Sunday, September 7, 2008

US Unveils Takeover of Two Mortgage Giants

This article is from the New York Times, September 7, 2008


WASHINGTON -- The Treasury Department seized control of Fannie Mae and Freddie Mac, the nation’s giant quasi-public mortgage finance companies, and announced a four-part rescue plan that includes an open-ended guarantee from the Treasury Department to provide as much capital as they need to stave off insolvency.

At a news conference on Sunday morning, Treasury Secretary Henry M. Paulson Jr. also announced that he had dismissed the chief executives of both companies and replaced them with two long-time financial executives. Herbert M. Allison, currently chairman of TIAA-CREF, the huge pension fund for teachers, will take over Fannie Mae and replace the chief executive, Daniel Mudd. David M. Moffett, currently a senior adviser at the Carlyle Group, one of the country’s biggest private equity firms, will replace Richard Syron as chief executive of Freddie Mac.

“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,” Mr. Paulson said. “This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation.”

Mr. Paulson refused to say how much capital the government might eventually have to provide, or what the ultimate cost to taxpayers might be.

The companies are likely to need tens of billions of dollars over the next year, but the ultimate cost to taxpayers will largely depend on how and how fast the housing and mortgage markets recover from their current crisis.

Mr. Paulson’s plan begins with a pledge to provide extra cash by buying up a new series of preferred shares that would offer dividends and be senior to both both the existing preferred shares and the common stock that investors around the world already hold.

The two companies would be allowed to “modestly increase” the size of their existing investment portfolios until the end of 2009, which means they will be allowed to use some of their new taxpayer-supplied capital to buy up and hold new mortgages in investment portfolios.

But in a strong indication of Mr. Paulson’s long-term intention to wind down the companies’ portfolios, the Treasury plan states that they must shrink their portfolios by 10 percent a year until they each total $250 billion. They now hold more than $700 billion apiece.

That covenant in the agreement responds to many in the Bush administration and in the private sector who had argued for years that Fannie and Freddie posed “systemic risks” to the entire economy because they had acquired more than $5 trillion in assets with only the thinnest of capital cushions to shield them from losses.

Treasury officials had little choice. With the credit markets still in a tailspin and investors deeply reluctant to buy up mortgages with even a hint of risk, Fannie Mae and Freddie Mac currently guarantee about 70 percent of all new home loans, according to James B. Lockhart, the director of the Federal Housing Finance Agency.

Mr. Paulson said the Treasury Department would provide as much money as needed to keep the companies’ capital reserves from falling below the levels that would trigger rules that automatically put them into receivership.

In addition, the Treasury Department will create a “Secured Lending Credit Facility,” a back-up source of borrowing for the companies in the event they cannot borrow enough money on the open market to finance their main business of buying mortgages and re-selling them as pools of mortgage-backed securities.

In a possibly unprecedented move into their private markets, the Treasury Department will also buy up billions of dollars in Fannie and Freddie mortgage securities on the open market. This move is likely to make it much easier for the companies to finance somewhat riskier loans.


West Toronto realtor said...

What to say - risky behavior "rewarded" again. "It would cause would be lost" they say. Aren't the turmoils already here? And what about default/foreclosure mortgages? Did they vaporize after this takeover? No, they are still there. However, elections are coming, we "solved" the problem and saved the day. And the same mistake will be made again and again...
Jill Stewart

Anonymous said...

As I said in today's post, Fannie and Freddie are so big that the US government could not allow them to fail. I guess if you are big enough you get bailed out. But if you are just trying to keep your family in their home, you're on your own!