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US Govt Takes Charge of Fannie & Freddie

On September 7, 2008, the Federal Housing Finance Agency (FHFA) officially assumed direct responsibility for not only regulating but also operating Fannie Mae and Freddie Mac. The authority to do so was granted by Congress in July by the Housing and Economic Recovery Act of 2008.

The two publicly held corporations provide funding for a large percentage of domestic home mortgages. The decision makes explicit the historical assumption that the U.S. government would support the two government-sponsored enterprises (GSEs). Treasury Secretary Henry Paulson said the action is being taken because the two institutions "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." The decision was made because of concerns that increasing mortgage defaults had impaired the GSEs' ability to both maintain their required capital reserves and continue to support mortgage lending efforts.

The plan, which Paulson said should be viewed as a "time out" to allow the GSEs to stabilize while their future role is decided, involves several key aspects.

Federal conservatorship of the GSEs

The FHFA will now run the two companies' business on a day-to-day basis, and their CEOs and boards of directors have been replaced. Treasury Secretary Paulson said that conservatorship was necessary for taxpayer money to be committed to the GSEs. As part of that takeover, the Treasury will receive shares of preferred stock in both companies. Though the agreement doesn't eliminate common and preferred shares, it means that common shareholders will now be last in line in terms of having a claim on any assets, and preferred shareholders will be next to last. Dividends for holders of both common and preferred stock have been suspended indefinitely.

The GSEs will be permitted to continue to increase the portfolios of mortgage-backed securities that they hold, and to purchase replacement securities for those portfolios. However, officials indicated that beginning in 2010, those portfolios would shrink by 10 percent each year in an effort to reduce the size and influence of the GSEs on the mortgage market.

Award of preferred stock and warrants in exchange for Treasury support

The Treasury has agreed to ensure that each operation maintains a positive net worth--an effort to reassure holders of GSE debt securities and help stabilize the bond and housing markets. In exchange, the Treasury will receive $1 billion of senior preferred stock in each organization. It also will receive warrants to purchase almost 80% of the shares of common stock in each company. Shares awarded under these Preferred Stock Purchase Agreements will receive preference over existing common and preferred shares in terms of having a claim on the companies' assets.

Banks that hold existing common or preferred shares of either institution as part of their capital reserves are being encouraged to contact their federal regulatory agency if losses on those holdings affect their ability to meet their capital requirements.

New secured lending credit facility

The Treasury is establishing a new credit facility to lend money to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks on an "as needed" basis until Dec. 31, 2009. Officials said this is intended to backstop efforts to fund GSE activities through ordinary capital markets. Loans will be secured by using existing Fannie Mae and Freddie Mac guaranteed mortgage-backed securities as collateral.

Treasury purchase of mortgage securities

To try to ensure continued availability of mortgage financing, the Treasury will purchase new GSE mortgage-backed securities on the open market over the next 15 months. The Treasury can hold these securities to maturity. Officials expressed hope that this would help reduce the spread between mortgage-backed securities and Treasury bonds, which has widened in recent months and made mortgages less affordable. This program also is intended to expire in December 2009.