With the nation riveted on what the next President will do, the current Administration showed on Sept. 7 that it's not ready to take its hands off the economy's steering wheel quite yet. The Bush Administration announced that it had seized control of Fannie Mae (FNM) and Freddie Mac (FRE), two huge but dysfunctional companies whose financial difficulties were weighing down the U.S. housing market and threatening global financial upheaval.
It was a dramatic move for the Republican Administration. The two privately owned companies are in effect being nationalized, something that's ordinarily anathema to conservatives. Treasury Secretary Henry Paulson, who announced the action (BusinessWeek, 9/7/08) at a rare Sunday news conference, justified it by saying that Fannie and Freddie are so "large and interwoven" into the global financial system that "a failure of either would cause turmoil around the world."
The Bush Administration's hand was forced by a dramatic deterioration of the housing market, which eroded the balance sheets of Fannie and Freddie and frightened the global investors who support them. Together, Fannie and Freddie have about $5 trillion in outstanding debt and mortgage-backed securities. Home prices are in a swoon, falling 15% over the past year in 20 major metro areas. Zillow.com, a real estate Web site, estimates that 29% of the homeowners who bought in the past five years owe more on their homes than the properties are worth. On Sept. 5, the Mortgage Bankers Assn. announced that the share of homes entering foreclosure in the second quarter reached 1.19%, the highest in the 29-year history of its survey.
Mudd and Syron Leaving
Allowing either Fannie or Freddie to fail (BusinessWeek.com, 8/28/08), Paulson said, would hurt families' savings, their ability to get home and auto loans, and even hamper economic growth and job creation.
The government will boot out the CEOs of both Fannie and Freddie—Daniel Mudd and Richard Syron, respectively—though they will stay on in advisory roles during a transition. It will ban the companies from lobbying. Treasury will invest up to a maximum of $100 billion in each of the companies in the form of senior preferred shares, as needed, to make sure the companies retain a positive net worth and thus retain the confidence of investors. Treasury will also make secured loans to the two companies if needed, and plans to break precedent and buy some mortgage-backed securities itself to provide financing to housing.
Fannie and Freddie support the housing market by purchasing mortgage loans from the banks that originate them, giving the banks the cash to make more loans. They package those loans into securities and ensure repayment. They sell the securities to investors around the world (BusinessWeek.com, 8/28/07) or retain them for their own portfolios.
Part of the Problem
At one point earlier this year, as the credit crunch worsened, the two companies were responsible for about 80% of all loans being originated in the U.S. But the rise of foreclosures weakened their balance sheets and raised their borrowing costs, reducing their ability to support the market. As the housing downturn worsened, the two companies came to be seen as part of the problem instead of part of the solution.
Technically, Fannie and Freddie have been placed under "conservatorship," a term that ordinarily means they are being stabilized with the objective of returning them to normal operation.