Paulson Readies Bazooka

6 09 2008

It took two months, but the bond market called Henry Paulson’s bluff: The Treasury Secretary was widely expected this weekend to announce a plan to take Fannie Mae and Freddie Mac under government control.

News reports say the mortgage giants will be placed under a “conservatorship” of their new regulator, the Federal Housing Finance Agency. The agency would likely temporarily run Fannie and Freddie and back any liabilities until the two companies’ financial standing was strengthened.

The reports come just two months after Paulson attempted to calm financial markets by pledging government support for Fannie (FNM, Fortune 500) and Freddie (FRE, Fortune 500), which were under siege by investors because of fears about their weak balance sheets.

Paulson asked Congress for the right to use taxpayer funds to intervene – but hoped the pledge alone would be sufficient. “If you have a bazooka in your pocket and people know it, you probably won’t have to use it,” he said at a July 15 Senate Banking Committee hearing.

But now Paulson is readying the bazooka, because the markets didn’t respond as hoped. Shares in the companies bounced back from multiyear lows in recent weeks, but bond markets have not regained confidence in Fannie and Freddie.

The amount the companies pay to borrow in the bond market has risen sharply during the past year.

Fannie and Freddie rely heavily on their ability to borrow money at good rates, which they use to buy mortgages from lenders – they now own or guarantee some $5 trillion in home loans.

Investors began shunning debt issued by Fannie and Freddie in favor of U.S. Treasury bonds. On Friday, yields on the 10-year Treasury note hit a five-month low at 3.55%, down a full percentage point from a year ago. This reflects greater demand for the perceived safety in Treasuries.

Foreign central banks, particularly China’s, have in recent years been among the biggest buyers of “agency” bonds, those issued by Fannie, Freddie and other government entities. But they’ve been backing away. Brad Setser, an economist at the Council on Foreign Relations, noted last month that Federal Reserve data showed foreign central banks were, for the first time in four years, net sellers of agency bonds.

The White House and the Treasury Dept. would not comment on the reports.


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