By John Brinsley and Rebecca Christie
July 25 (Bloomberg) -- In October 2003, Treasury Secretary John Snow told Congress ``we need to be on guard'' against the ``perception'' that the U.S. government stood behind the stocks and bonds of Fannie Mae and Freddie Mac.
This week his successor, Henry Paulson, has seen a plan to make such a guarantee explicit to the brink of passage, getting a presidential veto threat withdrawn and reversing years of Republican-led efforts to unhook the companies' fortunes from the government's finances.
The Fannie-Freddie legislation -- it cleared the House July 23 and the Senate may vote as soon as today -- is the result of circumstances and personality. A lame-duck White House is struggling to revive the economy and prevent a further meltdown in the housing market that would demolish the centerpiece of President George W. Bush's ``ownership society.'' Meanwhile, Paulson's desire to get a deal through the Democratic-majority Congress outweighed the administration's free-market orthodoxy.
``Paulson has been able to use a lot of leverage on the White House,'' said Vince Reinhart, who used to head the Federal Reserve's monetary-affairs division and is now at the American Enterprise Institute in Washington. The former chairman of Goldman Sachs Group Inc. ``has authority associated with his previous job, and events are such that if policy makers have to do something, they ultimately do it.''
Stock Purchases
Once Bush signs the legislation into law, the Treasury will have the right to buy unlimited stock in Fannie Mae and Freddie Mac, the government-chartered corporations that account for almost half of the U.S.'s $12 trillion mortgage market. The measures give a government backstop for their $5.2 trillion of debt outstanding, allowing them to borrow at a cheaper rate than private companies.
Largely missing from the bill are provisions the Bush administration and other Republicans have pursued for years: powers comparable to those over commercial banks that would limit the mortgage giants' lines of new business and their investment portfolios.
``This should have been a perfect opportunity'' for Republicans to ``demand real accountability and reform,'' Richard Armey, the former Republican leader in the U.S. House of Representatives, wrote in an opinion piece in the Wall Street Journal today. ``Having repeatedly called for Fannie and Freddie restructuring in the past, Mr. Paulson now fights to defend them in their current form.''
Treasury spokeswoman Michele Davis didn't immediately respond to a request for comment.
Bush Concession
The final concession on this week's deal came when Paulson persuaded the president to drop a veto threat over $3.9 billion in housing grants to communities pushed by Democrats.
``Congress knew it had the Bush administration over a barrel,'' said Peter Wallison, a Washington-based former Treasury general counsel and an author of a book on Fannie Mae and Freddie Mac. ``Paulson has had to make the best of a bad job.''
Snow told Congress in October 2003: ``We don't believe there is any government guarantee,'' for Fannie and Freddie. ``It's not in our view a reality, but it's a perception of an implied guarantee.''
The companies' lobbying efforts in Congress fended off Snow's effort to form a new, tougher regulator with power to approve new products and set capital requirements, two areas critical to their growth. That success came even as company officials came under scrutiny for accounting errors.
Taking Charge
When Paulson, 62, replaced Snow in July 2006, he took up the charge for tougher monitoring of the firms, calling on Congress to set up a new regulator.
The effort got caught up by the turmoil that engulfed Fannie Mae and Freddie Mac. Their shares slid to their lowest levels in more than 17 years as investors doubted whether they had enough capital to offset writedowns and losses.
Fannie Mae today fell 13 percent to $10.43 at 9:39 a.m. in New York trading, compared with $10.25 before Paulson announced his rescue plan July 13. Freddie Mac dropped 7.4 percent to $8.16, compared with $7.75 on July 11.
Because the companies now finance more than two-thirds of new U.S. mortgages, legislators said the government couldn't let them fail and bring down the home-loan market. That would have sent the economy into a deep recession, economists said.
Emergency Announcement
Officials discussed a range of options and consulted with congressional leaders over the weekend of July 12-13. Paulson announced his proposed rescue on the Sunday evening before Asian markets opened.
The legislation now before the Senate may even allow the companies to pay dividends and their officials to keep their current compensation levels if they tap the government for funding.
``The GSEs got what they wanted again,'' said Paul Miller, an analyst with Friedman Billings Ramsey & Co. in Arlington, Virginia. ``They got a big backstop and they got language that the Treasury doesn't necessarily have to stop them from paying dividends or cap compensation.''
Shares of Fannie Mae increased seven-fold and Freddie Mac stock multiplied eight times during the 1990s -- twice the gain during that decade of the Standard & Poor's 500 stock index.
The firms sell debt to invest in mortgages and package home loans into securities. Their federal charter and access to U.S. taxpayers' credit gave investors confidence that they had implicit government backing.
It's not the first time the Bush administration's free- market ideology was put aside to avoid a deeper crisis. Bush's first Treasury chief, Paul O'Neill, backed International Monetary Fund loans to Argentina and Turkey as the countries struggled with sliding currencies.
``O'Neill and Snow had headwinds to deal with,'' said Rob Nichols, a former Treasury official under O'Neill and Snow who is president of the Financial Services Forum, a Washington-based trade group for the nation's biggest banks. ``Paulson has had gale-force winds.''
To contact the reporters on this story: John Brinsley in Washington at jbrinsley@bloomberg.net; Rebecca Christie in Washington at Rchristie4@bloomberg.net
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