US to take control of mortgage giants: reports

Source : Business Times - 6 Sep 2008

The US government plans to put government sponsored mortgage finance companies Fannie Mae and Freddie Mac under federal control, the New York Times and Washington Post newspapers reported late Friday, in what could be the largest financial bailout in the nation’s history.

The two government sponsored enterprises (GSEs) own or guarantee almost half of the country’s US$12 trillion in outstanding home mortgage debt.

The The Wall Street Journal reported earlier on Friday that the US Treasury Department is close to finalising a plan to buttress the two companies that includes changes to their senior management. The plan could be announced as early as this weekend, the paper said.

The plan could be announced as early as this weekend, the Journal said.

US Treasury spokeswoman Brookly McLaughlin declined to comment on the Journal report on Friday.

Fannie Mae and Freddie Mac spokesmen also declined to comment.

The two firms would be placed in ‘conservatorship’, the Wasington Post said, citing sources familiar with the discussions.

The value of the company’s common stock would be diluted but not wiped out, while the holdings of other securities, including company debt and preferred shares, would be protected by the government, the Washington Post said.

Senior Bush administration and Federal Reserve officials called in top executives of Fannie Mae and Freddie Mac on Friday and told them that the government was preparing to place the two companies under federal control, officials and company executives told the New York Times.

Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson were present at meetings with James Lockhart, the director of the Federal Housing Finance Agency, the regulator of the two companies, and with Fannie Mae CEO Daniel Mudd and Freddie Mac CEO Richard Syron on Friday, Reuters can confirm. There were separate meetings with the two CEOs.

Mr Daniel H. Mudd, chief executive of Fannie Mae, and Mr Richard Syron, his counterpart at Freddie Mac, are expected to step down from their posts eventually, the Wall Street Journal reported.

Earlier, Mr McLaughlin had told sources the department was ‘making progress on our work’ with Morgan Stanley, the Federal Housing Finance Agency, and the US Federal Reserve.

The US Treasury had hired Morgan Stanley on Aug 5 to advise it on whether the companies were adequately capitalised and help it determine how it would use its new powers to support the GSEs.

The housing legislation signed into law by President George W. Bush in July requires the companies agree to a Treasury backstop.

Shares of the two government sponsored enterprises (GSEs) have plunged about 80 per cent since mid-May this year as the US housing market slump resulted in the two companies reporting about US$14 billion in losses in the past four quarters, eroding some of their capital.

‘People have priced in an equity infusion that would wipe out shareholders,’ said Mr Chuck Gabriel, managing director at Washington-based consultants Capital Alpha Partners. ‘On the other hand, they have come to understand you wouldn’t have such an event without the GSEs agreeing to it.’

The Wall Street Journal, citing people familiar with the matter, said the plan was expected to involve the creative use of authority the Treasury won from the US Congress to pump capital into the two government-sponsored enterprises if it believed it was necessary.

Instead of giving each company a big capital infusion up front, the government plans to make quarterly infusions as the companies’ losses warrant, sources told the Washington Post late Friday. This would be an attempt to minimize the initial cost of the rescue, the paper said.

Shares of Fannie Mae and Freddie Mac, which had rebounded since Aug 21 on speculation a government intervention might be averted, plunged in after-hours trading in New York on Friday.

Fannie Mae stock fell 16.9 per cent to US$5.85, while Freddie’s shares declined 7 per cent to US$4.74.

Analysts at Citigroup, Merrill Lynch, and Goldman Sachs since mid-August have issued reports saying the companies had plenty of capital to operate for the near term, and both companies have successfully rolled over debt on schedule in the meantime. Yield spread premiums on the companies’ senior debt narrowed as traders bet government funding would cut their risks.

However, the major credit rating companies since Aug 22 all cut their ratings on preferred stock of the two GSEs on expectations that the share price declines had cut access to capital, increasing the need for emergency financial support.

The companies never lost their access to capital markets where they raise money to support the US housing market, but the biggest buyers of the debt have grown more cautious.

Foreign central banks reduced their holdings of ‘federal agency’ debt in custody at the Federal Reserve in the past week for the seventh week in a row.

Russia has continued reducing its holdings of agency debt, Mr Alexei Ulyukayev, first deputy chairman of Russia’s central bank, said on Friday.

The US Congress created Fannie Mae as a government agency in 1938, during the Great Depression, to buy government-insured mortgages from lenders, providing them fresh money to make more loans.

Fannie continued to function as a government-run agency during the 1940s and 1950s, even as it took steps towards privatisation. In 1968, President Lyndon Johnson decided to turn Fannie into a shareholder-owned company.