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US Takes Bold Steps to Shore Up Fannie, Freddie

Reuters
Sunday, 13 Jul 2008 | 6:16 PM ET

The United States on Sunday offered massive aid to Fannie Mae and Freddie Mac to bolster confidence in the mortgage finance giants and head off a potential meltdown in financial markets.

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The dollar jumped and stock futures rallied on the powerful message of support from the U.S. Treasury and the Federal Reserve, which also drew criticism for being a potential bailout that could cost U.S. taxpayers dearly. Major Asian markets Monday were firmer on news of the U.S. proposals.

Unveiling the emergency measures to calm markets roiled by the country's
prolonged housing crisis, the Fed said Fannie Mae and Freddie Mac could have access to its emergency cash, echoing a move to backstop investment banks after the Fed orchestrated a takeover of ailing investment bank Bear Stearns in March.

The Treasury separately said it would temporarily boost its line of credit to the two mortgage financiers, as well as purchase equity in them, a step never taken before, if needed.

Both companies, which are shareholder-owned but also government-sponsored enterprises (GSE), said they are adequately capitalized, but welcomed the measures and said they would help confidence.

Nerves On Edge

Officials are desperate to calm nerves ahead of a crucial debt issue by Freddie Mac on Monday and after U.S. bank regulators on Friday seized mortgage lender IndyMac Bancorp in the third-largest bank failure in U.S. history.

"(Their) continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore, we must take steps to address the current situation as we move to a stronger regulatory structure," U.S. Treasury Secretary Henry Paulson said in a statement that he read on the steps of the Treasury building.

A senior Treasury official said all the actions it proposed need congressional approval, but expressed confidence that could be secured this week.

A spokesman for Speaker of the House of Representatives Democrat Nancy Pelosi said she would work with the Republican administration of President George W. Bush on this matter.

Shares in the two mortgage giants, which own or guarantee just under half of the country's $12 trillion in outstanding mortgage debt, have been hammered by concerns that they might run out of capital amid mounting home-loan losses.

On Sunday the Securities and Exchange Commission stepped in to warn against rumor-mongering of any kind against any firm.

The SEC said it will conduct investigations to make sure that no false information was being spread, although it did not name any companies it felt might be victimized.

Weight On Economy

Housing woes have forced the Fed to slash benchmark interest rates since September and open its discount window to investment banks for the first time since the Great Depression some 80 years ago.

Fannie and Freddie buy mortgages from lenders and package them into guaranteed securities, providing more funds to keep mortgage markets lubricated.

They also borrow regularly on capital markets to fund their operations and one investor predicted Freddie's planned auction of $3 billion in 3- and 6-month notes on Monday would go well.

Dan Fuss, vice chairman of Boston-based Loomis Sayles, which oversees more than $100 billion in fixed-income securities, also said he had been buying Fannie and Freddie paper in recent days because it was "outstanding value".

Freddie and Fannie debt rallied sharply on Friday as investors bet they would get closer government backing and analysts said that this was in fact happening.

"Fannie Mae and Freddie Mac have never been more related to the U.S. government," said Margaret Kerins, U.S. agency strategist at RBS Greenwich Capital in Chicago.

The Federal Reserve headquarters in Washington, DC.
The Federal Reserve headquarters in Washington, DC.

"Now that Paulson has reiterated their relationship to the government, they should be able to fund themselves probably even better than they had before this crisis," she said.

But Fannie and Freddie's shares have been savaged in recent days and reduced to a fraction of their value a year ago and analysts remain skeptical.

"The problems with Fannie Mae and Freddie Mac are pretty straightforward. Combined, the two GSEs have about $95 billion in capital but hold over $5 trillion in mortgages," said Mark Vitner, a senior economist for Wachovia in Charlotte.

The two companies play a vital role in U.S. housing markets, which already are experiencing their deepest downturn since the Great Depression, and Treasury and the Fed are on the spot to make sure they do not put a sorely stressed financial system in worse shape than it is already in.

Many fear that were they to fail it would unhinge already battered world financial markets and inflict a deep recession in the United States that would chill growth everywhere.

A senior Treasury official told reporters in a conference call the moves were not driven by any deterioration in market conditions since Friday. He said policymakers had consulted closely over the weekend and it "makes sense" to take the actions announced.

Treasury said its temporary increase in the line of credit that the GSEs now have with Treasury, would be up to an amount to be determined by Paulson. The current credit line for each lender is $2.25 billion.

In addition, "to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed," Paulson said. Critics fumed.

"It's outrageous. It's offensive. Welcome to the socialist state. In capitalism, winners are supposed to reap rewards and losers are supposed to take losses for bad risk management. These are private companies," said Josh Rosner, managing director at Graham Fisher in New York.

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