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Monday, 2 November 2009

Vampire squid squeezes Fannie Mae

You couldn't make this up. According to the WSJ, Goldman Sachs is in talks to buy millions of dollars of tax credits from government-controlled mortgage giant Fannie Mae. The tax credits are an incentive in US federal law designed to encourage spur investments in low-income housing. The law allows investors to receive tax credits for financing qualified housing developments. These credits tend to be drawn out over periods such as 10 years, and are attractive to companies that know they will be profitable during that span.

The trouble for Fannie Mae is that they lost $37.9 billion in the first six months of 2009 and the US Treasury has invested a combined $96 billion in Fannie Mae and Freddie Mac since the companies were taken over in September 2008. Eventually Fannie Mae will earn enough to wipe out all the losses it is carrying forward, but that time is so far out that the economic value of the tax credits, which can be used to reduce a tax liability but not increase a loss, will be miniscule.

Hence it make sense for Fannie Mae to sell the credits to a tax payer like Goldman Sachs who can use them now rather than in 15 years time. Actually what they may have to do is sell a company geared to the eyeballs with debt with all the free cash stripped out but effectively just the credits remaining. In 2007 Citigroup Inc.'s bank division bought a $676 million portfolio from Fannie Mae, consisting of funds owning 382 properties with 31,050 rental units.

Of course Goldman Sachs need to be incentivised to do this, and the incentive would be that they buy the tax credits at a considerable discount to their face value, although not as high a discount as the implied value to Fannie Mae if they hold them for 15 years. Nevertheless, the price will be high enough to convince the board of Fannie Mae that it is in the best interests of the company to do so.

But of course, not in the best interests of the US tax payer, who will see tax receipts from Goldman Sachs reduced by the full value of the credits. Some of that value will end up bolstering Fannie Mae, but the remainder, and probably the greater part, will end up bolstering the bonus pool at Goldman.

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