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Fannie, Freddie Shareholders Face Wipeout

Steve Liesman, CNBC Economics Reporter
Tuesday, 1 Sep 2009 | 6:20 PM ET

Details of a plan that could lead to a government takeover of Fannie Mae and Freddie Mac are expected to be announced Sunday.

The Treasury Department and the mortgage financing company's regulator, the Federal Housing Finance Agency have called a press conference for 11 am New York time.

While details of the plan could not be confirmed, these people point out that Treasury Secretary Hank Paulson has in the past insisted that shareholders, including common and preferred shareholders, pay the ultimate price in absorbing losses. That would suggest both classes of shareholders could be wiped out or severely diluted in a reorganization plan.

The plan will not preserve Fannie and Freddie in their current form as government officials believe that no amount of public funds would be sufficient to restore investor confidence.

It remained unclear how much the plan would cost taxpayers.

The two government sponsored enterprises (GSEs) own or guarantee almost half of the country's $12 trillion in outstanding home mortgage debt.

The Wall Street Journal reported earlier on Friday that the U.S. Treasury Department is close to finalizing a plan to restructure the two companies that includes changes to their
senior management.

U.S. Treasury spokeswoman Brookly McLaughlin declined to comment on the Journal report on Friday. Fannie Mae and Freddie Mac spokesmen also declined to comment. The Federal Reserve, which earlier this year gave both companies the right to borrow from its discount window if necessary, declined comment also.

The two firms would be placed in "conservatorship", the Washington Post said, citing sources familiar with the discussions.

Shortly after the Journal report on Friday, Pimco's Bill Gross told CNBC that he welcomed the potential for government intervention.

"To the extent that it does happen, it's a needed step," said Gross. (See the entire interview with Gross in the accompanying video.)

FNM & FRE Soar
Fannie and Freddie shares are soaring on new the Treasury is close to finalizing a backstop plan, with Bill Gross, PIMCO and CNBC's Trish Regan & Steve Liesman.

Senior Bush administration and Federal Reserve officials called in top executives of Fannie Mae and Freddie Mac on Friday and told them that the government was preparing to place the two companies under federal control, officials and company executives told the New York Times.

Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson were present at meetings with James Lockhart, the director of the Federal Housing Finance Agency, the regulator of the two companies, and with Fannie Mae CEO Daniel Mudd and Freddie Mac CEO Richard Syron on Friday, Reuters can confirm. There were separate meetings with the two CEOs.

The executives were told they and their boards would be replaced and shareholders value diluted, but the companies would be able to continue functioning with the government generally standing behind their debt, the New York Times said.

Daniel H. Mudd, chief executive of Fannie Mae, and Richard Syron, his counterpart at Freddie Mac, are expected to step down from their posts eventually, the Wall Street Journal reported.

The U.S. Treasury had hired Morgan Stanley on Aug. 5 to advise it on whether the companies were adequately capitalized and help it determine how it would use its new powers to support the GSEs.

An emergency plan approved by Congress in late July gave Treasury the authority to offer an undetermined amount of credit to the two companies, or take an equity stake in them if they ran into trouble. The housing legislation signed into law by President George W. Bush in July requires the companies agree to a Treasury backstop.

Shares of the two government sponsored enterprises (GSEs) have plunged about 80 percent since mid-May this year as the U.S. housing market slump resulted in the two companies
reporting about $14 billion in losses in the past four quarters, eroding some of their capital.

"People have priced in an equity infusion that would wipe out shareholders," said Chuck Gabriel, managing director at Washington-based consultants Capital Alpha Partners. "On the other hand, they have come to understand you wouldn't have such an event without the GSEs agreeing to it."

Financial markets have come to expect that an investment by the U.S. Treasury would explicitly back the companies' $1.6 trillion in debt, but leave their shares nearly valueless.

Analysts Had Been Confident

Analysts at Citigroup, Merrill Lynch, and Goldman Sachs since mid-August have issued reports saying the companies had plenty of capital to operate for the near term, and both companies have successfully rolled over debt on schedule in the meantime. Yield spread premiums on the companies' senior debt narrowed as traders bet government funding would cut their risks.

However, the major credit rating companies since Aug. 22 all cut their ratings on preferred stock of the two GSEs on expectations that the share price declines had cut access to capital, increasing the need for emergency financial support.

The companies never lost their access to capital markets where they raise money to support the U.S. housing market, but the biggest buyers of the debt have grown more cautious.

Foreign central banks reduced their holdings of "federal agency" debt in custody at the Federal Reserve in the past week for the seventh week in a row.

Russia has continued reducing its holdings of agency debt, Alexei Ulyukayev, first deputy chairman of Russia's central bank, said on Friday.

The U.S. Congress created Fannie Mae as a government agency in 1938, during the Great Depression, to buy government-insured mortgages from lenders, providing them fresh money to make more loans.

Fannie continued to function as a government-run agency during the 1940s and 1950s, even as it took steps toward privatization. In 1968, President Lyndon Johnson decided to turn Fannie into a shareholder-owned company.

-- Reuters contributed to this report

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