By Rebecca Christie and John Brinsley
Sept. 8 (Bloomberg) -- The U.S. Treasury's takeover of Fannie Mae and Freddie Mac is aimed at keeping the companies going into 2009, while leaving the next president and Congress to decide their long-term structure.
Treasury Secretary Henry Paulson and Federal Housing Finance Agency Director James Lockhart yesterday placed the two firms in a government-operated conservatorship, ousting their chief executives and eliminating their dividends. The Treasury may purchase up to $200 billion of stock in the firms to keep them solvent.
``Some of this is a stopgap to try to prevent the mortgage market from falling apart,'' former Federal Reserve Bank of St. Louis President William Poole said on Bloomberg Radio. The federally chartered, shareholder-owned structure, with risks covered by taxpayers, is ``an unacceptable situation,'' he said, projecting the Treasury may need to cover as much as $300 billion of losses.
Yesterday's action leaves open the option favored by former Federal Reserve Chairman Alan Greenspan, to split up and sell off the companies, or a full nationalization that would cement the government's role in mortgage markets. Avoiding a decision on the issue enhances the likelihood of congressional backing for the emergency steps, Democratic Senator Charles Schumer said.
``The new Congress and the next administration must decide what role government in general, and these entities in particular, should play in the housing market,'' Paulson said yesterday in Washington. There is a consensus now that ``they cannot continue in their current form,'' he added.
Ejecting CEOs
The FHFA, which will run the conservatorship, ejected Fannie CEO Daniel Mudd, 50, and Freddie CEO Richard Syron, 64. They were replaced by Herbert Allison, 65, former CEO of TIAA- Cref, and David Moffett, 56, who was a US Bancorp vice chairman.
The Treasury also said yesterday it will provide secured short-term funding to Fannie, Freddie and 12 federal home-loan banks, and purchase mortgage-backed debt in the open market.
``This is not a permanent solution -- they've not saved Fannie and Freddie, what they've done is they've bought 15 months,'' said Bill Ackman, founder of Pershing Square Capital Management in New York, which has sold short the two companies, or bet on declines in their securities. ``It's a band aid. They haven't permanently recapitalized the companies.''
1930s Creation
The takeovers bring Fannie, formed after the Great Depression and spun off in 1968, and Freddie, created in 1970, back under the government's fold. It's the biggest step yet in officials' efforts to grapple with a yearlong credit crisis that has caused more than $500 billion of losses and writedowns.
``This action should lead to an increased availability of mortgage financing, which will help achieve stability in housing,'' Bank of America Corp. Chief Executive Officer Kenneth Lewis, said in e-mailed remarks. Paulson consulted with Lewis last week, according to two people briefed on the discussions. Bank of America spokesman Scott Silvestri declined to comment on the talks.
Under the plan, the Treasury will receive $1 billion of senior preferred stock in coming days, with warrants representing ownership stakes of 79.9 percent of Fannie and Freddie. The government will receive annual interest of 10 percent on its stake.
As a condition for the assistance, Fannie and Freddie eventually will have to reduce their holdings of mortgages and securities backed by home loans.
Last in Line
While common stockholders of Fannie and Freddie won't be eliminated, they will be last in line for any claims, Paulson said. Preferred shareholders will be second in absorbing losses, he said. Interest and principal payments will continue to be made on the companies' subordinated debt, Lockhart said.
The government is taking an increasing role in financial markets, after the Fed six months ago provided $29 billion of financing to prevent Bear Stearns & Cos.'s collapse. Chairman Ben S. Bernanke praised yesterday's action in a statement.
Democratic presidential nominee Barack Obama said yesterday that ``some'' intervention was necessary to prevent a ``larger and deeper crisis.'' After the current crisis subsides, ``the plan must move toward clarifying the true public and private status of our housing policies,'' he said.
``We've got to keep people in their homes,'' Republican presidential candidate John McCain said in an interview with CBS's ``Face the Nation'' program. ``There's got to be restructuring, there's got to be reorganization, and there's got to be some confidence that we've stopped this downward spiral.''
Two-Month Saga
The government takeover comes almost two months after Paulson first sought emergency powers to inject capital into the beleaguered mortgage-finance companies. Congress approved the measure in legislation signed by President George W. Bush on July 30.
Paulson had indicated until early last month that it was unlikely he'd use the authority, and then kept silent even as investors clamored for clarity on how a government intervention would work.
Included in yesterday's measures is a Treasury program to purchase new mortgage-backed securities from the two companies, starting with a $5 billion purchase this month.
The Treasury will also hire independent asset managers to purchase and run the portfolio of mortgage-backed securities it will buy. ``There is no reason to expect taxpayer losses from this program, and it could produce gains,'' the department said.
`Threaded the Needle'
``Paulson has threaded the needle just right by taking necessary action to stabilize U.S. financial markets while minimizing the liability for taxpayers,'' Schumer of New York, who heads the congressional Joint Economic Committee, said in a statement. ``This plan will be met with broad acceptance in Congress because it doesn't prejudge the ultimate fate of Fannie Mae and Freddie Mac.''
Paulson's decision, taken after consulting with Bernanke, followed a review that found Washington-based Fannie and McLean, Virginia-based Freddie used accounting methods that inflated their capital, according to people with knowledge of the decision.
Paulson, 62, hired Morgan Stanley a month ago to probe the companies' finances. The investment bank concluded that the accounting, while legal, enabled Freddie, and to a lesser extent Fannie, to overstate the value of their reserves, according to the people who declined to be identified because the findings were confidential.
Fannie and Freddie own or guarantee almost half of the $12 trillion in U.S. home loans and the government had been leaning on the companies to help pull the economy out of the housing crisis.
Concern over the companies' capital pushed their borrowing costs to record levels over U.S. Treasuries, sent their common and preferred stocks tumbling and boosted mortgage rates. Fannie is down about 66 percent in New York Stock Exchange trading since the end of June. Freddie has fallen about 69 percent.
To contact the reporter on this story: Rebecca Christie in Washington at Rchristie4@bloomberg.net; Dawn Kopecki in Washington at dkopecki@bloomberg.net
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