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Paulson Offers No Hint of Fannie, Freddie Bailout

Reuters
Friday, 11 Jul 2008 | 3:09 PM ET

Alarm swelled on Friday that Fannie Mae and Freddie Mac might run short of capital, placing the fragile U.S. economy at even greater risk, as the Bush administration offered no hint of a government bailout of the largest U.S. providers of financing for mortgages.

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Treasury Secretary Henry Paulson, responding to reports a government takeover was under consideration, said "our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission."

Worries about Fannie and Freddie grew after The New York Times said the administration was considering a plan to put the companies, thought to have implicit government backing, into a conservatorship if their problems worsen, citing people briefed about the plan.

In morning trading, Fannie shares sank $5.39, or 40.8 percent, to $7.81, while Freddie tumbled $3.59, or 44.9 percent, to $4.41. Both have lost close to 90 percent of their value since August. The companies' bonds posted gains.

Shares came off those lows after Paulson spoke and even teetered on positive ground after Sen. Christopher Dodd (D-Conn.) said at an afternoon news conference that the government-sponsored enterprises were both well capitalized. But the gains were brief and Fannie approached a 30 percent loss shortly afterward.

Additional news Friday afternoon that the two entities would be allowed access to the Fed discount window sent shares in both higher, again not lasting long though they were well off their lows heading into the final hour of trading.

Fannie and Freddie own or guarantee $5 trillion of debt, close to half of all U.S. mortgages. They have been hit hard by the nation's housing crisis, seeing borrowing costs rise and suffering billions of dollars of losses as many investors lose confidence they can raise sufficient capital to stay afloat.

Were Fannie and Freddie unable to borrow, or find it too costly to borrow, they would not be able to buy mortgages from lenders. This would make it far more difficult and perhaps impossible for people to obtain home loans, which could cause the housing market to grind to a halt.

White House spokesman Tony Fratto declined to comment on "any internal deliberations" about Fannie and Freddie, but said Bush's economic advisers keep "close watch" on markets. He said the best thing for Fannie and Freddie would be for Congress to pass new oversight legislation.

Too Big to Fail?

Investors view Fannie and Freddie as the last bastions of support for a U.S. housing market in its worst downturn since the Great Depression.

Putting Fannie and Freddie into conservatorship could wipe out shareholders, and obligate taxpayers to cover losses on home loans Fannie and Freddie own or guarantee.

A spokesman for Freddie Mac declined to comment. Fannie Mae could not be reached for comment.

Some analysts said the government could not allow Fannie and Freddie to fail. "They are simply too big," said Phil Barleggs, Insight Investment's head of fixed product management. "There will be a lot of political pressure to bail them out."

Since the housing crisis began, Fannie and Freddie have lost more than $11 billion, and raised some $20 billion of capital.

James Lockhart, the director of the Office of Federal Housing Enterprise Oversight, Fannie and Freddie's regulator, on Thursday said the companies are "adequately capitalized."

The plunge in Fannie and Freddie pushed down stocks in Europe, with the FTSEurofirst 300 index of top European shares falling 2 percent to a three-year low. Major U.S. stock indexes fell more than 1.5 percent.

The dollar extended losses against the euro and yen. Gold rose to 3-month high, more as a reaction to record oil prices.

Treasury debt prices slipped on fears the government would need to sell more debt to back a takeover of Fannie and Freddie. Those fears sparked a rally in the mortgage companies' $1.6 trillion of debt, drawing investors away from Treasuries.

Fannie notes maturing in 2017 and Freddie notes maturing in 2018 yielded about 0.77 of a percentage point more than safe U.S. Treasuries, down from a 0.95 percent premium on Thursday.

Bondholders theoretically would have priority in any insolvency.

Meanwhile, the cost of protecting both companies' debt with credit default swaps for five years fell to 65 basis points, or $65,000 a year to protect $10 million of debt, from 80 basis points, according to Phoenix Partners Group.

"It is easy money for the debt holders because the government isn't going to let the two go under," said Chris Orndorff, who helps invest $50 billion at Payden & Rygel Investment Management in Los Angeles. "From an equity standpoint, I don't know if I would call them good value."

Foreign Impact

The fate of Fannie and Freddie has ramifications far beyond the United States.

U.S. agency debt and agency-issued mortgage bonds held by foreign central banks has grown 18 percent this year to a record $979 billion.

Meanwhile, the European Central Bank accepts Fannie and Freddie loans as collateral from commercial banks. It declined to discuss whether a U.S. government move would affect its collateral framework.

A rescue would mark the second time Washington stepped in to support the financial system since growing subprime mortgage defaults swelled into a global credit crisis a year ago.

In March, the Federal Reserve backed a plan for JPMorgan Chase to buy investment bank Bear Stearns.

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