U.S. Government Announces Takeover of Fannie Mae and Freddie Mac

In an effort to support the U.S. housing market at the minimum cost to the taxpayer, the U.S. government announced on Sunday plans to takeover Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac which have come under severe pressure as mortgage delinquencies continue to soar, and house prices collapse.

"Based on what we have learned about these institutions over the last four weeks - including what we learned about their capital requirements - and given the condition of financial markets today, I concluded that it would not have been in the best interest of the taxpayers for Treasury to simply make an equity investment in these enterprises in their current form," announced Treasury Secretary Henry Paulson at a press conference on Sunday.

"We examined all options available, and determined that this comprehensive and complementary set of actions best meets our three objectives of market stability, mortgage availability and taxpayer protection," he added.

The plan includes allowing Fannie Mae and Freddie Mac to "modestly" increase their portfolios though to the end of 2009, followed by an annual 10% reduction starting in 2010.

In addition, the Treasury Department agreed to set up Preferred Stock Purchase Agreements, contractual agreements, and a facility allowing the Treasury Department to purchase mortgage backed securities issued by both entities.

"This commitment will eliminate any mandatory triggering of receivership and will ensure that the conserved entities have the ability to fulfill their financial obligations," explained James Lockhart, Director of the Federal Housing Finance Agency who spoke alongside Paulson. "It is more efficient than a one-time equity injection, because it will be used only as needed and on terms that the Treasury has set. With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers."

Government has also agreed to continue the recent unlimited lending facility to both GSEs as the ultimate liquidity back-stop, and to come to the aid of those enterprises whose holding of Fannie Mae and Freddie Mac assets would reduce their "well capitalized" base.

"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," said Lockhart. "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 added. "And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today."

As a consequence, management of Fannie Mae and Freddie Mac now falls under the jurisdiction of the FHFA, which named Herb Alison, former Vice-Chairman of Merrill Lynch as CEO of Fannie Mae and David Moffett, former Vice Chairman and CFO of US Bankcorp, to head Freddie Mac.

Lockhart closed by urging the incoming administration in the United States to reform the GSE system to prevent such events from occurring again.

The news comes after a heavy month of difficulties for Fannie Mae and Freddie Mac which began experiencing capitalization issues after a collapse of the U.S. mortgage market and a sharp increase in mortgage delinquencies in the United States.

In July, congress signed an agreement allowing both Fannie and Freddie access to an unlimited liquidity backstop for both organizations in an effort to reassure market participants who began aggressively selling the stock, fearing a collapse of both institutions.

Both institutions currently have nearly $1.6 trillion in outstanding debt.

The plan also received support from the U.S. Federal Reserve, which has operated in a consultative capacity during the ordeal.

"I strongly endorse both the decision by FHFA Director Lockhart to place Fannie Mae and Freddie Mac into conservatorship and the actions taken by Treasury Secretary Paulson to ensure the financial soundness of those two companies," said Fed Chairman Ben Bernanke in a statement following the announcement. "These necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets."

By Erik Kevin Franco and edited by Megan Ainscow
©CEP News Ltd. 2008