Takeover of Fannie, Freddie to cost government billions

WASHINGTON — The Bush administration's seizure of troubled mortgage giants Fannie Mae and Freddie Mac is potentially a $200 billion bet that it will help reverse a prolonged housing and credit crisis.

The historic move announced Sunday won support from both presidential campaigns, but private analysts worried it may not be enough to stabilize the slumping housing market given the glut of vacant homes for sale, rising foreclosures, rising unemployment and weak consumer confidence.

Officials announced that both giant institutions were being placed in a government conservatorship, a move that could end up costing taxpayers billions of dollars.

Treasury Secretary Henry Paulson said allowing the companies to fail would have extracted a far higher price on consumers by driving up the cost of home loans and all other types of borrowing because the failures would "create great turmoil in our financial markets here at home and around the globe."

Key mortgage players

Fannie and Freddie buy home loans from banks then repackage those loans as mortgage-backed securities which they either hold on their books or sell to investors worldwide. This provides banks with more money to make more home loans, expanding homeownership.

Mark Zandi, chief economist at Moody's Economy.com, predicted that 30-year mortgage rates, averaging 6.35 percent nationwide, could dip to close to 5.5 percent. That's because investors will be more willing to buy the debt issued by Fannie and Freddie — and at lower rates — since the federal government is now standing behind that debt.

"Effectively, the federal government has now become the nation's mortgage lender," Zandi said.

While lower rates will be good news to homebuyers, the plan offers little relief to homeowners behind on their mortgage payments or who owe more than their homes are now worth.

"The bailout will give the mortgage industry a stability that we haven't had in a couple of years," said Rich Cosner, president of Prudential California Realty. "But frankly no, it won't help [struggling borrowers] to refinance."

Futures on all major stock indexes rose about 2 percent in electronic trading Sunday night, another sign of investor relief about the takeover plan.

Asian stocks surged today from the lowest levels in almost three years.

"It's good news for financials everywhere," said Saxon Nicholls, an Australian money manager. "The whole global financial system is so integrated, and Asian central banks are big buyers of Fannie and Freddie paper."

The two companies, which together own or guarantee about $5 trillion in home loans, about half the nation's total, have lost $14 billion in the past year and are likely to pile up billions more in losses until the housing market revives.

The Treasury Department said it was prepared to put up as much as $100 billion over time in each of the companies if needed to keep them from going broke, in exchange for senior preferred stock.

The department will immediately be issued $1 billion of such stock from each company, which will pay 10 percent interest. Further purchases of preferred stock will be triggered if quarterly audits find the companies' capital cushion is below prudent standards.

The government, which will receive warrants representing ownership stakes of 79.9 percent in each company, is hoping that its moves will reassure nervous investors that they can continue to buy the debt of the two companies.

In a statement, President Bush said: "Americans should be confident that the actions taken today will strengthen our ability to weather the housing correction and are critical to returning the economy to stronger sustained growth."

Democratic presidential nominee Barack Obama agreed some intervention was needed. "I will be reviewing the details of the Treasury plan and monitoring its impact to determine whether it achieves the key benchmarks I believe are necessary to address this crisis."

Republican presidential nominee John McCain also voiced support, while his running mate, Alaska Gov. Sarah Palin, said Fannie and Freddie "have gotten too big and too expensive to the taxpayers. The McCain-Palin administration will make them smaller and smarter and more effective for homeowners who need help."

The conservatorship will be run by the Federal Housing Finance Agency, the agency created by Congress this summer to regulate Fannie and Freddie, a move taken at the same time Congress greatly expanded the power of the Treasury Department to make loans to the two companies and buy their stock.

Changes at top

The executives and boards of both institutions are being replaced. Herb Allison, the former head of the TIAA-CREF retirement investment fund, will head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp, was picked to head Freddie Mac.

Paulson was careful not to blame Daniel Mudd, the outgoing CEO of Fannie Mae, or Freddie Mac's departing CEO Richard Syron for the companies' problems.

The impact of the government takeover on the shares, which have slumped in value in the past year, will depend on how investors react to Paulson's assertion that they must absorb the cost of further losses first. Under the plan, dividends on both common and preferred stock would be eliminated, saving about $2 billion a year.

After the Treasury Department's announcement, credit-rating agency Standard & Poor's downgraded Fannie and Freddie's preferred stock to junk-bond status but reaffirmed the government's Triple A rating.

The Fed released a letter from Fed Chairman Ben Bernanke to James Lockhart, the director of the Federal Housing Finance Agency, in which the Fed chief said he concurred in Lockhart's decision to take control of Fannie and Freddie.

Analysts were split on how much the takeover could eventually cost taxpayers although they all agreed the upfront costs will be substantial, possibly hitting $100 billion as the Treasury is called upon to bolster the capital cushions at both institutions.

However, if the plan does the trick of stabilizing the housing market and home prices stop falling and rebound, the assets of both Fannie and Freddie should rise in value and the government should be able to sell off the companies and recoup its investments.

But it could take a long time

"I think the government will end up having to put in far more money then they are planning right now [given all the problems facing housing] but the important thing is the agencies have been taken over by the government," said Sung Won Sohn, an economics professor at California State University Channel Islands. "That means there will be less panic in financial markets."

Information from Bloomberg News is included in this report.