This May 2, 2007 file photo shows the Fannie Mae building in Washington. The U.S. Treasury and the Federal Reserve announced steps Sunday, July 13, 2008 to shore up mortgage giants Fannie Mae and Freddie Mac. Manuel Balce CenetaBy JEANNINE AVERSA (AP Economics Writer)
From Associated Press
July 13, 2008 8:39 PM EDT
WASHINGTON - The Federal Reserve and the Treasury announced steps Sunday to shore up mortgage giants Fannie Mae and Freddie Mac, whose shares have plunged as losses from their mortgage holdings threatened their financial survival.

The steps are also intended to send a signal to nervous investors worldwide that the government is prepared to take all necessary steps to prevent the credit market troubles that started last year from engulfing financial markets and further weakening the economy and housing markets.

The Fed said it granted the Federal Reserve Bank of New York authority to lend to the two companies "should such lending prove necessary." They would pay 2.25 percent for any borrowed funds - the same rate given to commercial banks and big Wall Street firms.

The Fed said this should help the companies' ability to "promote the availability of home mortgage credit during a period of stress in financial markets."

Secretary Henry Paulson said the Treasury is seeking expedited authority from Congress to expand its current $2.25 billion line of credit to each company should they need to tap it and to make an equity investment in the companies - if needed.

"Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies," Paulson said Sunday. "Their support for the housing market is particularly important as we work through the current housing correction."

The Treasury's plan also seeks a "consultative role" for the Fed in any new regulatory framework eventually decided by Congress for Fannie and Freddie. The Fed's role would be to weigh in on setting capital requirements for the companies.

The White House, in a statement, said President Bush directed Paulson to "immediately work with Congress" to get the plan enacted. It also said it believed the plan outlined by Paulson "will help add stability during this period."

Investors may not be as sanguine, however, according to Chris Johnson, an investment manager and president of Johnson Research Group in Cleveland. Stocks of financial institutions "are going to get clobbered," he predicted. "It is a situation where regulators and the government are trying to play catch up, and that means everything is not discounted in the stock prices yet."

The Dow Jones industrials on Friday briefly fell below 11,000 for the first time in two years and Johnson expects shares of investment banks and regional banks could fall even lower as investors react to this weekend's developments.

Fannie Mae and Freddie Mac either hold or back $5.3 trillion of mortgage debt. That's about half the outstanding mortgages in the United States.

The announcement marked the latest move by the government to bolster confidence in the mortgage companies. A critical test of confidence will come Monday morning, when Freddie Mac is slated to auction a combined $3 billion in three- and six-month securities.

Fannie was created by the government in 1938 to provide more Americans the chance to own a home by giving financial institutions an outlet to sell mortgage loans they originated, freeing more cash to make more home loans. It moved from government to public ownership in 1968 and Freddie was started two years later.

Sunday's announcements are likely to raise anew criticism that the government should have moved sooner to rein in the two companies, especially since investors widely assumed they would be bailed out if they got into trouble.

The government denied it, but what was seen by investors as an implicit guarantee of support allowed Fannie and Freddie to borrow at rates only slightly higher than the Treasury - and lower than what their banking competitors had to pay.

"This really blows away the notion of an implicit guarantee," independent banking consultant Bert Ely said of the Treasury's plan to ask Congress to allow it to make equity investments in Fannie Mae and Freddie Mac. "It suggests a greater concern about how these companies are doing. It says the problems are deeper. It gets to the solvency of the companies, not just the liquidity."

Paulson's goal is to get his plan attached to a sweeping housing-rescue package. The Senate and House have each passed bills and a final package has to be hammered out. The centerpiece of the legislation is to help strapped homeowners avoid foreclosure legislation but it also contains provisions to revamp oversight of Fannie Mae and Freddie Mac.

Senate Majority Leader Harry Reid, D-Nev., said "Senate Democrats stand ready to work with the administration to quickly and effectively address the situation currently facing these institution."

Democratic presidential contender Barack Obama, speaking with reporters before the plan was announced, said he favored congressional action to shore up the housing market, as well as legislative consultation about any taxpayer dollars used to support the mortgage companies.

Republican rival John McCain believes the measures announced Sunday "are consistent with the goal of providing support for a path through the current duress toward steps that include regulatory reform, market discipline and mission focus," said Douglas Holtz-Eakin, senior policy adviser.

House GOP leader John Boehner, R-Ohio, and Republican Whip Roy Blunt, R-Mo., said they "stand ready to work with Secretary Paulson and congressional Democrats to take appropriate steps to ensure the soundness of our mortgage markets."

Officials from Treasury, the Fed and other regulators worked in close consultation throughout the weekend after growing investor fears about the companies' finances sent their shares and the overall market plummeting last week.

Shares of Fannie Mae plunged 45 percent last week and are down 74 percent since the beginning of the year. Freddie Mac shares fell 47 percent last week, and have fallen 77 percent so far this year.

A senior Treasury official said any increase in the line of credit - now at $2.25 billion for each company- would be at the Treasury secretary's discretion. The same would apply to any equity investment made by the government.

The official, who spoke on condition of anonymity, also sought to send a calming message about Fannie's and Freddie's financial shape, saying: "There's been no deterioration of the situation since Friday."

The Fed's offer of funds is viewed as a temporary backstop until Treasury can get its plan in place. The collateral they would have to pledge - Treasury securities and federal agency securities - is more narrow than the collateral commercial banks and Wall Street firms must pledge for emergency lending privileges.

Freddie Mac Chairman Richard Syron said Sunday that preliminary second-quarter results show that his company had "a substantial capital cushion" above the 20 percent minimum surplus it is required to maintain.

Fannie Mae President and CEO Daniel Mudd said he believes the steps could send a calming message. "Given the market turmoil, having options to access provisional sources of liquidity if needed will help to strengthen overall confidence in the market. We will continue to do our part to provide liquidity, stability and affordability to the housing market now and in the future."

Last week Fed Chairman Ben Bernanke and Paulson, appearing before the House Financial Services Committee, made a point of saying that the regulator of Fannie and Freddie, the Office of Federal Housing Enterprise Oversight, has found both companies adequately capitalized.

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AP Business Writers Stephen Bernard and Joe Bel Bruno in New York contributed to this report.

Such an approach could mean beaten-down investment banks like Lehman Brothers Holdings Inc. and regional banks must now fend for themselves as they try to recover from billions of dollars in mortgage-related losses - unlike Bear Stearns Cos., whose buyout the government helped orchestrate in March. That is bound to unnerve an already turbulent Wall Street and make investors even more anxious as they await financial companies' earnings expected to be down a stunning 69 percent from a year ago when all the numbers are in.

And, for consumers already squeezed by tightening credit standards, it could mean getting a mortgage will become even harder.

The short-term uncertainty about Freddie Mac and Fannie Mae - which together hold or guarantee half the nation's mortgage debt - was to an extent relieved on Sunday. Federal officials again threw their support behind the government-sponsored enterprises; the Treasury pledged to expand its current line of credit to the two companies and Treasury Secretary Henry Paulson also said the government could, if needed, buy equity capital in the companies, whose stocks lost half their value last week. The Treasury's moves would require congressional approval.

Meanwhile, the Federal Reserve said it will provide additional loans if needed.

But some of Wall Street's biggest investors believe there was another message in the government's announcement - the rest of the financial sector seems unlikely to get a helping hand. Global banks and brokerages have already written down nearly $300 billion in soured mortgage investments - a number projected to ultimately reach $1 trillion.

"The credit crisis has obviously entered into a new phase - the government has one bailout left in them, and this is it," said Jeffrey Gundlach, chief investment officer of TCW Group in Los Angeles, which invests $160 billion.

"One consequence of Freddie and Fannie is that other firms are allowed to go under," he said. "If you couldn't get your act together after four months of unprecedented financing terms, maybe you don't deserve to be thrown yet another lifeline."

Worries about financial companies failing intensified after a run on IndyMac Bancorp Inc. led to the bank's takeover by the government on Friday. It wasn't the Treasury or Fed helping to keep IndyMac in business, but a transfer of control to the Federal Deposit Insurance Corp. - which backs deposits on all the nation's banks.

Analysts said these kind of failures will curtail competition among financial institutions, which might in turn make it even harder for some borrowers to get mortgages, personal or auto loans or credit cards.

On Wall Street, Monday could be a critical day, with investors quite nervous amid the uncertainty in the financial sector. Friday, as investors tried to assess the health of the mortgage financiers, the Dow Jones industrial average dropped below 11,000 for the first time in nearly two years, and the overall market was left with its fourth straight weekly loss. The government's support of Fannie and Freddie in part was meant to assuage investors around the world.

Wall Street will get a better sense of how concerned investors are with Fannie Mae and Freddie Mac's future immediately Monday morning. Freddie Mac is scheduled to hold its weekly debt auction beginning at 8 a.m. EDT. The auction closes at 9:45 a.m., shortly after U.S. markets open.

Successful completion of the debt auctions allows both lenders to remain liquid - replacing old debt with new. Liquidity has been one of the key questions facing financial companies during the credit crisis.

Freddie Mac is auctioning off a combined $3 billion in three- and six-month securities. Wall Street will be looking very closely at the number of bidders and the rate at which the securities are auctioned, said Bert Ely, a banking consultant who has been critical of the companies in the past.

"I'll be surprised if the results aren't strong," he said, noting the government was likely heavily encouraging investors throughout the weekend.

The banking industry was already dealt a severe blow in March when Bear Stearns nearly collapsed amid the evaporation of its liquidity. JPMorgan Chase & Co. stepped in to purchase Bear Stearns in a deal orchestrated by the Federal Reserve.

Bear Stearns was unhinged by mounting losses tied to investments in bonds backed by mortgages. As the mortgages increasingly defaulted, the value of bonds backed by the troubled loans tumbled. After Bear collapsed, investment banks were given the opportunity to borrow directly from the Fed, an option that was previously only granted to retail banks.

Financial companies' reports of write-downs of troubled debt are likely to increase this week as some of the country's largest institutions, including JPMorgan Chase, Merrill Lynch & Co. and Citigroup Inc., report second-quarter results. That trio has already taken a combined $73 billion in write-downs since the credit crisis began last summer.

Lehman Brothers, whose shares have lost 78 percent since this year's peak in February, is considered to be on the shakiest ground because it is the smallest Wall Street bank and has significant mortgage holdings. Last month, the investment bank announced it lost nearly $3 billion during the second quarter and was forced to offset that by raising $6 billion of fresh capital.

Meanwhile, analysts believe regional banks in areas hardest hit by the real estate downturn are also at risk for failure. Some of the most bandied about names include Washington Mutual Inc., National City Corp., and Fifth Third Bancorp.

"Fannie and Freddie are too big to fail only because of the repercussions, not to just the mortgage and housing markets but the entire financial market," said Joe Balestrino, fixed-income market strategist at Federated Investors. "The U.S. is in disarray ... these regionals could be gone, they are in a tough spot with housing and employment going south."

2008 The Associated Press

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