Mortgage bailout aimed at stemming financial crisis

WASHINGTON — The U.S. government Sunday seized control of mortgage finance companies Fannie Mae and Freddie Mac, launching what could be its biggest bailout ever in a bid to support the U.S. housing market and ward off more global financial market turbulence.

The action, prompted by worries over the companies' shrinking capital, was the latest in a series of emergency steps taken by U.S. officials to prop up the wobbly housing sector and quell what is now a year-long crisis in credit markets that has helped push many economies toward recession.

“Our economy and our markets will not recover until the bulk of this housing correction is behind us,” U.S. Treasury Secretary Henry Paulson said in a statement read to reporters.

Fannie Mae and Freddie Mac, which own or guarantee almost half of the country's $12-trillion (U.S.) in outstanding home mortgage debt, were so large 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.

The government-sponsored companies, which are publicly traded but which also serve a government mission to support housing, were put in a conservatorship that allows their stock to keep trading but puts common shareholders last in any claims.

The normal powers of the companies' directors and officers will be held by the conservator – their regulator, the Federal Housing Finance Agency – until the businesses are restored to “safe and solvent” financial health.

President George W. Bush said the action was necessary because the troubles at Fannie Mae and Freddie Mac, which have $1.6-trillion in debt outstanding, posed “an unacceptable risk to the broader financial system and our economy.”

As part of the plan, the Treasury is taking an equity stake in the companies, will purchase mortgage-backed securities they issue and will extend a credit line to them – actions that together could top $200 billion.

In addition, the top executives were ousted. Freddie Mac chief executive Richard Syron and Fannie Mae's CEO Daniel Mudd were replaced by David Moffett, a former top official at US Bancorp and Herb Allison, a former top official at both Merrill Lynch and pension fund TIAA-CREF.

The Treasury will immediately take stakes of $1-billion in each company. Those stakes could grow to be as large as $100-billion each and would be senior to both existing preferred and common shares. The Treasury will also receive warrants to buy up to 79.9 per cent of the common stock.

The Treasury this month will begin buying mortgage-backed securities issued by the companies and has authority to make such purchases through Dec. 31, 2009. The credit line, which will also serve the 12 federal home loan banks, will be in place through the end of next year as well.

The actions reflect a growing willingness by the devoutly free-enterprise Bush administration to involve the government in business to help an economy mired in a mortgage crisis.

Several analysts said the move should help instill some confidence in shaky credit markets and lower mortgage costs.

“The government had to do something to eliminate uncertainty,” said Peter Goldman, a principal with Front Barnett Associates in Chicago. “Anything that eliminates uncertainty in the credit markets is a good thing.”

The Treasury Department said the ultimate cost of the plan depends on how well the companies perform in future. In July, congressional budget analysts estimated a rescue would likely cost taxpayers $25-billion.

The proposals outlined Sunday, less than two months away from the U.S. election, leave the ultimate fate of Fannie Mae and Freddie Mac in the hands of the next president.

Democratic presidential contender Sen. Barack Obama said it will be necessary to clarify whether they are truly public companies, subject to market discipline, or special entities that investors feel they can put money in risk-free.

A senior adviser to Republican presidential nominee Sen. John McCain described the companies as examples of “crony capitalism” and said McCain believes they should eventually be privatized.

Both candidates said action was needed to ensure the companies, which have enjoyed lower borrowing costs in financial markets due to their governmental ties, did not end up endangering the economy.

The congressionally chartered companies – the two largest sources of U.S. housing finance – have suffered combined losses of nearly $14-billion in the past four quarters and large holders of their debt, including overseas central banks, have shown increasing nervousness over their health.

Foreign central banks reduced their holdings of “federal agency” debt in custody at the Federal Reserve in the past week for the seventh week in a row.

Mr. Paulson said information on the companies' capital gained over the past four weeks led him to conclude officials needed to act. The Treasury hired Morgan Stanley on Aug. 5 to advise it on whether the companies were adequately capitalized.

FHFA Director James Lockhart said the companies lacked sufficient capital to support the housing market at a time they were suffering big losses.

“As house prices, earnings and capital have continued to deteriorate, their ability to fulfill their mission has deteriorated,” he said. “They have been unable to provide needed stability to the market.”

Fed Chairman Ben Bernanke strongly endorsed the action. “These necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets,” he said.