Fannie, Freddie sink on government rescue fears

WASHINGTON — Fears that the government will be forced to rescue Fannie Mae and Freddie Mac could well become a self-fulfilling prophecy.

Shares of the government-chartered mortgage finance giants plummeted Thursday. If the prices don't recover, it will be harder for the two companies to raise more money to compensate for losses from the housing bust. Investors are afraid that their stakes will vanish if the government is forced to rescue the two companies.

"The government has to step in and do something," said Friedman, Billings, Ramsey & Co. analyst Paul Miller.

Freddie Mac shares fell $2.32 or 22.6 percent, to $7.94 in late-afternoon trading, after sinking as low as $6.75 earlier in the day. Shares of Fannie Mae fell $2.31, or 15.1 percent, to $13, after earlier falling to $11.70.

In testimony on Capitol Hill, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke sought to calm investor jitters about the financial health of Fannie and Freddie.

They are "working through this challenging period," Paulson told lawmakers. "Their regulator has made clear that they are adequately capitalized."

Asked whether such companies could pose a risk to the U.S. financial system, Paulson replied: "In today's world, it is not helpful to speculate about any financial institution and systemic risk."

Meanwhile, politicians vowed to intervene if necessary. "They cannot and will not fail," presumptive Republican presidential nominee Sen. John McCain of Arizona told reporters.

"If they need additional support, Congress will act quickly," Sen. Charles Schumer, D-N.Y., said in a statement.

The two companies are coping with worries that they won't be able to withstand soaring losses from foreclosures and home loan defaults.

Washington-based Fannie Mae raised $7.4 billion in May to fortify its balance sheet. McLean, Va.-based Freddie Mac plans to raise $5.5 billion, but has been waiting to initiate the offerings because its stock is not yet registered with the Securities and Exchange Commission.

Congress created Fannie in 1938 and Freddie in 1970 to keep money flowing into the home-loan market by buying up mortgages and bundling them into securities for sale to investors worldwide — thereby making home ownership affordable for low- and middle-income Americans.

Today the companies hold or guarantee around $5.3 trillion in home-loan debt, though under a 1992 law they are required to hold only a fraction of what is mandated for commercial banks as a financial cushion against risk.

While the government isn't obligated to assist Fannie or Freddie in a financial emergency, there is a widespread perception that they would be bailed out in the event of a collapse. The idea that they are "too big to fail" enables the two companies to borrow relatively cheaply on global markets by issuing top-rated mortgage-backed securities.

Fannie and Freddie play a vital role in the U.S. mortgage market, one that has grown dramatically over the past year after the subprime mortgage market's collapse. The companies issued about three-quarters of all new mortgage-backed securities in the second quarter of 2008, up from under 40 percent in 2006, according to trade publication Inside Mortgage Finance.

If fears about Fannie and Freddie's health continue to grow — causing the cost of routine debt sales to soar even further — the Federal Reserve and Treasury Department would likely provide emergency support to ensure the companies can continue to buy loans, said Alexandria, Va.-based banking industry consultant Bert Ely.

"There would have to be some effort to salvage them," Ely said.

Still, some question whether such anxieties are justified.

"It's way overblown," said mortgage industry consultant Howard Glaser. "Psychology is the major problem here."

Glaser, a former housing official in the Clinton administration, says the companies' government regulator could give them more flexibility — and reduce the need to raise money — by loosening capital requirements.

The Wall Street Journal reported Thursday that Bush administration officials have held talks to develop plans that would be enacted should the companies fail. Though the Treasury Department has long worked on plans for what to do if a large financial firm such as Fannie or Freddie failed, a department spokeswoman declined to comment on whether such plans have been accelerated recently.

Critics such as former St. Louis Federal Reserve President William Poole have long warned that the companies could threaten the economy and do not have enough capital to withstand financial turmoil. Poole roiled financial markets Thursday after he was quoted in a Bloomberg News story saying lawmakers should recognize that the companies "are insolvent."

However, Fannie and Freddie executives have consistently called such worries unfounded.

"It would really require an almost catastrophic collapse for us to really get into that situation," Freddie Mac CEO Richard Syron said in a late May interview broadcast on C-SPAN.

Freddie Mac spokeswoman Sharon McHale said in an e-mail Thursday that the company "continues to hold a surplus above its regulatory requirement that will enable it to continue to support the nation's housing markets."

Fannie Mae is "managing our business and maintaining a capital position that will allow us to fulfill our congressionally chartered mission now and in the future," spokesman Brian Faith said in an e-mail, noting that Fannie has raised more than $14 billion in capital since last November.