July 11, 2008
U.S. Weighs Takeover of Two Mortgage Giants
WASHINGTON — Alarmed by the growing financial stress at the nation’s two largest mortgage finance companies, senior Bush administration officials are considering a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, people briefed about the plan said on Thursday.
The companies, Fannie Mae and Freddie Mac, have been hit hard by the mortgage foreclosure crisis. Their shares are plummeting and their borrowing costs are rising as investors worry that the companies will suffer losses far larger than the $11 billion they have already lost in recent months. Now, as housing prices decline further and foreclosures grow, the markets are worried that Fannie and Freddie themselves may default on their debt.
Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers.
The government officials said that the administration had also considered calling for legislation that would offer an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies. But that is a far less attractive option, they said, because it would effectively double the size of the public debt.
The officials also said that such a step would be ineffective because the markets already widely accept that the government stands behind the companies.
The officials involved in the discussions stressed that no action by the administration was imminent, and that Fannie and Freddie are not considered to be in a crisis situation. But in recent days, enough concern has built among senior government officials over the health of the giant mortgage finance companies for them to hold a series of meetings and conference calls to discuss contingency plans.
A conservatorship or other rescue operation would be the second time in four months that the Bush administration has stepped in to engineer a rescue to prevent the financial system from collapsing. Last March, it forced the sale of Bear Stearns to JPMorgan Chase to avert a bankruptcy of that venerable investment house.
Officials have also been concerned that the difficulties of the two companies, if not fixed, could damage economies worldwide. The securities of Fannie and Freddie are held by numerous overseas financial institutions, central banks and investors.
Under a 1992 law, Fannie or Freddie could be put into conservatorship if their top regulator found that either one is “critically undercapitalized.” A conservator would have sweeping powers to overhaul them, but would not have the authority to close them.
The markets showed fresh signs on Thursday of being nervous about the future of the companies. Their stock prices continued a weeklong slide, hitting their lowest level in 17 years. The debt markets, meanwhile, pushed up the two companies’ cost of borrowing — their lifeblood for buying mortgages.
The companies are by far the biggest providers of financing for domestic home loans. If they are unable to borrow, they will not be able to buy mortgages from commercial lenders. In turn, that would make it more expensive and difficult, if not impossible, for home buyers to obtain credit, freezing the United States housing market. Even healthy banks are reluctant to tie up scarce capital by offering mortgages to low-risk home buyers without Fannie and Freddie taking the loans off their books.
Together the two companies touch more than half of the nation’s $12 trillion in mortgages by either owning them or backing them. They hold more than $1.5 trillion of the mortgages as securities. Others are sold to investors in the form of mortgage-backed bonds.
In recent weeks, the companies have spiraled downward, undermined by declining confidence in their future and shaken by sharp declines in their assets as the housing markets have continued to slide and foreclosures have risen.
In the last week alone, Freddie has lost 45 percent of its value, and Fannie is off 30 percent. Expectations of default at the companies have also risen; it costs three times as much today to buy insurance on a two-year Fannie bond as it did three years ago.
Analysts expect the companies to announce a new round of write-downs and possibly be forced to raise capital by issuing additional shares, which would dilute their value for current shareholders.
Despite repeated assurances from regulators about the financial soundness of the two institutions, financial markets have concluded that by some measures they are deeply troubled.
Freddie, for instance, is technically insolvent under fair value accounting rules, in which the company puts a market value on assets as if it had to sell them now.
Although Treasury Secretary Henry M. Paulson Jr. and Ben S. Bernanke, the chairman of the Federal Reserve, passed up invitations by lawmakers on Thursday to seek legislation to deal with the crisis, officials said that the administration had been privately considering a government takeover should the markets continue to turn against the companies.
At a hearing of the House Financial Services Committee on Thursday, both Mr. Paulson and Mr. Bernanke were guarded, carefully trying not to say anything that could further erode confidence in Fannie and Freddie. They both said that the regulator of Fannie and Freddie had found that they were, in the words of Mr. Paulson, “adequately capitalized,” meaning that they had sufficient cash and other assets to withstand the turbulence in the markets.
“Fannie Mae and Freddie Mac are also working through this challenging period,” Mr. Paulson said.
Neither official would address a question posed by Representative Dennis Moore, Democrat of Kansas, who asked whether the failure of either institution would pose a risk to the financial system.
“In today’s world I don’t think it is helpful to speculate about any financial institution and systemic risk,” Mr. Paulson said. “I’m dealing with the here and now, and the important role that they’re playing and other financial institutions are playing.”
Mr. Bernanke said that Fannie and Freddie “are well-capitalized in the regulatory sense” but added that they, and other major financial institutions, needed to raise their capital levels further.
Despite repeated denials by officials in the Bush and prior administrations, financial markets have long assumed the government would stand behind Fannie Mae and Freddie Mac in times of difficulty, both because they are integral to the housing and financial markets and because the companies have a line of credit to the Treasury.
But Congress set that credit more than 38 years ago, long before the companies rose to such size and prominence, and its limit, $2.25 billion for each, has become a tiny fraction of the companies’ overall debt.
Some analysts have begun to propose that the Fed also permit the two companies to borrow from it, as Wall Street investment banks began doing after the rescue of Bear Stearns. But there is no indication that the Fed is contemplating such a move.
On Thursday, the rapid sell-off of shares of Fannie Mae and Freddie Mac came after a former central banker made comments that the companies might not be solvent, and an analyst at UBS issued a report critical of Freddie Mac.
The turmoil also shook the debt of the companies, with one main measure indicating that their cost of borrowing has risen to the highest level since mid-March, when the government rescued Bear Stearns. Throughout the day, senior officials sought to reassure the markets about the financial health of Fannie and Freddie.
Later in the afternoon, James B. Lockhart, the regulator who oversees the two companies, issued a statement that his agency was carefully watching the companies’ “credit and capital positions” and said that they were adequate to get through the current turmoil.
Fannie Mae issued a statement saying that it remained financially strong.
“Our company has raised more than $14 billion in capital since November 2007, including $7.4 billion most recently in May,” the company said. “As our regulator has stated, and has reiterated in public statements this week, we are adequately capitalized.”
Sharon McHale, vice president for public relations at Freddie Mac, said: “Our regulator has emphasized that we have continued to maintain the highest capital rating, and we are in the market every day. We’ll continue to do so.”
Shares of Freddie Mac plunged more than 30 percent and Fannie Mae’s more than 20 percent in the first hour of trading on Thursday. By the close of trading, Fannie shares had fallen nearly 14 percent, and Freddie shares had dropped 22 percent. It was the second straight day of declines for the companies.
While their stocks trade on the New York Stock Exchange, Congress created the two companies to promote housing, and the marketplace has long come to believe that they would be bailed out should they become insolvent. They hold a far lower level of capital than banks do. In recent years, they have both suffered from accounting scandals and management shake-ups.
Neither Mr. Paulson nor Mr. Bernanke, at the hearing on Thursday, would answer a question about whether Congress needs to give the regulators more tools to deal with the possible insolvency at either company.
“I don’t think we should be speculating or talking about what-if’s with any particular institutions, and so with Fannie or Freddie, what I’m emphasizing is that the tool that I want is the reform and the reform legislation that would inject confidence into the marketplace,” Mr. Paulson said, referring to a measure that would revamp the oversight of the companies.
The problems of the two companies spilled onto the campaign trail on Thursday when Senator John McCain, the presumptive Republican nominee for president, said he supported federal intervention to save Fannie or Freddie from collapsing.
“Those institutions, Fannie and Freddie, have been responsible for millions of Americans to be able to own their own homes, and they will not fail, we will not allow them to fail,” Mr. McCain said during a stop at the Senate Coney Island Restaurant in Livonia, Mich. “They are vital to Americans’ ability to own their own homes. And we will do what’s necessary to make sure that they continue that function.”
Jason Furman, the economic policy director for the Democratic presidential campaign of Senator Barack Obama of Illinois, said that Mr. Obama “believes the Bush administration’s willful neglect of warning signs in housing, in financial markets and in the job market, have compromised the nation’s housing finance system.”
“The challenges facing Fannie and Freddie are part of the broader weakness in our economy,” Mr. Furman said.
Senator Charles E. Schumer, Democrat of New York and chairman of the Joint Economic Committee, said that the markets should rest assured that the mortgage giants have a “federal lifeline” and would not be allowed to fail — though he said he thought a government rescue would not be needed and should be a last resort.
