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Treasury, Fed announce rescue plan for Fannie, Freddie

July 13, 2008 |  4:03 pm

The Bush administration acknowledged today that it couldn't afford to leave mortgage giants Fannie Mae and Freddie Mac on their own to face another ravaging by Wall Street.

The government announced plans to provide financial backup to the battered companies amid fears that they could face failure as home loan defaults keep rising.

Treasury Secretary Henry M. Paulson Jr. said the Bush administration’s proposal, which will need Congress' approval, would boost the companies’ ability to borrow from the Treasury if needed, and would allow the Treasury to buy stock in the companies to bolster their capital.

Separately, the Federal Reserve today said it would permit the companies to borrow directly from the central bank if they needed short-term cash.

Shares of Fannie Mae and Freddie Mac, which combined own or guarantee about $5 trillion in home loans -- roughly half the entire U.S. market -- both lost more than 45% of their value last week amid furious selling tied to rising concerns about the companies’ solvency.

Paulson_2 Paulson last week insisted that the companies’ finances were sound. But the deepening pessimism about the firms on Wall Street, and the spillover into financial markets in general, left the government little choice but to step up with a potential rescue plan -- even though it is sure to be perceived as yet another government bailout of private interests.

Because of the companies’ size and their importance in providing funding to the mortgage market, "we must take steps to address the current situation," Paulson said in a statement this afternoon.

Key elements of the proposal the White House will send to Congress:

--Bigger credit lines with the Treasury: As a "liquidity backstop," the Treasury would temporarily increase the lines of credit Fannie Mae and Freddie Mac have with the agency. The companies currently can borrow up to $2.25 billion each from the Treasury, although they’ve never tapped those lines. The current lines long have been minuscule compared with the growth of the companies' assets (now $843 billion for Fannie, $803 billion for Freddie).

The Treasury didn't spell out the size of the new credit lines.

--Possible stock purchases by the Treasury: To ensure that the companies have "access to sufficient capital to continue to serve their mission," the Treasury would get temporary authority to buy stock in either of the companies "if needed."

"Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer," Paulson said.

The idea of an equity infusion may be the most contentious issue in the Treasury's plan because it will be seen as a bailout of the companies' current shareholders, which include some of the nation's biggest investment firms. But any equity stakes the Treasury would take almost certainly would result in severe  dilution to current investors, if not wiping out their stakes entirely.

Some experts, including former Federal Reserve Bank of St. Louis President William Poole, have said that nationalizing the companies -- turning them back into government agencies -- is the only practical solution to the challenges they face from surging losses on defaulted home loans.

--New oversight by the Federal Reserve: To protect the financial system from "systemic risk" going forward, the Federal Reserve would be given a "consultative role" in setting capital requirements and other "prudential standards" for Fannie Mae and Freddie Mac. This looks like an admission of a lack of faith in the companies' current regulator, the Office of Federal Housing Enterprise Oversight.

In its separate announcement today, the Fed said it granted its New York branch the authority to lend to Fannie Mae and Freddie Mac "should such lending prove necessary." The Fed normally lends to commercial banks, and, since March, has opened its borrowing window to brokerages as well, in an attempt to ease the credit crisis stemming from the bursting of the housing bubble.

Daniel Mudd, chief executive of Fannie Mae in Washington, said in a statement that the company "appreciates today’s announcements and the expressions of support."

Freddie Mac's CEO, Richard Syron, said the McLean, Va.-based company was "heartened" by the Treasury and Federal Reserve announcements.

Whether Wall Street is comforted will be evident in the action in the companies' stocks Monday and the reaction of the credit markets to Freddie Mac's plan to issue $3 billion in short-term debt, part of its routine financing program.

Photo: Henry M. Paulson Jr. by Karim Jaafar/AFP Photo