WASHINGTON – The Bush administration seized control of the nation’s two largest mortgage finance companies Sunday, seeking to shrink dramatically their outsize influence on Wall Street and on Capitol Hill while at the same time counting on them to pull the nation out of its worst housing crisis in decades.
The bailout plan for the companies, Fannie Mae and Freddie Mac, a seismic event in a year of repeated financial crises followed by aggressive federal intervention, places the companies in a government conservatorship, much like a bankruptcy reorganization. The plan also replaces the management of the companies.
The rescue package represents an extraordinary federal intervention in private enterprise. It could become one of the most expensive financial bailouts in American history, though it will not involve any immediate taxpayer loans or investments.
Still the seizure is potentially a $200 billion bet that it will help reverse a prolonged housing and credit crisis.
The Treasury Department said it was prepared to put up as much as $100 billion over time in each of the companies if needed to keep them from going broke, in exchange for senior preferred stock. Treasury will immediately be issued $1 billion of such stock from each company, which will pay 10 percent interest. Further purchases of preferred stock will be triggered if quarterly audits find that the companies’ capital cushion is below prudent standards.
Mark Zandi, chief economist at Moody’s Economy.com predicted that 30-year mortgage rates, currently averaging 6.35 percent nationwide, could dip to close to 5.5 percent. That’s because investors will be more willing to buy the debt issued by Fannie and Freddie – and at lower rates – since the federal government is now explicitly standing behind that debt.
“Effectively, the federal government has now become the nation’s mortgage lender,” he said. “This takes a major financial threat off the table.”
Treasury Secretary Henry Paulson said allowing the companies to fail would have extracted a far higher price on consumers by driving up the cost of home loans and all other types of borrowing because the failures would cause turmoil in financial markets in the United States and around the world.
“This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement,” he said. “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.”
The plan received wide bipartisan support Sunday, from congressional lawmakers and both presidential campaigns.
As part of the plan, the chief executives of both companies were replaced. Herbert Allison, the former chairman of TIAA-CREF, the huge pension fund for teachers that also offers mutual funds, will take over Fannie Mae and succeed Daniel Mudd; and at Freddie Mac, David Moffett, currently a senior adviser at the Carlyle Group private equity firm, succeeds Richard Syron. Mudd and Syron, however, will stay on during a transition period.
The plan eliminates dividend payments to current shareholders while protecting the principal and interest payments on the debt, now held by foreign central banks, financial institutions, pensions funds and others.
The Treasury will force both companies to shrink their portfolios in the near term – they now hold or guarantee about half of the country’s mortgages – by having the government buy as much as $5 billion of their mortgage-backed securities on the open market starting this month.
This step, never before undertaken by the government, could begin to restore some confidence in the credit markets and lead to lower interest rates for home mortgages.
For the companies, the takeover caps an ignominious downfall. Fannie was created during the depths of the Great Depression, and Freddie in 1970, to help make mortgages more affordable for homeowners.
The companies buy billions of dollars in mortgages each month from commercial lenders. Some are sold to investors as mortgage-backed securities; others are held by the companies in their own investment portfolios.
The plan represents a temporary cease-fire in a decades-long ideological battle over the proper role of the companies. Free-market conservatives see the companies as extensions of “big government,” while Democrats have protected them as their main vehicle to promote affordable housing for middle- and lower-income people.
Alan Greenspan, the former Federal Reserve chairman, and Lawrence Summers, a former Treasury secretary under President Clinton, along with many other critics, have long maintained that the companies were too powerful politically and financially, and that their huge portfolios posed enormous risks to the financial system.
Moreover, these critics have complained, the companies have used their ability to borrow at low interest rates to dominate the mortgage-finance market, usurping the role of other financial institutions that do not have the same subsidy.
The Associated Press contributed to this report.
WASHINGTON – Treasury Secretary Henry Paulson on Sunday moved to take control of Fannie Mae and Freddie Mac, which operated like private companies but had enjoyed implicit government backing until their seizure.
The move aimed to bolster the complex workings of mortgage finance. Here are some answers to what the plan does and how it affects U.S. homeowners.
How do Fannie and Freddie impact mortgage finance?
They buy mortgages from commercial banks and other home lenders, then package these pooled mortgages and sell them into a secondary mortgage market as bonds, called mortgage-backed securities. This process is called securitization, and it allows banks to pass on the loan and not keep it on its own books, freeing up its balance sheet for more lending.
Are Fannie and Freddie going bust?
No. But investors who purchase mortgage-backed securities – banks, investment funds and even foreign central banks – were concerned that as more Americans fall behind on their home payments, especially those with good credit, that Fannie and Freddie may have insufficient capital to withstand losses.
So they could run short of cash?
That would be unlikely but not impossible. And Paulson believed it better to get out in front of a problem than wait for it to occur. Already, big investors like Pacific Investment Management Co., or PIMCO, the world’s biggest bond fund, were frowning on buying Fannies and Freddies unless the government took bolder action.
How does this help homeowners?
It helps in a broader sense. Since Fannie Mae and Freddie Mac own or back more than half of U.S. mortgage debt, anything to stabilize them helps the broader financial markets. In recent months, investors have demanded higher returns in exchange for buying Fannies and Freddies. That led to a widening spread, or gap, between these bonds and, say, a 10-year Treasury bond. Mortgage rates take their cues from long-term U.S. government bonds, so it has had the effect of driving up mortgage rates. Since a Fannie or Freddie will now effectively be government-issued debt, the gap should narrow and rates fall. A drop of 1 percentage point in rates equals about 15 percent savings on the costs of a mortgage over its life.
So will the housing slump end because of Paulson’s plan?
It won’t end just like that. Mortgage rates are just one part of the equation. But given the erosion in home prices, lenders are still very reluctant to lend and have sharply tightened credit. Low rates won’t mean much if banks won’t lend. And the other half of the secondary mortgage market that doesn’t involve Fannie and Freddie is run by the private sector – termed private-label mortgage-backed securities. And this part of the market is frozen over like tundra.
Then what’s the significance of the Treasury action?
It assures that the functioning part of mortgage finance, while facing challenges, continues to operate smoothly. Paulson himself spelled out why it’s important to average Americans that turmoil in financial markets not be allowed to spread.
“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,” he said. “And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today.”
• Fannie Mae and Freddie Mac are placed under “conservatorship,” a legal status similar to bankruptcy, with the goal of restructuring the companies.
• The Federal Housing Finance Agency, the firms’ direct regulator, appoints senior managers and oversees all operations. Chief executives have been dismissed (but have agreed to help during the transition) and replaced with outsiders, who are to be paid significantly less.
• The federal government stands ready to inject money if either company is found to have liabilities that exceed its assets, an assessment to be made quarterly.
• Holders of debt in the companies, and of mortgages that they guarantee, are protected against losses.
• The companies will pay no dividends to owners of their stock, and the current shareholders – who now own 100 percent of each company – will have their stakes reduced to 20 percent, subject to further dilution if the government injects money.
• The government receives $1 billion worth of a special class of stock in each company that puts taxpayers’ interests ahead of those of any other shareholders.
• The companies will be prohibited from lobbying and other political involvement. Their charitable giving is being reviewed.
• Fannie Mae and Freddie Mac will increase mortgage funding between now and the end of 2009 to help stabilize the troubled housing and mortgage markets.
• Starting in 2010, they will be forced to reduce the volume of mortgages they fund by 10 percent per year for about 10 years, to reduce the risk the companies pose to the financial system as a whole.
• Officials expect Congress to restructure the firms before 2010.
• The government will also start a program to buy pools of mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac. The program is to be operated at the Treasury secretary’s discretion and an initial $5 billion worth of such purchases will be made in the coming days. That is likely to reduce the interest rates Americans pay on a new home loan.
The Washington Post