Monday, September 8, 2008

Government Takes Control of Fannie Mae and Freddie Mac

On Sunday, Treasury Secretary Henry Paulson announced at a news conference that the U.S. Government had seized control of mortgage finance companies Fannie Mae (FNM) and Freddie Mac (FRE) in an aggressive move to help the distressed U.S. housing market and economy.

Government officials had voiced concerns about the mounting debt at each of the two companies. The companies' debt was the overriding problem as foreign countries that have held their debt became wary of it or were selling it. Both companies were having issues being able to raise the capital reserves needed through recent debt offerings.

Together Fannie Mae and Freddie Mac either own or guarantee approximately $5 trillion of the country's $12 trillion in outstanding home mortgage debt.

"Our economy and our markets will not recover until the bulk of this housing correction is behind us," Treasury Secretary Henry Paulson said at a news conference. "Fannie Mae and Freddie Mac are critical to turning the corner on housing." He continued by saying that, “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.”

"I strongly endorse both the decision by (Federal Housing Finance Agency) Director (James) Lockhart to place Fannie Mae and Freddie Mac into conservatorship and the actions taken by Treasury Secretary Paulson to ensure the financial soundness of those two companies," Federal Reserve Chairman Ben Bernanke said in a statement. "These necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets."

Both companies were placed into a government conservatorship that will be run by the Federal Housing Finance Agency, the new agency created by Congress this summer to regulate Fannie and Freddie. As part of the plan, FHFA will operate both companies until they are stabilized and the Treasury will extend financing until December 31, 2009, if needed. In addition to the new financing facility, the Treasury said it will take an equity stake in the two firms through senior preferred equity shares and warrants. It must also be noted that Paulson told regulators that he would not commit taxpayers' funds to Fannie Mae and Freddie Mac without a conservatorship.

"Under the terms of the agreement, common and preferred shareholders bear losses ahead of the new government senior preferred shares," Paulson said.

Officials also announced that the executives and board of directors of both institutions had been replaced. Herb Allison, a former vice chairman of Merrill Lynch, was selected to head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp, was picked to head Freddie Mac.

The Treasury also set up a program under which it would buy mortgage-backed securities (MBS) currently held by Fannie Mae and Freddie Mac to pump fresh funds into the mortgage market. It said it would begin buying MBS later this month, and it would have authority to make such purchases through December 31, 2009.

Lockhart said in order to conserve about $2 billion in capital the dividend payments on both common and preferred stock would be eliminated by both companies. He said that all lobbying activities of both companies would stop immediately. Both companies over the years made extensive efforts to lobby members of Congress in an effort to keep the benefits they enjoyed as government-sponsored enterprises.

Both Paulson and Lockhart did not blame Daniel Mudd, the former CEO of Fannie Mae, or former Freddie Mac CEO Richard Syron for the companies’ current problems. While both men are being removed as the top executives, they have been asked to remain for an unspecified period to help with the transition.

What does this mean? Thus far, many analysts have said that it essentially removes a huge cloud that has been hovering over skittish markets. The move has been seen as a positive for banks around the world. This should also help the indexes on Monday since Monday morning futures trading for the U.S. stock indexes were all up about 2%. The global markets were also responding positively with financials from around the world showing large gains.

CNBC interviewed Warren Buffett, Paulson, and Lockhart on Monday morning. Paulson and Lockhart reiterated the fact that this move was necessary to stabilize and strengthen the debt and financial markets, and it was much better than the alternative (do nothing - let them fail). Buffett completely agreed that the deal was sound, and it was something that he would have done in the same manner. A vote of confidence from the "Oracle of Omaha" is never a bad idea.

Sources: Reuters, CBS Maketwatch,, CNBC

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