Feds Unveil Fannie/Freddy Rescue Plan

7 09 2008

Federal officials on Sunday unveiled an extraordinary takeover of Fannie Mae and Freddie Mac, putting the government in charge of the twin mortgage giants and the $5 trillion in home loans they back.

The move marks Washington’s most dramatic attempt yet to shore up the nation’s housing market, which is suffering from record foreclosures and falling prices.

The sweeping plan, announced by Treasury Secretary Henry Paulson and James Lockhart, director of the Federal Housing Finance Agency, places the two companies into a “conservatorship” to be overseen by the Federal Housing Finance Agency. Under conservatorship, the government would temporarily run Fannie and Freddie until they are on stronger footing.

“A failure [of Fannie and Freddie] would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance,” Paulson said at a press conference in Washington. “And a failure would be harmful to economic growth and job creation.”

Freddie (FRE, Fortune 500) and Fannie (FNM, Fortune 500), which were created by the U.S. government, have been badly hurt in the last year by the sharp decline in home prices and the rise in mortgage delinquencies and foreclosures, racking up about $12 billion in losses.

On Sunday, officials stressed that both Fannie and Freddie will be open for business on Monday morning, although the firms will have undergone a dramatic facelift.

Freddie CEO Richard Syron and Fannie CEO Daniel Mudd will no longer run the agencies, while the FHFA will assume control of the boards of both companies. Regulators took care not to foist blame on the two men, adding that they would remain with the firms to help with the transition.

Syron and Mudd will be replaced by two finance veterans charged with restoring the mortgage titans to health. Herb Allison, the former chairman and CEO of pension provider TIAA-CREF, will head Fannie Mae. Allison formerly served as president of Merrill Lynch.

David Moffett, who served as vice chairman and chief financial officer of U.S. Bancorp until early 2007 and then joined the Carlyle Group private-equity firm as a senior advisor, will take over Freddie Mac.

At the same time, dividends on both common and preferred shares will be eliminated in an effort to conserve about $2 billion annually. All of the firms’ lobbying and political activities will be halted immediately and charitable activities reviewed.

In addition, the Treasury Department announced a series of moves targeted at providing relief to both housing and financial markets.

Paulson said Treasury would boost mortgages by purchasing mortgage-backed securities from Freddie and Fannie, as well as offering to lend money to the companies and the 12 Federal Home Loan Banks. The home loan banks advance funds to more than 8,000 member banks. (Read what Paulson said)

The Treasury, with fellow regulator FHFA, will also buy preferred stock in Fannie and Freddie to provide security to the companies’ debt holders and bolster housing finance.

How we got here

Sunday’s decision culminates weeks of meetings and analysis by top federal regulators and management teams assessing the health of the companies.

“We examined all options available, and determined that this comprehensive and complementary set of actions best meets our three objectives of market stability, mortgage availability and taxpayer protection,” Paulson said.

The two firms buy loans, attach a guarantee, then sell securities backed by the loans’ income stream. All told, they own or back $5.4 trillion worth of home debt – half the mortgage debt in the country.

At the same time, Fannie and Freddie have become virtually the only source of funding for banks and other home lenders looking to make home loans. Their ability to do so is crucial to the recovery of the battered home market and the broader U.S. economy.

In mid-July, the Treasury Department and Federal Reserve announced steps in to make funds available to the firms if necessary and Congress approved the sweeping proposals later that month.

Shares of both companies are down more than 80% so far this year.

Unanswered questions

The cost of the government intervention remains unclear. Experts argue that it will depend in large part on the structure of the rescue, the direction of home prices and mortgage default rates.

Still it seems almost certain it will run into the billions and will most likely eclipse such other high-profile government bailouts including than the Federal Reserve’s $29 billion backing of Bear Stearns assets when it was taken over by J.P. Morgan Chase.

In his remarks, Paulson said that the cost to taxpayers would largely depend on how Freddie and Fannie perform.

Another unintended yet unavoidable consequence may be the impact to the nation’s banks.

Some of the nation’s largest financial institutions including JPMorgan Chase (JPM, Fortune 500) and Sovereign Bancorp (SOV, Fortune 500) own a big chunk of the estimated $36 billion in preferred shares of Fannie and Freddie, which are at risk of being wiped out should Fannie and Freddie do end up getting a cash infusion from the Treasury Department. To top of page


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