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Treasury Secretary Henry Paulson speaks at a news conference announcing a federal takeover of Fannie Mae and Freddie Mac as Federal Housing Finance Agency Director James B. Lockhart looks on September 7, 2008 in Washington, DC. (Brendan Hoffman/Getty Images)
NEW YORK—On Sunday, the U.S. government seized control of Fannie Mae and Freddie Mac, two struggling government sponsored enterprises (GSE) which together guarantee $5.5 trillion in home loans. The Treasury department announced a four-step plan in the latest—and most aggressive—move to shore up the U.S. mortgage market amidst record foreclosure rates and plummeting real estate prices.
The announcement was made Sunday morning by Hank Paulson, U.S. Treasury Secretary, and James Lockhart, Director of FHFA.
The current CEOs of Fannie and Freddie were dismissed, and Fannie and Freddie will both be put in a federal “conservatorship” to be overseen by the Federal Housing Finance Agency (FHFA). Herb Allison, former president of giant pension fund TIAA-CREF, will be appointed to run Fannie, and David Moffett, former CFO of U.S. Bancorp, will lead Freddie.
“I have long said that the housing correction poses the biggest risk to our economy. It is a drag on our economic growth, and at the heart of the turmoil and stress for our financial markets and financial institutions,” Paulson said in a statement. “Our economy and our markets will not recover until the bulk of this housing correction is behind us.”
“Fannie Mae and Freddie Mac are critical to turning the corner on housing,” the Secretary added.
Together, the GSEs account for more than 70 percent of all U.S. home loans, and if left to collapse, many analysts believe its consequences on the U.S. economy and consumers may be devastating.
The takeovers of Fannie and Freddie will halt dividend payments to both common and preferred shareholders, and all lobbying and political activities at the GSEs will be suspended.
Perhaps hinting that Fannie and Freddie may wind down in the long term, Paulson said the GSEs may “modestly increase” their mortgage-backed securities portfolio through the end of next year, followed by a ten percent reduction every year, starting in 2010.
Fannie lost $2.3 billion in the second quarter, and Freddie posted a loss of $821 million during the same period.
A Four Part Plan
The federal government’s four-step plan begins with putting the GSEs in a federal conservatorship, where the FHFA will maintain oversight of the companies to ensure solvency.
“The goals of the conservatorship are to help restore confidence in the company, enhance its capacity to fulfill its mission, and mitigate the systemic risk that has contributed directly to the instability in the current market,” FHFA said in a release.
The U.S. Treasury, together with FHFA, will purchase a new series of senior preferred stock from Fannie and Freddie. The shares will pay dividends and are senior to current preferred and common shareholders in the event of liquidation.
In an unprecedented effort to increase market liquidity, the U.S. Treasury plans to buy billions of dollars worth of Fannie and Freddie’s mortgage-backed securities from the open market.
The Treasury also announced the creation of a “Secured Lending Credit Facility,” a line of credit for Fannie and Freddie for emergency funding. The loans should provide cash in a liquidity crisis, and will be secured by Fannie and Freddie’s mortgage-backed securities holdings.
“Given the combination of actions we are taking, including the Preferred Share Purchase Agreements, we expect the GSEs to be in a stronger position to fund their regular business activities in the capital markets,” Paulson said. “This facility is intended to serve as an ultimate liquidity backstop.”
‘A Very, Very Big Step’
Along with investment bank Bear Stearns, Fannie and Freddie are among the largest casualties of the U.S. subprime mortgage crisis that began in late 2006.
The housing bubble of several years ago led to an abundance of credit that ultimately left many homeowners unable to make timely payments as interest rates increased. The subsequent spike in foreclosures and fall in home prices caused billions of dollars in losses at lenders, investment banks, and investors who hold positions in mortgage-backed securities.
Fannie and Freddie are in the business of purchasing individual loans and structuring them into such securities. As mortgage-backed securities fell out of favor among investors, Fannie and Freddie became saddled with debt they are unable to sell, igniting rumors of a collapse until this summer, when the federal government announced plans to step in.
For years, analysts have questioned the viability of Fannie and Freddie’s roles as the companies tacked on more exposure while maintaining barely the minimum required reserve amounts. But yesterday’s actions should calm the market down, at least temporarily.
“This was a problem that started 15 years ago, when Fannie Mae and Freddie Mac started expanding their portfolios beyond their mandate of insuring and purchasing conforming loans,” Andrew Harding, Director of Taxable Fixed-Income at Allegiant Asset Management, said in an interview with Reuters.
“The reality is that some action like this needed to be taken and this was the linchpin,” he added. “What you will see is a tremendous rally in mortgage-backed securities and (senior agency debt) … This is certainly a very, very big step to fixing the credit markets.”
Many analysts noted that the measures will introduce short term market stability, but may not generate a rebound in the housing market.
On Sunday, Paulson reiterated the importance of rescuing Fannie and Freddie, and the move’s impact on the U.S. economy.
“Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe,” he said.
“This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation.”
