US Considers Nationalizing Fannie and Freddie

July 11, 2008
U.S. Weighs Takeover of Two Mortgage Giants
By STEPHEN LABATON and STEVEN R. WEISMAN
New York Times

WASHINGTON — Alarmed by the growing financial stress at the nation’s two largest mortgage finance companies, senior Bush administration officials are considering a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, people briefed about the plan said on Thursday.

The companies, Fannie Mae and Freddie Mac, have been hit hard by the mortgage foreclosure crisis. Their shares are plummeting and their borrowing costs are rising as investors worry that the companies will suffer losses far larger than the $11 billion they have already lost in recent months. Now, as housing prices decline further and foreclosures grow, the markets are worried that Fannie and Freddie themselves may default on their debt. (At one time we estimated the money market funds exposure to Fan and Fred at about 8%. It most surely is much lower now just because of their price collapse. But just how secure are those 1.00 NAVs? - Jesse)

Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers. (Social Services for banks are our highest priority - Jesse)

The government officials said that the administration had also considered calling for legislation that would offer an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies. But that is a far less attractive option, they said, because it would effectively double the size of the public debt.

The officials also said that such a step would be ineffective because the markets already widely accept that the government stands behind the companies. (But not with an overly wide stance - Jesse)

The officials involved in the discussions stressed that no action by the administration was imminent, and that Fannie and Freddie are not considered to be in a crisis situation. (When will they be in a crisis, when their stocks go to zero? When the Republicans leave office in disgrace? - Jesse) But in recent days, enough concern has built among senior government officials over the health of the giant mortgage finance companies for them to hold a series of meetings and conference calls to discuss contingency plans.

A conservatorship or other rescue operation would be the second time in four months that the Bush administration has stepped in to engineer a rescue to prevent the financial system from collapsing. Last March, it forced the sale of Bear Stearns to JPMorgan Chase to avert a bankruptcy of that venerable investment house. (Maybe the banks could consider private savings plans instead of relying on the government? - Jesse)

Officials have also been concerned that the difficulties of the two companies, if not fixed, could damage economies worldwide. The securities of Fannie and Freddie are held by numerous overseas financial institutions, central banks and investors.

Under a 1992 law, Fannie or Freddie could be put into conservatorship if their top regulator found that either one is “critically undercapitalized.” A conservator would have sweeping powers to overhaul them, but would not have the authority to close them.

The markets showed fresh signs on Thursday of being nervous about the future of the companies. Their stock prices continued a weeklong slide, hitting their lowest level in 17 years. The debt markets, meanwhile, pushed up the two companies’ cost of borrowing — their lifeblood for buying mortgages.

The companies are by far the biggest providers of financing for domestic home loans. If they are unable to borrow, they will not be able to buy mortgages from commercial lenders. In turn, that would make it more expensive and difficult, if not impossible, for home buyers to obtain credit, freezing the United States housing market. Even healthy banks are reluctant to tie up scarce capital by offering mortgages to low-risk home buyers without Fannie and Freddie taking the loans off their books.

Together the two companies touch more than half of the nation’s $12 trillion in mortgages by either owning them or backing them. They hold more than $1.5 trillion of the mortgages as securities. Others are sold to investors in the form of mortgage-backed bonds.

In recent weeks, the companies have spiraled downward, undermined by declining confidence in their future and shaken by sharp declines in their assets as the housing markets have continued to slide and foreclosures have risen.

In the last week alone, Freddie has lost 45 percent of its value, and Fannie is off 30 percent. Expectations of default at the companies have also risen; it costs three times as much today to buy insurance on a two-year Fannie bond as it did three years ago.

Analysts expect the companies to announce a new round of write-downs and possibly be forced to raise capital by issuing additional shares, which would dilute their value for current shareholders.

Despite repeated assurances from regulators about the financial soundness of the two institutions, financial markets have concluded that by some measures they are deeply troubled.

Freddie, for instance, is technically insolvent under fair value accounting rules, in which the company puts a market value on assets as if it had to sell them now.

Although Treasury Secretary Henry M. Paulson Jr. and Ben S. Bernanke, the chairman of the Federal Reserve, passed up invitations by lawmakers on Thursday to seek legislation to deal with the crisis, officials said that the administration had been privately considering a government takeover should the markets continue to turn against the companies.

At a hearing of the House Financial Services Committee on Thursday, both Mr. Paulson and Mr. Bernanke were guarded, carefully trying not to say anything that could further erode confidence in Fannie and Freddie. They both said that the regulator of Fannie and Freddie had found that they were, in the words of Mr. Paulson, “adequately capitalized,” meaning that they had sufficient cash and other assets to withstand the turbulence in the markets.

“Fannie Mae and Freddie Mac are also working through this challenging period,” Mr. Paulson said.

Neither official would address a question posed by Representative Dennis Moore, Democrat of Kansas, who asked whether the failure of either institution would pose a risk to the financial system.

“In today’s world I don’t think it is helpful to speculate about any financial institution and systemic risk,” Mr. Paulson said. “I’m dealing with the here and now, and the important role that they’re playing and other financial institutions are playing.”

Mr. Bernanke said that Fannie and Freddie “are well-capitalized in the regulatory sense” but added that they, and other major financial institutions, needed to raise their capital levels further.

Despite repeated denials by officials in the Bush and prior administrations, financial markets have long assumed the government would stand behind Fannie Mae and Freddie Mac in times of difficulty, both because they are integral to the housing and financial markets and because the companies have a line of credit to the Treasury.

But Congress set that credit more than 38 years ago, long before the companies rose to such size and prominence, and its limit, $2.25 billion for each, has become a tiny fraction of the companies’ overall debt.

Some analysts have begun to propose that the Fed also permit the two companies to borrow from it, as Wall Street investment banks began doing after the rescue of Bear Stearns. But there is no indication that the Fed is contemplating such a move....

Charles Duhigg and Jenny Anderson contributed reporting from New York; Michael Cooper from Livonia, Mich.; and David M. Herszenhorn from Washington.