U.S. offers plan to steady Freddie Mac and Fannie Mae

Also Sunday, the Federal Reserve agreed to permit the companies to borrow directly from the central bank, as investment firms were allowed to do after the near-collapse of Bear Stearns Cos. in March. The money would tide Fannie and Freddie over while the administration and Congress rush the emergency measures through.

Both the companies and the government said they did not fear a collapse but that assurances were needed to soothe Wall Street, where the companies' shares lost nearly half their value last week.

"Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies," Treasury Secretary Henry M. Paulson Jr. said in disclosing the administration's plan. "Their support for the housing market is particularly important as we work through the current housing correction."

The two own or guarantee nearly half of the nation's $12 trillion in mortgage debt, and the new proposals would allow them to borrow billions of dollars, both to shore up their finances and to expand.

"This is basically a safety net," said Assistant Treasury Secretary Michelle Davis. "We do not expect to need to execute on either [the increased Treasury lending or the government stock purchase] immediately."

The government stopped short of an outright takeover of the two companies, which have suffered billions of dollars in losses as rising numbers of Americans default on their mortgages.

Nevertheless, the plan amounted to a blunt acknowledgment that what began as a stock-market sell-off by jittery investors had grown in intensity and begun to threaten the functioning of the mortgage market and health of the broader U.S. economy.

"It is very dramatic and historic," said Ed Grebeck, chief executive of Tempus Advisors, a debt-strategy firm in Stamford, Conn. "The government must have felt it had no choice because of the situation in the residential property market combined with mortgage defaults of an unprecedented nature."

The government's plans are aimed at persuading Wall Street to renew its faith in the operations of Fannie Mae and Freddie Mac, to reassure holders of the companies' bonds that the government stands behind the debt and to allow the firms not only to continue running but to expand operations so they can ease the grip of the credit crunch on the nation's economy.

The plan calls on Congress to increase the companies' existing $2.25-billion credit lines at Treasury and to allow the department to take the extremely rare step of buying equity stakes, if needed, to bolster the companies' capital.

The plan also calls for tighter regulation of the mortgage giant by having the Federal Reserve play a role in overseeing them.

The 5-0 vote by the Fed's Board of Governors to lend money directly to Fannie and Freddie marked the second time this year that the Fed had stepped in to help bolster the nation's jittery financial system. In March, as Bear Stearns nearly failed, it allowed similar borrowing by investment banks.

Though publicly owned, Fannie and Freddie were chartered by the government and are relied on to grease the wheels of the housing market. They buy mortgages and mortgage-backed securities with money borrowed in the credit markets, and any sign that they can't get access to funding could throw another monkey wrench into the troubled housing market.

Between them, Fannie and Freddie have about $90 billion in capital as a cushion against future loan losses. By contrast, the two companies lost a combined $11.8 billion in the nine months ended March 31.

But investors fear that U.S. home prices will continue to decline and that the losses on loans the companies either own or guarantee will get much worse over the next year, depleting their remaining capital.

The government took action early Sunday night in advance of a crucial debt sale by Freddie Mac scheduled for today. Originally viewed as a routine refunding of maturing debt, Freddie was expected to sell $3 billion of short-term notes in a litmus test of the two companies' ability to raise cash for routine operations.

"That'll pretty much tell you what the global markets think of Fannie and Freddie and the broader U.S. residential real estate situation," Grebeck said. If debt investors demand that Freddie Mac pay significantly higher interest rates than usual compared with Treasury securities, "that'll basically establish global-market skepticism."

The plan is certain to be highly controversial, with critics saying it bails out shareholders of companies that took excessive risks during the housing boom in recent years.