Government Takes Control of Fannie, Freddie

The Government on Sunday seized control of mortgage finance companies Fannie Mae and Freddie Mac, launching what could be its biggest federal bailout ever, in a bid to support the U.S. housing market and ward off more global financial market turbulence.

Officials were concerned mounting losses at the two companies, which own or guarantee almost half of the country's $12 trillion in outstanding home mortgage debt, was sapping their vitality and threatening to undermine them at a time other sources of housing finance have largely run dry.

"Our economy and our markets will not recover until the bulk of this housing correction is behind us," U.S. Treasury Secretary Henry Paulson said at a news conference. "Fannie Mae and Freddie Mac are critical to turning the corner on housing."  (See accompanying videos of Paulson's  and Lockhart's remarks below.)

Pre-market trading in Fannie Mae and Freddie Mac stock was suspended and trading will resume at 9:30 am New York time. In Europe, Fannie Mae and Freddie Mac's shares were down more than 50 percent before they were also suspended.

The two companies, publicly traded but also serving a government mission to support housing, were put in a conservatorship that allows their stock to keep trading but puts common shareholders last in any claims.

Their top executives were ousted. Freddie Mac chief executive Richard Syron and Fannie Mae's CEO, Daniel Mudd, were replaced by David Moffett, a former top official at US Bancorp and Herb Allison, formerly with Merrill Lynch and pension fund TIAA-CREF.

In addition, the U.S. Treasury will immediately take a $1 billion equity stake in each company in the form of senior preferred stock and if needed could inject up to $100 billion into each firm.

The government's senior preferreds stock would rank above both existing preferred and common shares and will carry warrants that could give the government an ownership stake of 79.9 percent.

Treasury also set up a program under which it would buy mortgage-backed securities currently

Click for the full coverage

held by Fannie Mae and Freddie Mac to pump fresh funds into the mortgage market. It said it would begin buying MBS later this month, and it would have authority to make such purchases through Dec. 31, 2009.

Paulson said Fannie Mae and Freddie Mac were so large that "a failure of either of them would cause great turmoil in our financial markets here at home and around the globe."

Several analysts said the move should help instill some confidence in shaky credit markets and lower mortgage costs.

"The government had to do something to eliminate uncertainty," said Peter Goldman, a principal with Front Barnett Associates in Chicago. "Anything that eliminates uncertainty in the credit markets is a good thing."

The Treasury Department said the plan to shore up the finances of the two government-sponsored enterprises, which have $1.6 trillion in debt outstanding, should not cost U.S. taxpayers money in the long run and could even return cash to the government coffers eventually.

The companies have suffered combined losses of nearly $14 billion in the last four quarters and large holders of their debt, including overseas central banks, have begun to show signs of increasing nervousness over their financial health.

Worries over their shrinking capital position led their regulator, the Federal Housing Finance Agency, to place them in conservatorship.

"As house prices, earnings and capital have continued to deteriorate, their ability to fulfill their mission has deteriorated," FHFA Director James Lockhart told the news conference. "They have been unable to provide needed stability to the market."

He said the companies lacked sufficient capital to continue taking losses while supporting the housing market at the same time.

Federal Reserve Chairman Ben Bernanke said in a statement that he "strongly" endorsed the action. "These necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets," he said. 

As part of the plan, FHFA will operate the companies until they are stabilized and the Treasury will extend financing to the companies, as well as to the Federal Home Loan Banks, through a new lending facility until Dec. 31, 2009, if needed.

In addition to the senior preferred stake Treasury is taking in the companies, it will immediately receive warrants for the purchase of some common stock.

The stock of the two companies has fallen more than 90 percent in the past year and in recent months foreign investors have pared their holdings of the companies' securities.

Paulson had briefed both Democratic presidential nominee Sen. Barack Obama and Republican contender Sen. John McCain earlier in the weekend. Both candidates indicated they would support the plan, but wanted to ensure taxpayers were safeguarded and shareholders and management took a hit.

-- CNBC.com contributed to this report

Copyright 2009 Reuters. Click for restrictions.