Feds take control of Fannie Mae, Freddie Mac

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Feds intervene, take control of Fannie Mae, Freddie Mac
Sam Zuckerman, Chronicle Staff Writer
Sunday, September 7, 2008

The federal government took control of Fannie Mae and Freddie Mac today in a bid to keep the two mortgage giants from failing, catastrophes that would have made home loans harder to get and taken the nation's housing collapse to a new level of crisis.

The government agreed to pump billions of dollars into Fannie Mae and Freddie Mac and assume responsibility for trillions of dollars of their debt, while handing control of the companies to federal regulators. The takeovers mark the most dramatic government effort thus far to stem the financial chaos precipitated by the housing bust. At the same time, seizure of the two could ultimately cost taxpayers tens of billions of dollars, experts estimate, widening an already bloated federal deficit.

Officials said they moved because the potential failure of the companies threatened incalculable harm to the mortgage market, the financial system and the broader economy. Fannie Mae and Freddie Mac bankruptcies would have left them unable to finance mortgages, potentially wreaking more havoc than a failure of brokerage giant Bear Stearns, whose near collapse and government-forced sale earlier this year sent credit markets around the world into a panic.

"Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe," said Treasury Secretary Henry Paulson. "A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance."

Democratic leaders, including presidential nominee Barack Obama, said government intervention was necessary to keep the housing crisis from worsening.

Outside experts said the takeovers could stabilize the home loan market, making mortgages cheaper and easier to get. That, in turn, could act to limit any further downward spiral in home prices.

"The housing and mortgage market should benefit from the actions," said Sung Won Sohn, an economist at California State University Channel Islands in Camarillo. "Mortgage rates should be lower than they would be without the government guarantee."

Fannie Mae and Freddie Mac don't offer mortgages themselves. But they play a central, perhaps irreplaceable, role in the American system of home finance. Together, the two companies own or guarantee more than $5 trillion in mortgages, almost half the total outstanding in the United States.

They buy mortgages from banks and others that make the loans, either keeping them as investments or packaging them for resale to investors. This ready market for mortgages multiplies the capacity of front-line lenders such as Wells Fargo and Washington Mutual to make loans and allows them to offer lower interest rates.

Fannie Mae and Freddie Mac accept only high-quality mortgages made to borrowers who meet strict financial standards. They buy only so-called conforming loans, mortgages made to prime borrowers up to a limit that varies by locality. In San Francisco, the conforming loan limit was recently raised to $729, 750.

Yet, as the housing boom has turned into a bust, even top-notch borrowers have fallen behind on their mortgages or defaulted altogether. The two companies have posted billions of dollars in losses, crippling their ability to raise money and buy additional loans, ultimately threatening their survival.

Congress chartered Fannie Mae in 1938 as the Federal National Mortgage Association and created Freddie Mac in 1970. Both later were reorganized as private, for-profit companies and sold off to shareholders. But their beginnings as government-sponsored enterprises and the vital part they play in the housing market convinced many experts that they were "too big to fail," meaning the government would not let them go under.

That implicit guarantee permitted the two companies to borrow money at nearly the same low rate as the federal government. Their ability to get money cheaply meant they could buy loans with low interest rates and still make a profit, a key factor keeping mortgages affordable in the United States. In recent months though, the interest rates they have had to pay has jumped as skittish lenders backed off, despite the assumed federal protection.

Sunday's developments transformed the too-big-to-fail doctrine from a theory to a reality. Nonetheless, it's not a full bailout. Top Fannie Mae and Freddie Mac executives are being replaced and the companies will be put under the supervision of conservators. They will be forced to stop lobbying efforts.

Dividends to shareholders are suspended. And if losses continue, common shareholders could find their stock worthless. However, holders of Fannie Mae and Freddie Mac mortgage securities and other debt will be paid in full.

The takeovers mean that if the capital of the two companies is wiped out, any further losses would be covered by the federal government. Given that home prices are still falling, it's probable that the government will have to pump many billions into the two companies, analysts say. The Congressional Budget Office several months ago estimated the potential cost of Fannie Mae and Freddie Mac takeovers at roughly $25 billion.

"The markets are still going down," said Dean Baker, an economist with the Center for Economic and Policy Research in Washington. "They're already holding debt that will go bad. And if they continue to make bad loans, it could get much worse. I would be surprised if we get off for less than $50 billion and it could easily be as much as $100 billion.

The ultimate fate of the two companies remains in doubt. Some Democrats want to transform Fannie Mae and Freddie Mac into government agencies. Some conservatives want to keep them private and break them up into smaller companies.

"It's not clear at all what the government plans to do," said Michael Carney, professor of financial institutions at California Polytechnic State University Pomona.

How rescue will play out

The government financial rescue of mortgage companies Fannie Mae and Freddie Mac includes the following provisions:

-- The two companies will modestly increase their holdings of mortgage securities through 2009, growth that is needed to stabilize the mortgage market. After that, they will be required to cut back their direct mortgage holdings to reduce risk.

-- The Treasury Department will buy up to $100 billion in preferred stock from each of the companies to ensure they have capital and are able to pay off their private debt.

-- Treasury will also lend directly to Fannie Mae and Freddie Mac as needed through 2009.

-- The department will buy mortgage securities from brokers to help keep the market healthy.

Source: U.S. Treasury Department

E-mail Sam Zuckerman at szuckerman@sfchronicle.com