration: cronyismOf course there are many more that apply but in this instance, that’s what we’ve got going on in our capital markets

      1. Brian

        How exactly is this Bush “Crony Capitalism”?Bush is the only person in government that has challenged Fannie Mae and Freddie Mac.Shareholders are wiped out? Where is the cronyism?

        1. Guest

          Brian,by deregulating the financial sector Bush created environment which allowed Wall Street to book imaginary paper profits, thus leading to the distribution of obscene bonuses among Bush’s cronies. Now that the tide is receding, the resulting deficiencies are being socialized by taxpayers, foreign investors, and pension funds.Paul Krugman has written extensively on this, however, in this case his opinion is shared by the likes of Warren Buffet and Kevin Philips: not exactly Krugman-like liberals.

          1. Brian

            What does any of that have to do with Fannie Mae and Freddie Mac?The subprime debacle has nothing to do with financial deregulation. Regulations on the GSEs actually increased under the Bush administration.Mortgages are the most regulated part of the financial industry. The problem were banks were encouraged by Congress to increase home ownership by giving loans to people who cannot pay their bills.Fan and Fred’s time bomb started n the 90s when they were allowed to buy MBS (Mortgage Back Securities) to put on their books.Last time I checked ACORN, Jim Johnson, and Frank Raines were not Bush cronies.

          2. Guest

            Yes and no. Deregulation of the industry led to Fannie Mae and Fred Mac losing market share to less regulated players. To stay competetive they tried to do a whole bunch of things to keep their earning growth (according to Buffet), which ultimately led to their demise.

          3. Brian

            All of their derivative activity started in the 90s. The problem started when they went beyond just issuing securities to actually purchasing securities.OPHEO raised a stink, but Congress shouted them down.Fannie and Freddie have been bad news for the past 15 years. They were just finally put in a situation that they could not lobby their way out of.What mortgage rules have been eased over the last 7 years? No doc, interest only, and sub prime have been around for years.The only change is congress coercing banks to lend to people who have no means to repay loans in the name of affordable housing goals.

        2. fredwilson

          Bondholders are made whole

      2. Steven Kane

        hi fred. in what way do you see the bush administration as being at fault in the demise of fannie and freddie?as many of the other comments have pointed out, the two GSEs have been much more the creation and ward of the democrat leadership, in congress.which is not to say that the cheap money policies and ecosystem of the last 6-7 years haven’t had a negative impact. gas on the fire, of course.but jeez louise, i don’t see how we go about doing things better next time if we create a scapegoat called “the bush administration” and will ourselves to believe we can simply smash idols and be rid of demons

        1. fredwilson

          My cronyism comment was not implying that the Bush Administration is atfault for the demise, I think we can lay that at the hands of our governmentbroadly. But the decision to make the bond holders whole leaves me shakingmy head. Why do they get spared when the taxpayers are paying the bills?

          1. Steven Kane

            Yes, that seems to be the strategy of the times. I can’t say I’ve ever seenit explained. Btw, I know its a bit unfashionable to say but I still thinkthe glass is half full. Or 3/4 full. Mortage default rates are upsetting asabsolute numbers of course but are not out of whack, historically. Ditto thefederal deficit. Ditto the unemployment rate. And while its clear we wenttoo far flooding the money supply, for me, having an ³ownership society² asour goal still seems like a noble pursuit. What’s the alternative. I thinkits called fuedalism? 😉

          2. MassMan

            With $5.2 trillion in mortgage securities at risk, the Bushies bailed them out because they had to. They simply had no other choice. The lending markets have responded and it seems to be working. The yield of Fannie Mae perfect coupons has drop in the last few days (5.16% current yield versus the approximately 6%last week).As far as punishing the investors goes, you’ll have to look at each class.The equity investors have been crushed. The pref shareholders ($36 Billion) will get diluted which was a Hobson’s choice. Crush the preferreds or wipe out the shareholders of a lot of banks and have the FDIC pick up the costs. By the way, Congress and bank regulators encouraged banks to buy preferred shares by giving them special status and tax breaks. Expect the FDIC to foot some of the bill on this one.The debt was essentially off limits. If that defaulted then it would ignite a fire the Credit Default Swap market that would make the current crisis look like a picnic.It’s ugly. It was foretold and everyone (bushies, clintons, congress, etc.) stood around and did nothing to stop it.

          3. fredwilson

            So now we move on to lehman. The markets are testing to see where the govt will stop bailing out bad portfolios

          4. MassMan

            It’s all over for Lehman. They will be sold or merge with another institution with the Fed underiting the risk on the transaction. Lehman, like Bear, is too important to the CDS market to fail.Unfortunately, what we really have is corporatism. And the essential characteristic of this system is that while profits are private, losses are socialized, i.e., ultimately covered by the mass of people without political clout.

          5. fredwilson

            The alternative is real capitalism where we don’t incent people to take stupid risks

          6. Steven Kane

            Ah.But that simple statement is an incredibly difficult ‹ maybe impossible ‹ideal to live up to.And worse, it is anti-innovation.What is a ³stupid risk²?I feel bad for people who overextended ‹ and predatory lenders and theirenablers should be jailed ‹ but my grandfather and my father ‹ and myself ‹have prospered by taking what many people ‹ most — admonished us were³stupid risks².Trying to protect people from themselves is impossible ‹ and antithetical toan innovation and entrepreneurship society

          7. fredwilson

            Not suggesting protecting themJust suggesting not incenting them to do itMargins on stock investingNo money down loansTeaser interest ratesEtc

  4. Don Jones

    In the S&L crisis, the Feds always took over banks on Friday morning before they opened, so they were closed only three days, per the post Depression-era laws requiring it, ready to re-open Monday. Now they’re doing things on the weekend before the Asian markets open, since they own so much of the debt.As to being closer to the bottom than the top, unfortunately I don’t share your view. The Fan-Fred repercussions are likely to be many smaller bank failures, especially those that are holding their preferred shares and are exposed to mortgages.Also, we’ve only seen write-offs in the low few hundred billion, with many believing the total price tag to top $1 trillion. I was in commercial real estate during the S&L crisis, and it was the longest 5 years of my life. Real estate ain’t technology…it takes a long time to fix this stuff. And other than the regulatory step-ins, nothing will happen until after the election. Then you’ll see Barney Frank and the Congress putting together Resolution Trust Corp. II.

    1. terra210

      What is Resolution Trust Corp. II?

      1. Don Jones

        The first RTC was created to liquidate and sell off all the bad S&L banks in the early 90’s. People are already talking about the need for a second one to do the same now.

  5. gregorylent

    no economist would ever, ever, believe a psychic, but psychics have been saying for a couple of decades that in this time many financial institutions and systems would go belly up, that there would be an intractable war in the middle east, and a bunch of other things about the global situation that seem obvious today.i am just trying to say that this is only a surprise to the insiders. which is worth contemplating.the last to know what is going on are those with the most interest in continuing the status quo.

    1. fredwilson

      We’ve evolved our thinking about health and wellness here in the US to include eastern approaches. Maybe its the time to the same with business and economics. What do the psychics think is coming next?

      1. gregorylent

        relative chaos, near term. new paradigm being forced upon an unwilling (to change) populace.

        1. markslater

          you absolutely have to be kidding me. thats exactly what i was thinking…spooky.

  6. Peter Smith

    glad it’s just the Fed that likes to release bad news on Friday afternoon, else I don’t know what we’d do. i mean, it’s not like this has been a pattern for the last, say, umpteen years. it’s not like any other agency dumps documents on Friday afternoon. it’s not like the Democrats do it, because, well, if they did, it’d be a whole different ballgame. I mean, i know obama would never do anything like that. it’s not like the US government is trying to cover anything up. i mean, it’s not like the US government is trying to subvert democracy or anything. you’d probably have to be one of those crazy anarchists to think that. and if that was the case, you’d probably be rotting in a Shanghai, i mean, St. Paul jail right now – so no need to worry about you. i have a lot of faith in the good ‘ol us of a. yep. they say it, and i spray it. that’s my job.

  7. MassMan

    A couple of points to make:1) This was not a Black Swan event. Their own regulator was warning this would happen in early 2003. The head of that agency was forced out because he told the truth. Congress (mostly Democrats) didn’t want to hear it. You can read the report here:… As an aside, leveraging a financial firm 70 to 1 was an accident waiting to happen. If wasn’t a question of “if” but “when”.2) Of the two parties, the blame resides mostly with the Democrats, although there is plenty of blame to go around. Fannie Mae, in particular, was Donkey Central during the Clinton years. Clinton’s budget boss, Franklin Raines, and Deputy Attorney-General Jamie Gorelick moved into the top jobs and profited hugely on the option packages from bogus “earnings” generated during their tenure. The Bush Administration took on the managements of Fannie Mae and Freddie Mac by mandating that these firms had to begin publishing accurate, timely financial statements (just like every other publicly trade corporation). This of course initiated a war with the administration whereby Fannie and Freddie used their powerful Congressional cheerleaders as a proxy army. Remember quotes like this: ”These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,” said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ”The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.” Published: September 11, 2003 Any hoot, the Bushies won the first battle and Fannie and Freddie were forced to admit that they couldn’t publish accurate financials because (here’s the shocker) they had been inflating their profits for years. It’s incredible that no one has been sent to jail over this. The massive scale of their accounting cover-ups make Enron look like petty theft. It is truly the crime of the century.That said, are we closer to the end? I doubt it. The size ofhangover is inversely proportional with the binge and whata huge binge it was. The Federal Government has no choice inthis matter. They have to bail these entities out. If they don’t,we the people face a systemic collapse of our banking system.What does this mean for venture capital? It’s hard to say.It’s doubtful that deals won’t get done. There are too manypromising technologies that need funding. I do believevaluations will take a hit as risk gets repriced.

    1. Jimroperaz

      What are you smoking?

      1. MassMan

        Marlboro Reds. You?

        1. markslater

          good response massman – it continues to amaze me that this scandal is ignored.

    2. Francis Hwang

      As somebody who almost always votes Democratic it pains me to admit it, but MassMan’s synopsis of the problem seems to jibe with what I’ve been reading too … GSEs are basically a horrible idea, because it’s so easy for them to accumulate enough power to influence their own regulators, and we as a country turned a blind eye to it because it was all supposedly for the purpose of making it easier for working people to buy homes.If you still want the federal government to make it easier to buy homes, we shouldn’t be doing it with GSEs at all, which look like a free lunch for a few decades until Freddie & Fannie default and the U.S. taxpayer ends up with a giant fiscal bomb in his hands. We should be setting aside a fund of X dollars per year, and saying that any private company that wants to give mortgages to first-time homeowners can draw on that fund to guarantee against default or whatever. That way you’d have a bunch of private companies doing the work of making it easier to buy a house, but the government would know its liabilities up-front, and no one lender would be too big to fail.That’s, of course, assuming you think the government should be focusing so much on homeownership. Personally, I’d rather that money be spent on education and health care instead. In the long term you’ll get farther by making your people smarter and healthier–once they’ve got decent job training and reduced chronic illnesses, they’ll be able to buy their homes on their own …

      1. fredwilson

        Bush’s ‘ownership’ mantra has come back to haunt us

      2. daddysteve

        It’s a good thing people are beginning to realize that both parties are to blame for most of our problems.

  8. terra210

    Thanks for this post. I edited fthese bits from my tweets on August 20th:My predictions: $LEH will go under. $GS & $BAC will survive all. Countrywide is smart. They took a position early.”$BAC and $GS sit back & become owners of land, homes, mortgages & business lending. They always survive.The Chinese banks are now moving to US.The Chinese banks will become competitors/partners with $GS and $BAC. $Ozm and $BX also will have huge growth: scooping up as $FRE and $FNM fail”We are fundamentally changing who controls our capital, our land & our funds for education. This will have huge impact on our culture.$GS just went ahead with First Marblehead deal; (educational lending).End TweetsSo my thoughts now are; If we (our governement) now own the $FRE and $FNM debt, does this mean we control some larger piece of our own US mortgages, rather than having sovereign wealth own them? And in the larger picture, might this not be good?$LEH is now looking like it might survive because of investments by sovereign wealth from Japan and Korea. Or is this just the dead cat bounce before the final drop?I think $BAC made a smart move in taking over Countrywide. I know the press blamed Countrywide for much of the mortgage crisis, but this was just for appearances sake. Countrywide is very savvy; and made a move at the right time to keep their position in the mortgage market. $BAC will benefit greatly from this move. I also think part of the housing boon was fueled by the Baby Boomers buying houses, and is negatively impacted by their aging, and so flight or selling as they downsize or gather assets for retirement. This was not the cause of the mortgage crisis of course, but I think it has an impact that very few are talking about.I think this current financial crisis in the US has perforated our boundaries as a country more than in any other time in history. I am not sure this is bad, but it is definitely a transformation. The fact that US investors own so little of our mortgages, land, business lending, means that we are much further indebted to other countries. And our educational lending has now been completely transformed.I also think the announcement that a Chinese Bank will open for the first time on US soil, is huge, and marks the definative transformation on many levels, including politically.As we keep our eyes on the abstractions of the markets, we forget that real changes are transforming the fundamental ownership and so culture of our country.

    1. Guest

      terra:there is no question that a massive transfer of wealth is heading out of the U.S. and it’s been happening for a few years now. In my mind though, it is largely moderated by the fickleness of financial assets vs. real assets.I will give you a real local perspective. Our state, Queensland, is extremely rich in coal, natural gas and other resources. We have had traditionally run budget surpluses that were being invested by a sovereign fund. Last year we had a massive hole in the budget related to losses in the Fund from US financial assets (mostly mortgages). So basically, our very real BTUs from coal and natural gas got converted into financial paper that bombed out.I was in the Parliament last week and talked about this to several MPs. We should invest our surpluses locally, in health, education, research and infrastructure, rather than feeding the Wall Street monster. We’ll see how this goes.Another thing that I completely do not understand is the world’s appetite for U.S. treasuries. The 10 yr yields are bellow inflation. Can someone explain to me: if the U.S. entity was a commercial entity, would somebody buy their debt given that they have $53 trillion in unfunded liabilities and just added another $12 trillion of total (X% of them likely unfunded)? I know that the U.S will make good on them, but mostly because they can print the very currency with which they are paying. Does this even make any sense?

  9. Daniel Weinreb

    See…. Fannie Mae was an accounting trick: by maintaining that the U.S. Government did NOT stand behind Fannie’s loans, the government did not have to consider these loans part of its liabilities. But everybody guessed that this was a fib, which allowed them to borrow money more cheaply than their competitors. They became incredibly leveraged, leading to their downfall.

  10. jer979

    Just finished Foold by Randomness, so we’re on the same page. Thing I am having a hard time understanding/coming to terms with (Fannie/Freddie and Bear Stearns) is: why is the gov’t (i.e. taxpayer) on the hook for when execs make bets that don’t pay off?When you guys invest in a start-up that goes bust, no one bails you out. It’s the market. Why didn’t we just let Bear, et al. fail? What am I missing?And, if these firms know they will be bailed out if they do make bad decisions, won’t that lead to more unwise decisions?

    1. Brian

      The firm is not being bailed out. Most likely equity holders will be wiped out.This is about taking over the GSEs so they stop buying mortgages to buy for their portfolios (which is the cause of this mess in the first place).The feds have always been on the hook for the GSEs debt. This is just making the implicit explicit.

    2. fredwilson

      Its called moral hazard and the markets are full of it now

      1. Brian

        In this case the markets have ALWAYS been full of moral hazard since Fannie and Freddie got into the securitization business over 20 years ago.This is treasury cleaning up the mess Congress created. There is one small type of GSE debt that is considered a bailout, but the rest is just Fan and Fred servicing MBS. I have heard that after treasuries, GSE debt is the next largest holding of central banks.I wish all equity and non-MBS debt was wiped out, but that would not fly by Congress. I think Paulson (for once) did the best he could under the circumstances. Hopefully, after the election plans will be put in place to completely eliminate the GSEs.

  11. Brian

    More details of the real corruption that contributed to the Fan and Fred mess:…Who is going to hold the likes of Barney Frank to account? Where is the outrage?