Posted on Sun, Sep. 07, 2008
last updated: September 07, 2008 10:41:36 PM
WASHINGTON — The historic seizure Sunday of mortgage finance titans Fannie Mae and Freddie Mac is expected to bolster the nation's sinking housing sector by lowering mortgage rates and jump-starting the obscure background market that is vital to home lending.
Treasury Secretary Henry Paulson announced in a Sunday morning news conference that the government was seizing Fannie Mae and Freddie Mac on the grounds that their weak accounting standards and ambiguous role as quasi-public enterprises posed a growing threat to global financial markets.
"We examined all options available and determined that this comprehensive and complimentary set of actions best meets our three objectives of market stability, mortgage availability and taxpayer protection," Paulson said.
The White House praised the move, saying that "Americans should be confident that the actions taken today will strengthen our ability to weather the housing correction and are critical to returning the economy to stronger sustained growth in the future."
Fannie and Freddie will continue to operate as normal but under conservatorship, a process similar to a Chapter 11 bankruptcy, where a business is allowed to restructure its operations.
Treasury will purchase, as of later this month, Fannie and Freddie bonds in the open market to boost home lending and set an example for investors. It also will provide a special lending fund to help Fannie and Freddie weather any future financial storms. This fund will be open-ended, so it guarantees the two can't become insolvent.
Paulson didn't put a price tag on his plan, but the Congressional Budget Office earlier this year estimated a rescue could cost as much as $25 billion. The Treasury plan was designed to recover the upfront costs over time and could result in profits for the federal government over a larger horizon.
The plan, worked out with the Federal Housing Finance Agency, the regulator of the two entities, will eliminate the dividend on Fannie's and Freddie's common and preferred stock to save about $2 billion in capital that otherwise would have gone to investors.
In the short run, the plan has the effect of diluting the value of current shares of Fannie and Freddie stock. But shareholders may win in the longer term if the plan stabilizes the housing market and leads to a rebound.
FHFA chief James Lockhart appointed private sector bankers to head Fannie and Freddie and said that their "compensation will be significantly lower than the (respective) outgoing CEOs," Daniel Mudd at Fannie Mae and Richard Syron at Freddie Mae. He was pointing to a frequent criticism of the for-profit entities that enjoyed implicit U.S. government backing but operated as private companies with huge bonuses for their directors.
Herb Allison, who was chairman of retirement-plan administrator TIAA-CREF, will now run Fannie Mae. David Moffett, who was the chief financial officer of U.S. Bancorp up until last year, will head Freddie Mac. He is a senior adviser to private equity giant The Carlyle Group, and his appointment suggests the Bush administration sees these entities eventually privatized.
The Treasury Department in late July was given by Congress additional powers to inject money into Fannie and Freddie, but Paulson determined an actual takeover would calm nervous markets more than pumping money into the two.
He was supported Sunday by Federal Reserve Chairman Ben Bernanke, who in a statement said the action "will provide critical support for mortgage markets in this period of unusual credit-market uncertainty."
The two mortgage finance companies purchase mortgages from commercial banks and other lenders, then pool them and sell them as bonds in what's called the secondary mortgage market.
While arcane and complex, this secondary market makes possible the widespread mortgage lending that's a hallmark of the American way of life. Fannie and Freddie together own or back more than half of the nation's mortgage debt, or about $5.4 trillion. Fannie Mae was created in 1938 to boost home ownership after the Great Depression, while Freddie Mac was created in 1970 to provide more competition.
"The unprecedented steps announced today will provide confidence that the housing finance system will continue to operate without major disruption, and offer an opportunity for a recovery of the housing market," John Courson, head of the Mortgage Bankers Association, said in a statement Sunday.
Since home prices began plunging two years ago and home sales ground to a near halt, banks and other home lenders protectively tightened their lending standards, making it harder for consumers to get a loan.
During this period, Fannie and Freddie were vital to allow what home lending was happening to continue. But in recent months, the private-sector market for Fannie and Freddie bonds has virtually dried up.
This buyer's strike happened as existing homes soured at an alarming rate. The Mortgage Bankers Association reported Friday that 6.41 percent of all mortgages nationwide were at least 30 days late — an all-time record. The national average rate for a 30-year fixed mortgage stood at 6.26 percent last week, and Treasury hopes its action will knock that down over time.
Investors are demanding higher returns in exchange for continuing to buy Fannie and Freddie bonds in the secondary market, and that has pushed up mortgage rates, adding another pull against a recovery in the housing market.
Paulson hopes his unprecedented action will shock the housing market's heartbeat back into rhythm.
"Our economy and our markets will not recover until the bulk of this housing correction is behind us," said Paulson. "Fannie Mae and Freddie Mac are critical to turning the corner on housing. Therefore, the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance" for average Americans.
Under Paulson's plan detailed Sunday, the government-controlled Fannie and Freddie would temporarily increase through the end of 2009 the size of their portfolios of bonds comprised of mortgages. That would help spur more mortgage lending but would leave the taxpayers on the hook if the housing market worsened further or investors keep demanding higher returns.
In 2010, Fannie and Freddie would reduce by 10 percent a year the size of those portfolios, and between now and then the next president and Congress would determine whether to privatize, nationalize or leave as is Fannie and Freddie. Speaking to reporters, Lockhart, who will oversee the two in conservatorship, said the move buys time to revamp needed regulation.
"Some of the key regulations will be minimum capital standards, prudential safety and soundness standards and portfolio limits," he said. "It is critical to complete these regulations so that any new investor will understand the investment proposition."
MORE FROM MCCLATCHY
For Paulson's statement, click here:
For Bernanke's statement, click here:
For Lockhart's statement, click here:
For details of Treasury's purchase of Fannie and Freddie bonds, go here:
For details of Treasury's lending to Fannie and Freddie, click here:
McClatchy Newspapers 2008