Fannie & Freddie in Conservatorship - Another Sunday Announcement Intended to Stabilize the U.S. Housing Mortgage Market and Reassure U.S. & Global Financial Markets

The Perils of Fannie and Freddie (playing out somewhat like that old cliff-hanger series, "The Perils of Pauline") have kept financial commentators on the edge of their seats all summer.  Today, regulators made another Sunday announcement of actions taken to address the severe capital problems facing these two secondary mortgage market giants.

Treasury Secretary Henry Paulson's statement represents the most concise summary of today's government action:

1.  Jim Lockhart, Director of the newly created Federal Housing Finance Agency (FHFA), placed both Fannie Mae and Freddie Mac into conservatorship.

2. Treasury will initially be issued $1 Billion in senior preferred stock in each of the two entities (Fannie & Freddie), with the likelihood of more infusions of Treasury investments as needed.  the aim is to reassure the markets and avoid moving from conservatorship to receivership (total insolvency and liquidation).  Treasury will also be granted warrants assuring 79.9% ownership control.  Common stockholders will not immediately be completely wiped out, but the value of their holdings is now in the "junk bond" range.

3.  Treasury has established a new secured lending facility available to Fannie, Freddie, and the Federal Home Loan Banks to assure continued liquidity in the mortgage market.

4.  Treasury is also initiating a temporary program to purchase Mortgage Backed Securities (MSBs) from Fannie and Freddie -- again more liquidity.

5.  Fannie and Freddie will "modestly" increase their mortgage-backed securities portfolios through 2009 and then begin gradually decreasing their portfolios at 10% per year.  Obviously, there is a need to increase the number of players in the secondary mortgage market to avoid the current situation in which problems with these two giant GSEs have such overwhelming market impact.

Paulson reiterated three goals:  Providing stability to the financial markets; Supporting the availability of mortgage finance; and Protecting taxpayers.  Both Fannie and Freddie have experienced major stock price drops and increasing lack of confidence from the financial markets.  The U.S. housing market depends on these two Government Sponsored Entities (GSEs) for continued operation of the secondary mortgage market and the liquidity our banking system needs to continue making home mortgages.  Taking action now is intended to stop the financial bleeding and limit the inevitable bailout pricetag. 

Paulson and the Federal Banking Agencies reassured the public and the markets that these actions with respect to Fannie and Freddie should not undermine confidence in other financial institutions.  These two GSEs are different because their portfolios are limited to mortgages, whereas other financials are better diversified.  In addition, the federal banking agencies noted that they would work with financial institutions holding investments in preferred or common stock in Fannie or Freddie as these other affected financial institutions develop capital restoration plans.

This is not an outright nationalization of Fannie and Freddie -- although that issue is clearly on the table.  Paulson did say that the GSEs had been operating under a business model that created an unacceptable conflict between the interests of shareholders and the public interest in stable housing finance.  In addition, the current rescue plan was necessitated because of ambiguity over the nature of government backing for Fannie and Freddie as GSEs.

We can certainly expect debate and clarification over the next few days -- and more permanent restructuring after the November election, regardless of which party controls the White House.

Link to Paulson statement:  http://www.treas.gov/press/releases/hp1129.htm

(ag) Sept. 7, 2008, in Economy