Pressure mounted on Friday for the U.S. government to act more swiftly to prevent the housing crisis from dragging down the nation's top mortgage finance agencies, as Treasury Secretary Henry Paulson indicated that a bailout was unlikely.
A spokeswoman at the U.S. Federal Reserve told CNBC late Friday that the central bank was monitoring the situation at Fannie Mae or Freddie Macclosely, but that it had not held any discussions with the two Government-Sponsored Entities (GSEs) about giving them access to funds through its so-called discount window.
The Fed made the comment following a wire report quoting an unidentified source saying that Fed Chairman Ben Bernanke talked to Freddie's CEO about the possibility of Freddie using the discount window.
The Fed spokeswoman added that the Fed was not ready to discuss possible options with regard to the two mortgage lenders.
Earlier Friday, a key senator said the Fed was considering allowing Fannie and Freddie to borrow directly from the central bank, spurring speculation that the Fed may take action as early as this weekend. Fannie and Freddie shares recovered some of their morning losses.
Sen. Christopher Dodd, the Connecticut Democrat who chairs the Senate Banking Committee, said he spoke with Fed Chairman Ben Bernanke and Paulson. They were looking at various options, Dodd said, including opening access to the discount window, at which the Fed acts as a lender of last resort for the U.S. banking system.
Investors were worried that the mortgage agencies, which finance nearly half of U.S. homes, might run short of capital, placing the fragile U.S. economy at even greater risk and deepening the housing slump. Dodd sought to reassure financial markets about the health of the two companies.
"These institutions are fundamentally sound and strong," Dodd said at a news conference. "There is no reason for the kind of (stock market) reaction we're getting."
Paulson said the government's primary focus was on supporting Fannie and Freddie "in their current form as they carry out their important mission."
The reference to keeping Fannie and Freddie in their current form was a signal the government was not on the verge of nationalizing them, and that it wanted to see them survive as congressionally chartered but privately held companies, a source familiar with the administration's thinking said.
That came as a disappointment to many on Wall Street. (See the accompanying video for a full take on the day's events with Fannie and Freddie.)
"While Paulson is making supportive comments to the GSEs, there was no suggestion of any imminent bailout—nor enough specifics to the support they would give," said Bret Barker, portfolio manager with Metropolitan West Asset Management in Los Angeles. "The markets were looking for more from Paulson."
Concern about Fannie and Freddie burgeoned 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 worsened, citing people briefed about the plan.
A conservatorship is where regulators appoint a person or entity to run a troubled financial institution until it can be stabilized.
A former Fed policy-maker said on Friday that it was crucial that the government bolster Fannie and Freddie and their huge assets.
"It would produce a worldwide financial crisis of unspeakable magnitude if they were allowed to default," said former St. Louis Federal Reserve president William Poole.
Fannie shares closed Friday down 22.35 percent at $10.25, but well above the session low of $6.87. Freddie finished 3.13 percent lower at $7.75, after touching a low of $3.89 earlier in the session. Both have lost close to 90 percent of their value since August.
The companies' bonds posted gains. Bondholders theoretically would have priority in any insolvency.
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, suffering billions of dollars of losses and higher borrowing costs as many investors lose confidence they can raise sufficient capital to stay afloat.
Since the crisis began, Fannie and Freddie have lost more than $11 billion, and raised some $20 billion of capital.
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.
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 them into conservatorship could wipe out shareholders, and obligate taxpayers to cover losses on home loans Fannie and Freddie own or guarantee.
James Lockhart, the director of the Office of Federal Housing Enterprise Oversight (OFHEO), Fannie and Freddie's regulator, on Thursday said the companies are "adequately capitalized."
Some on Wall Street speculated the Federal Reserve might announce some sort of action this weekend, much like it did in March when Bear Stearns was on the brink of bankruptcy and the central bank stepped in on a Sunday to orchestrate its sale to JPMorgan.
Apart from the idea of opening the discount window, another possibility might be increasing their credit lines from the Treasury, currently at $2.25 billion each.
Citigroup analyst Bradley Ball said the sell-off in Fannie and Freddie shares had more to do with fear that fundamentals.
"In our view, the current crisis of confidence calls for a more proactive approach on the part of regulators and Congress and the administration to instill market confidence in the GSEs," he wrote in a note to clients.
Fannie and Freddie: We Have Enough Capital
In a statement Friday, Fannie said its capital level is "substantially above" both its statutory minimum capital level and that required by OFHEO—a 15 percent surplus over minimum capital.
"Fannie Mae raised $7.4 billion of additional capital in May, for a total of more than $14 billion in new capital since November of 2007," the statement said, adding, "In fact, we have more core capital, and a higher surplus over our regulatory requirement, than at any time in this company's history."
Freddie released a similar statement:
"Freddie Mac is adequately capitalized, highly liquid and an essential part of the nation's housing system. We are in the process of finalizing our results and we estimate that at June 30, 2008, we will have a substantial capital cushion above the 20% mandatory target surplus established by our regulator," the statement said, "and a much greater surplus above the statutory minimum capital requirement."