Apparently, Hank Paulson is against bailing out the shareholders of the two entities - Fannie Mae and Freddie Mac (WSJ). His argument is that bailing out the shareholders will fan moral hazard. This was the same argument he used to suggest Bear Sterns be sold at $2.
However, he is forgetting about the moral hazard that is being created by bailing out the debt holders. Fannie Mae yields might actually tighten if the US govt gives explicit guarantee to its debt. Similarly, Bear Sterns bondholders benefitted when the bigger JPM took BSC over.
What Paulson and co dont want is for credit costs to jump up even more. If mortgage rates in US were to rise - they haven't really come down despite all the Fed cuts due to spread widening - housing will take a further beating. Paulson, Bernanke and co are deciding right now who wins and who looses.
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