THE US government took over mortgage giants Fannie Mae and Freddie Mac yesterday, placing them in a “conservatorship” to help avert a financial system meltdown from the housing crisis.
Treasury Secretary Henry Paulson announced the US regulator was seizing control of the government-chartered, shareholder-owned firms underpinning trillions of dollars of home loans.
The move constitutes a massive government intervention in the financial system in an effort to contain the damage from the worst housing slump in decades, which has rippled through the banking system and led to multibillion-dollar losses for Fannie and Freddie.
The plan “is the best means of protecting our markets and the taxpayers from the systemic risk posed by the current financial condition” of the two government-sponsored enterprises, or GSEs, Mr Paulson said.
“Because the GSEs are in conservatorship, they will no longer be managed with a strategy to maximise common shareholder returns, a strategy which historically encouraged risk-taking,” he said.
New chief executives have been installed as part of the action Mr Paulson said was needed in view of “the inherent conflict and flawed business model embedded in the GSE structure”.
Departing CEOs Dan Mudd of Fannie Mae and Dick Syron of Freddie Mac “have agreed to stay on for a period to help with the transition”, Mr Paulson said.
Federal Reserve chairman Ben Bernanke, part of frantic several days of talks to come up with the rescue plan, lauded the effort.
“These necessary steps will help to strengthen the US housing market and promote stability in our financial markets,” Mr Bernanke said.
Tne key element in the plan enables the Treasury and Federal Housing Finance Agency to purchase a new class of preferred stock in the firms that “will ensure that each company maintains a positive net worth”, Mr Paulson said.
The Treasury will initially purchase $US1 billion ($1.23 billion) in shares in each of the firms, but will have the authority to boost that total to $US100 billion in each.
This will mean cash will be injected as needed, an action “more efficient than a one-time equity injection, because it will be used only as needed and on terms that Treasury has set”.
The new plan does not eliminate the existing common and preferred shares but means they would absorb any losses ahead of the government, Mr Paulson said.
“With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers,” the treasury chief said.
“Additionally, under the terms of the agreement, common and preferred shareholders bear losses ahead of the new government senior preferred shares.”
Another step — authorised by emergency legislation passed by Congress in July — opens up a new, unspecified, treasury line of credit to the two firms through the Federal Reserve.
“This facility is intended to serve as an ultimate liquidity backstop,” and will be available through December next year, Mr Paulson said.
He also said Treasury “is initiating a temporary program” to purchase mortgage-backed securities of Fannie and Freddie, to help provide liquidity in a financial market strained by a credit crunch.
“Treasury will begin this new program later this month … Additional purchases will be made as deemed appropriate,” Mr Paulson said, adding: “There is no reason to expect taxpayer losses from this program, and, in fact, it could produce gains.”
The scale of the program “will be based on developments in the capital markets and housing markets,” according to a Treasury fact sheet.
Under the plan, Fannie and Freddie will “modestly” increase their portfolios of debt through the end of next year. Then, these will be reduced at the rate of 10 per cent a year in an effort to limit “system risk” to the financial system, Mr Paulson said.
The portfolios will eventually stabilise “at a lower, less risky size”, he said.
Too big to fail, and too big to completely nationalise, Freddie Mac and Fannie Mae, the errant twins of world finance remain stuck in a credit warp until the US Government can work out just what to do with these elephants.
