Another day, another FRE/FNM bombshell

This morning's Fannie/Freddie fiasco centers on whether the twin monsters will be able to roll over $200B worth of debt. Bloomberg's piece raises (yet again) the spectre of treasury intervention, despite all denials from Paulson et al:

Fannie Mae and Freddie Mac's success in repaying $223 billion of bonds due by the end of the quarter may determine whether they can avoid a federal bailout.

Rising borrowing costs and evidence that demand for their debt was waning last month led Treasury Secretary Henry Paulson to seek the authority to pump unlimited amounts of capital in Fannie and Freddie in an emergency. Their interest costs are again increasing amid concern that credit losses are depleting the capital of the beleaguered mortgage-finance companies.

Rolling over the debt "is the single most important factor to their ability to remain liquid," said Moshe Orenbuch, an analyst at Credit Suisse in New York. "So far, they've been able to do that."

"This whole backstop mechanism was set up so the actual need for it could be avoided," said Mahesh Swaminathan, a mortgage strategist for Credit Suisse in New York. ``The market is testing the Treasury's resolve."

New Capital

The companies, responsible for 42 percent of the U.S. home loan market, need as much as $15 billion each in fresh capital to reserve against losses on mortgages and related securities that they either own or guarantee, Paul Miller, an analyst with Friedman Billings Ramsey & Co. in Arlington, Virginia, said.

The Treasury will probably be forced to buy as much as $30 billion of preferred shares in both Fannie and Freddie by the end of next month, according to Bill Gross, who manages the world's biggest bond fund at Pacific Investment Management Co.

I find it both hilarious and sad that the treasury asked for a blank check while claiming that they had no intention of using it. Perhaps those tactics were required in order to get congress to vote for it while holding their nose.

Initial optimism that Paulson's proposal would bolster confidence in the companies has vanished on concern that the deteriorating housing market may force a bailout, a move that would likely wipe out common shareholders and potentially some preferred stockholders, Miller said.

It's time to face facts: The Paulson plan is only a stopgap to kick the problem into the next administration. Who knows? Maybe he'll still pull it off. However, there was no actual "solution" to the problem: The initial loss of confidence requires more than money, it requires serious housecleaning.

The AP put some color on the upcoming capital raising that needs to occur:

Freddie has said it is committed to raising $5.5 billion to help shore up its troubled balance sheet -- that is nearly twice the size of Freddie's current market capitalization of about $2.84 billion.

Fannie's market capitalization is about $6.58 billion. Friedman, Billings & Ramsey Co. analyst Paul Miller estimates Fannie needs to raise between $5 billion and $10 billion in new capital.

But the prospect of government help has been one of the greatest hang-ups in efforts to raise capital from other investors.

Fannie and Freddie could raise those funds through non-governmental investors, but the cost would likely be severe in terms of interest or dividend payouts depending on the structure of the capital raise and in terms of dilution to current shareholders, analysts said.

"The cost of capital of this nature is just staggering," said Ladenburg Thalmann Inc. analyst Richard Bove. Fannie and Freddie could likely raise capital, but it would cost them so much during the current downturn in the credit market that it is unattractive, Bove said.

At a certain price, though, analysts said the companies would find investors. It is just a matter of what costs and stock dilution investors are willing to incur.

I predict that current investors are going to be unpleased with the results.