U.S. seizes mortgage titans in multibillion-dollar rescue
The federal government executed a sweeping takeover of mortgage giants Fannie Mae and Freddie Mac on Sunday in a move aimed at expanding the pool of money available for home finance and arresting a plunge in housing prices that endangers the nation’s economy.
The basic elements of the aggressive plan start taking effect immediately, but longer-term measures -- especially provisions to grow, then shrink the firms -- are likely to be targets of contention for months to come.
“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 . . . at home and around the globe,” Treasury Secretary Henry M. Paulson said in announcing the government’s actions.
“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,” he said.
The first phase of the government’s plan came Sunday as it seized control of the firms and ousted their chief executives, placing the companies under the indefinite management of their regulator, the Federal Housing Finance Agency.
The plan also calls for buying as much as $200 billion of special stock in the firms soon, standing ready to fund an expansion over the next 15 months and then shrinking operations over a number of years to wean the nation from its dependence on the massive financial might of the combined operations.
Officials would not disclose how much the government might lend the companies to expand, so it was unclear how much more taxpayer money might be needed.
Fannie and Freddie already own or guarantee $5.4 trillion in mortgages, or about half the total outstanding. In the second quarter, the companies backed 84% of all new home loans made, according to industry research firm Inside Mortgage Finance. A separate government agency, the Federal Housing Administration, insures many of the rest.
Asian stocks surged in early trading Monday after the takeover as investors concluded it would shore up global financial markets reeling from more than $500 billion in credit losses.
But even as government officials moved to take control of the troubled firms, it was clear they still faced challenges and a delicate balancing game. They must satisfy enough investors to ensure that the companies’ bonds and mortgage-backed securities are considered safe bets. At the same time, they must avoid seeming to risk billions of tax dollars to bail out the firms’ investors.
In perhaps the most unexpected aspect of its rescue effort, the government said that the Treasury would start buying up an undetermined quantity of the mortgage-backed securities issued by the troubled firms. And it will even permit Fannie and Freddie to temporarily ratchet up their own buying of such securities in an effort to expand the funds available for mortgages and drive down the interest rates that home buyers must pay.
Despite dramatic rate cuts by the Federal Reserve over the last year, the rate for a standard 30-year fixed-rate mortgage has remained stubbornly above 6%.
Many policy analysts had hoped the rescue would set the stage for Washington to finally divest itself of the firms and, with them, the expensive responsibility of riding to their rescue in the future. These critics complained that the takeover’s structure all but assured the opposite.
“The effect will be to keep the companies alive and in government hands,” said Peter J. Wallison, a former Reagan administration Treasury official who has been the firms’ sharpest critic. “I just don’t understand why anybody would do this.”
On the other hand, longtime congressional supporters of Fannie and Freddie were surprised by Treasury’s call for the firms to shrink their operations dramatically after briefly expanding them. They pledged to fight the move.
“There is no basis for that,” said Rep. Barney Frank (D-Mass.), the influential chairman of the House Financial Services Committee. “This thing is not at all binding, and we’ll debate that,” he said of the Treasury’s cutback order.
Paulson and James B. Lockhart, director of the Federal Housing Finance Agency, would not say what spurred the government to act now.
Both refused to comment on reports that investment advisors hired by Treasury had uncovered accounting irregularities at Freddie Mac that inflated the amount the company had set aside as a financial cushion in case of trouble.
But the Federal Housing Finance Agency is scheduled to issue a report this month that is widely expected to show the firms have sustained huge new losses and that one or both may be insolvent by some measures. The two already have reported losing $14.9 billion over the last year.
“I have determined the companies cannot continue to operate safely and soundly and fulfill their critical public mission . . . in supporting the residential mortgage market in this country,” Lockhart said.
Many worries about Fannie and Freddie have centered on their complicated nature. As publicly chartered but shareholder-owned, they have been responsible for both making profit for their investors and helping Americans buy homes. Those worries intensified after the start of the current crisis, when some critics said the firms’ desire to satisfy shareholders was trumping their ability to help the government buoy the housing market.
Government officials asserted Sunday that the takeover plan resolved any mismatch of aims in favor of the firms’ public mission.
Lockhart said that all lobbying by Fannie and Freddie, which were famous for getting their way in Congress, “will be halted immediately.” He said the companies also would be ordered to stop paying more than $2 billion a year in common and preferred stock dividends.
Paulson said that the pair had been operating with a “flawed business model” and that henceforth their chief purpose would be to help the housing market.
“Our economy and our markets will not recover until the bulk of the housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing,” he said.
The government replaced Fannie Chief Executive Daniel Mudd with Herbert M. Allison Jr., the former chairman of investment firm TIAA-CREF, and replaced Freddie Chief Executive Richard Syron with David M. Moffett, a senior advisor at Carlyle Group, a private equity firm.
Mudd and Syron are expected to stay on for a transition period.
Paulson said that the firms would expand their portfolios of mortgages and mortgage-backed securities from their current sizes of about $750 billion for Fannie and almost $800 billion for Freddie to $850 billion between now and the end of 2009.
But starting in 2010, Paulson wants the companies to reduce their mortgage holdings by 10% a year until they each hold only about $250 billion.
Instead of choosing to push the firms into a bankruptcy-like receivership, officials chose to allow stockholders to hold on to their shares and profit at least to some degree if the pair ultimately recover.
Any government investment in the companies would involve the purchase of so-called senior preferred stock, which would put Washington first in line among shareholders to get its money back. The Treasury’s investments would come with the right to buy up to 80% of the firms for $1 or less a share.
Lockhart said that the companies would continue to pay principal and interest on all of their debt, including payments on about $15 billion of so-called subordinated debt whose holders usually get nothing in conventional bankruptcies.
Paulson described the goal of the takeover as a “time out” to stabilize Fannie and Freddie “while we decide their future role and structure.”
In the end, however, Washington’s move means the federal government will directly back the great majority of the nation’s home mortgages.
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Voices
‘Americans should be confident that the actions taken today will strengthen our ability to weather the housing correction and are critical to returning the economy to stronger sustained growth.’
president
‘Given the substantial role that Fannie Mae and Freddie Mac play in our housing system, I believe that some form of intervention is necessary to prevent a larger and deeper crisis throughout our entire economy.’
‘These necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets.’
‘This is not going to prevent a meaningful number of foreclosures, in and of itself.’
‘We own lots of mortgage-backed bonds, and I would expect on Monday and in the ensuing weeks for them to do very well. So yes, I’m smiling at the moment.’
‘The new Congress and the next administration must decide what role government in general, and these entities in particular, should play in the housing market. There is a consensus . . . that these enterprises pose a systemic risk and they cannot continue in their current form.’
Treasury secretary
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$1 billion
- Initial U.S. investment in each firm
$100 billion
- Maximum U.S. investment in each firm
79.9%
- Government’s initial stake in each company
10%
- Interest rate U.S. will get on its investment
$1.56 trillion
- Home loans and mortgage-backed bonds owned by Fannie and Freddie.
Source: Times research
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Stabilization plan
Key elements of the federal government’s rescue, announced Sunday, of mortgage giants Fannie Mae and Freddie Mac:
The Federal Housing Finance Agency seized control of Fannie and Freddie by placing them into so-called conservatorship.
The companies’ chief executives were replaced by outsiders appointed by the government.
The Treasury is buying $1 billion initially -- and as much as $100 billion eventually -- of senior preferred stock in each company, as much as necessary to keep the firms solvent.
The Treasury will buy, in the open market, mortgage-backed securities issued by Fannie and Freddie, beginning with a $5-billion purchase this month.
Fannie and Freddie are banned from lobbying and other political activities.
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Source: Times research
