Greenspan & PIMCO: A Gross Conflict of Interest
Former Federal Reserve chairman Alan Greenspan was on CNBC last week, ranting about Fannie Mae (FNM) and Freddie Mac (FRE):
“I think the solution here ultimately is going to be ultimately, a nationalization of both Fannie and Freddie. And I hope a restructuring in nationalization more capital coming from taxpayer money. And then split them up into five or ten separate entities and sell them back in the market.”
Appearing with Greenspan on the “Closing Bell” show was PIMCO’s Managing Director and portfolio manager Paul McCulley. PIMCO, the world’s largest bond fund manager, hired Greenspan in May 2007 as a consultant. Yet at no time during the interview did Maria Bartiromo ask Greenspan and McCulley to disclose this relationship and how nationalizing the GSEs would result in a windfall profit for PIMCO.
If the GSEs are nationalized, the spread between Treasuries and the Fannie and Freddie debt will be compressed. The GSEs interest rate costs will go down as their debt would be seen as almost equal to Treasuries. Bond values are inversely correlated to interest rates. Treasury interest rates would rise and their values would decline due to the added equivalent supply. Correspondingly, the outstanding GSE debt will show sharp capital gains, so PIMCO will see a large benefit as they are a big holder of GSE debt. Besides PIMCO, banks would also benefit from GSE nationalization. Banks are also large holders of GSE debt as the debt can partially count toward a bank’s capital requirements. Banks are holding over 50% of the GSEs $5 trillion debt.
Greenspan, PIMCO and the banks should be careful what they wish for. GSE nationalization would cause investors to be wary of purchasing equity in any US financial institution. This would raise the cost of new capital to all financial institutions, regardless of their condition. Banks would have to reduce their balance sheets and contract lending. The fallout would be higher interest rates for both businesses and consumers.
Basically, Greenspan/PIMCO would like the government to do a hostile takeover LBO of Fannie and Freddie so PIMCO could benefit at the expense of shareholders and US taxpayers. Then the investment banks would immediately work on creating IPOs for Greenspan’s “five or ten separate entities.” The IPOs will fail to attract subscribers because if the government takes over a financial institution once, who’s to say they wouldn’t do it again? GSE nationalization is a one-time “total return” for Bill Gross and PIMCO.
Related Post: “What is Paulson Cooking Up For Fannie and Freddie?”
Disclosure: Long FRE
Posted 8/08/2008 09:26:00 AM