History: Fannie, Freddie Seized by Federal Government

September 7, 2008 will now be remembered as the day the U.S. government took over the mortgage market

September 7 will now be remembered as the day the U.S. government took over the mortgage market. What that means for financial markets going forward has never been less certain. This is no longer the worst mortgage crisis since the Great Depression; this is the worst mortgage crisis, period. It’s also the end of an era.

The U.S. Treasury on Sunday announced a takeover of both Fannie Mae (FNM) and Freddie Mac (FRE), a move that has nearly no precedent in U.S. history. Together, the companies own or guarantee roughly $5.3 trillion in home loans, roughly half of all outstanding U.S. mortgages. The bailout will involve as much as $200 billion in capital and credit lines to both GSEs, according to documents released Sunday afternoon by the Treasury.

Treasury officials said the government will immediately purchase $1 billion in senior preferred stock from each company; the preferred stock comes with a 10 percent coupon, quarterly dividend payments and provides warrants representing an ownership stake of 79.9 percent of each GSE going forward. All other preferred and common shares in Fannie and Freddie will see dividends halted by their new regulator, the Federal Housing Finance Agency, of FHFA — the FHFA will essentially serve as receiver for both GSEs, as both companies have been placed into conservatorship as part of the government’s plan.

Under the Treasury preferred stock purchase agreement, the government may purchase an additional $100 billion in preferred interests in each GSE if needed, although FHFA director James Lockhart suggested such a large investment likely wouldn’t be needed.

But after hearing from Lockhart for weeks that the GSEs were in solid financial condition, and that the Treasury had no intention to step in, how much of whatever is said can really be believed at this point? “Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe,” Paulson said in a press conference on Sunday. “This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement.”

As part of the nationalization, FHFA immediately canned Fannie CEO Daniel Mudd and Freddie chairman and CEO Richard Syron, although both will stay on in transitional roles. FHFA’s Lockhart named Herb Allison, former vice chairman at Merrill Lynch & Co. (MER), to the CEO post at Fannie Mae; former US Bancorp (USB) vice chairman David Moffett will now lead Freddie Mac.

“Unfortunately, as house prices, earnings and capital have continued to deteriorate, [the GSEs] ability to fulfill their mission has deteriorated,” said Lockhart. “In particular, the capacity of their capital to absorb further losses while supporting new business activity is in doubt.”

Beyond the capital injections, the federal government said it will begin purchasing unknown amounts of agency MBS on the open market, a move it said would “promote the stability of the mortgage market.”

The Treasury said it will appoint two independent asset managers as financial agents of the U.S. government to manage the a government portfolio of MBS with the goal of “promoting stabiliity and protecting taxpayers.” Which means that the U.S. government could become akin to the single largest hedge fund on the planet. Amazing to think, for anyone that has been in the mortgage market.

Early sentiment suggests that the bailout may do little to quell investor’s nerves, however; the few sources we’ve talked to thus far have suggested that concern over commercial banks is likely to intensify. “I can think of four large commercial banks in more tenuous positions that either Fannie or Freddie,” said one source, a hedge fund manager that asked not to be named. “Does this mean things are really even worse than we think there? Or that the government will need to step in there as well for the good of the US home owner?”

Read More:

Parsing the Losers in Fannie, Freddie Bailout

Preferred Backlash to GSE Bailout Grows

Upheaval Continues at Fannie Mae, Freddie Mac

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