Gretchen Morgenson’s New York Times “What Will Mac ’n’ Mae Cost You and Me?” column states that “no bailout exists in a vacuum”. Gretchen spends most of her column discussing the effects on Fannie Mae’s (FNM) unsecured debt and the related possible large dollar value of credit default insurance being traded on it. Fannie is required to defer interest payments for up to 5 years on the unsecured debt if their core capital falls below certain levels. The assumption being the Treasury would only intervene because of inadequate capital, so if the Treasury intervened the unsecured debt would be in default from an insurance standpoint.

In "Banks Lose, but You could Win on Fannie and Freddie Preferreds", I wrote that the best GSE opportunity for individuals (with a high risk tolerance) could be in the preferreds. I said retail investors with a long time horizon should wait until the common and preferred dividends are completely halted. The deferral of interest payments on the unsecured debt would further enhance my case for the GSE recapitalizing through earnings as shareholder owned companies.

Gretchen amplifies my case. She writes that the common and existing preferred shareholders would be hurt most because dividends paid on preferreds issue to the Treasury would take preference to existing shareholders of any kind. I say fine, common only pays a few pennies anyway and new investors should hold off buying the preferreds until they’re priced for no dividend at all. As long as the common and preferreds still exist after the Treasury’s actions, elimination of all dividends and deferral of unsecured debt interest clearly benefits existing common shareholders.

Gretchen does throw in the caveat that everyone’s liquidating preference is bumped down with any Treasury involvement. Liquidation or complete nationalization is the only way common shareholders can lose more from here. Substantial dilution is already built in to the GSE share prices. Gretchen does not address common stock dilution directly, but most analysts believe that the Treasury will demand predatory conversion rights for its preferreds. I think that the Treasury will be more cautious about exerting pain on the common shareholders.

Fannie Mae provides links to the offering circulars of its outstanding preferred issues on its Investor Resources web page. All of the preferred issues are non-cumulative meaning undeclared preferred dividends are lost forever.