U.S. seizes Fannie and Freddie
Treasury chief Paulson unveils historic government takeover of twin
mortgage buyers. Top executives are out.
NEW YORK (CNNMoney.com) -- Federal officials on Sunday unveiled an
extraordinary takeover of Fannie Mae and Freddie Mac, putting the
government in charge of the twin mortgage giants and the $5 trillion in
home loans they back.
The move, which extends as much as $200 billion in Treasury support to
the two companies, marks Washington's most dramatic attempt yet to shore
up the nation's housing market, which is suffering from record
foreclosures and falling prices.
The sweeping plan, announced by Treasury Secretary Henry Paulson and
James Lockhart, director of the Federal Housing Finance Agency, places
the two companies into a "conservatorship" to be overseen by the Federal
Housing Finance Agency. Under conservatorship, the government would
temporarily run Fannie and Freddie until they are on stronger footing.
"A failure [of Fannie and Freddie] would affect the ability of Americans
to get home loans, auto loans and other consumer credit and business
finance," Paulson said at a press conference in Washington. "And a
failure would be harmful to economic growth and job creation."
Fannie (FNM, Fortune 500) and Freddie (FRE, Fortune 500), which were
created by the U.S. government, have been badly hurt in the last year by
the sharp decline in home prices and the rise in mortgage delinquencies
and foreclosures, racking up about $12 billion in losses.
On Sunday, officials stressed that both Fannie and Freddie will be open
for business on Monday morning, although the firms will have undergone a
dramatic facelift.
Freddie CEO Richard Syron and Fannie CEO Daniel Mudd will no longer run
the agencies, while the FHFA will assume control of the boards.
Regulators took care not to foist blame on the two executives, adding
that they would remain with the firms to help with the transition.
Syron and Mudd will be replaced by two finance veterans charged with
restoring the mortgage titans to health. Herb Allison, the former
chairman and CEO of pension provider TIAA-CREF, will head Fannie Mae.
Allison formerly served as president of Merrill Lynch.
David Moffett, who served as vice chairman and chief financial officer
of U.S. Bancorp until early 2007 and then joined the Carlyle Group
private-equity firm as a senior adviser, will take over Freddie Mac.
At the same time, dividends on both common and preferred shares will be
eliminated in an effort to conserve about $2 billion annually. All of
the firms' lobbying and political activities will be halted immediately
and charitable activities reviewed.
In addition, the Treasury Department announced a series of moves
targeted at providing relief to both housing and financial markets.
Paulson said Treasury would boost housing by purchasing mortgage-backed
securities from Freddie and Fannie, as well as offering to lend money to
the companies and the 12 Federal Home Loan Banks. The home loan banks
advance funds to more than 8,000 member banks. (Read what Paulson said.)
The Treasury, with fellow regulator FHFA, will also buy preferred stock
in Fannie and Freddie to provide security to the companies' debt holders
and bolster housing finance.
The government, in agreeing to backstop the firms, said it would receive
$1 billion in each company's senior preferred stock. The government will
also receive a quarterly dividend payment and the right to own 79.9% of
each company.
How we got here
Sunday's announcement brought an end months of speculation about the
fate of the two firms. Shares of Fannie and Freddie, which have fallen
more than 80% as of the end of Friday's session, were hammered this
summer among concerns they would need to raise additional funds to cover
future losses or need to be taken over by its federal regulator.
Investors feared that either step would reduce or wipe out the value of
current shareholders' stakes.
In mid-July, the Treasury Department and Federal Reserve announced steps
in to make funds available to the firms if necessary and Congress
approved the sweeping proposals later that month.
Shortly thereafter, regulators stepped up their review of Fannie and
Freddie. Paulson announced in August that he had tapped Wall Street firm
Morgan Stanley (MS, Fortune 500) to help him examine the firms.
Sources familiar with the matter told Fortune that Morgan Stanley had
determined that both Freddie and Fannie faced "meaningful" capital
issues before deciding last week that government intervention was
necessary. Morgan Stanley has called a firm-wide meeting on Monday
morning to explain the deal.
Following an exhaustive review, FHFA's Lockhart said Sunday that the two
companies could not continue to operate without taking "significant
action."
Fannie and Freddie have become virtually the only source of funding for
banks and other home lenders looking to make home loans. Their ability
to do so is crucial to the recovery of the battered home market and the
broader U.S. economy.
The two firms buy loans, attach a guarantee, then sell securities backed
by the loans' income stream. All told, they own or back $5.4 trillion
worth of home debt - half the mortgage debt in the country.
Reaction to the news
The Treasury-FHFA plan, which was widely anticipated after financial
markets closed on Friday, drew praise from regulators, lawmakers and
some market experts.
President Bush called the move "critical" to the housing market
recovery. "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," he said.
Federal Reserve Chairman Ben Bernanke, who along with Paulson has led
efforts to help get the U.S. housing market and the broader economy back
on track, endorsed the move by Lockhart and Paulson.
"These necessary steps will help to strengthen the U.S. housing market
and promote stability in our financial markets," Bernanke said in a
statement.
Sen. Charles Schumer, D-N.Y., a member of the Senate Banking Committee,
said that Paulson had "threaded the needle just right" with the plan,
noting that it will likely be met with praise from other lawmakers.
At first blush, Wall Street seemed encouraged by the news, although the
true test will come when financial markets around the globe open Monday.
Pimco's Bill Gross, a widely followed bond fund manager, said that the
Freddie-Fannie plan was the right move.
"This is a significant step and almost exactly what we had hoped for,"
Gross told CNNMoney.com Sunday.
In addition to confirming the government's sovereign credit rating,
Standard & Poor's affirmed its sterling AAA rating on both Fannie
Freddie on the news, adding that its outlook for the two firms is
stable.
Unanswered questions
The cost of the government intervention remains unclear. Experts argue
that it will depend in large part on the structure of the rescue, the
direction of home prices and mortgage default rates.
Still it seems almost certain it will run into the billions and will
most likely eclipse such other high-profile government bailouts
including than the Federal Reserve's $29 billion backing of Bear Stearns
assets when it was taken over by J.P. Morgan Chase.
Paulson said that the cost to taxpayers would largely depend on the
future financial performance of Fannie and Freddie.
Another unintended yet unavoidable consequence may be the impact to the
nation's banks.
Some of the nation's largest financial institutions including JPMorgan
Chase (JPM, Fortune 500) and Sovereign Bancorp (SOV, Fortune 500) own a
big chunk of the estimated $36 billion in preferred shares of Fannie and
Freddie, according to research published last month by Keefe, Bruyette &
Woods, an investment bank that specializes in financial firms. Those
stakes are at risk of being wiped out should Fannie and Freddie as a
result of Sunday's announcement.
Top banking regulators, including the Federal Reserve as well as the
Federal Deposit Insurance Corp., said in a joint statement Sunday that a
limited number of smaller institutions have significant preferred share
holdings in Fannie and Freddie. They added they are prepared to work
with these institutions to come up with a plan should they need to raise
capital.
Still, the rescue of Fannie and Freddie could go a long way toward its
intended aim - bringing stability to the housing market while making it
easier for consumers to obtain affordable mortgages.
--CNNMoney.com senior writer Tami Luhby and Fortune editor at large
Patricia Sellers contributed to this report.
