The U.S. government seized control of the mortgage giants Fannie Mae (‘FNM’) 7.04, +0.62, +9.65% and Freddie Mac FRE 5.10, +0.15, +3.03% on Sunday, placing the liabilities of more than $5 trillion worth of mortgages onto the backs of the U.S. taxpayer. Both companies have been now been placed into a government conservatorship that will be run by the recently created Federal Housing Finance Agency.
The chief executives of the two government-backed companies – Dick Syron of Freddie Mac and Daniel Mudd of Fannie Mae – have stepped down, but will continue stay on temporarily to oversee the transition. Herb Allison, former chairman of TIAA-CREF, will take over as CEO of Fannie, while U.S. Bancorp (USB: 32.74, +1.09, +3.44%) Chief Executive David Moffett will become CEO of Freddie.
“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,” said Treasury Secretary Henry Paulson at a press conference in Washington D.C. “A failure would affect the ability of americans to get home loans, auto loans and other consumer credit and business finance.”
The Sunday announcement and themes of “too big to fail” brought stark reminders of the government’s March intervention of Bear Stearns, which came within hours of filing for bankruptcy.
As part of the plan, both Fannie and Freddie’s day-to-day operations will be under the direction of FHFA’s Director Jim Lockhart. Officials provided no indication of when the government conservatorship will end – that will be up to the health of the U.S. housing economy as well as the next administration.
“Conservatorship will give the enterprises time to restore the balances between safety and soundness and provide affordable housing and stability and liquidity to the mortgage markets,” Lockhart said.
Paulson said the Treasury will receive $1 billion in senior preferred stock, with a yield of 10% a year, in both Fannie and Freddie, and will also receive “warrant for the purchase of common stock of each company representing 79.9% of the common stock of each company on a fully-diluted basis at a nominal price.”
The government’s plan will basically wipe out any worth common or preferred stock holders have in the two mortgage companies. All dividends for Fannie and Freddie will be eliminated, Paulson said.
All company political lobbying efforts will cease as well.
While under the direction of the government, the two companies will then take additional mortgage-backed securities to help stabilize the mortgage markets through the end of 2009, Paulson said. As the market begins to recover in 2010, both Fannie and Freddie will reduce the size of their mortgage portfolios at a rate of 10% a year.
Now because the government controls the liabilities of Fannie and Freddie, it could potentially cost the taxpayers billions of dollars in losses. However, Paulson emphasized that, because of the long-term value of these securities, the taxpayer would have “a large stake in the future value of these entities.”
“The ultimate cost to the taxpayer will depend on the business results of (Fannie and Freddie) going forward,” Paulson said.
The plan was endorsed and planned in cooperation with the Federal Reserve and Congress, including House Financial Committee Chairman Rep. Barney Frank, D-Mass.
“These necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets,” said Fed Chairman Ben Bernanke in a statement.
Rating agency Standard & Poor’s affirmed Fannie and Freddie’s long-term AAA credit rating.
“We believe the government has now clearly reinforced its support of (Fannie and Freddie),” said S&P’s credit analyst Victoria Wagner, in a statement.
Democratic Presidential Candidate Sen. Barack Obama, D-Ill., said “given the substantial role that Fannie Mae and Freddie Mac play in our housing system, I believe that some form of intervention is necessary to prevent a larger and deeper crisis throughout the entire economy.”