Fannie Mae, Freddie Mac: Price Tag Unclear

By Reuters -  |  Posted 2008-09-08 Print this article Print

Equity markets around the world surged on the bailout news of Freddie Mac and Fannie Mae as hopes rose that the U.S. Treasury's plan to take control of the companies -- which together back about half of the country's $12 trillion in home mortgages -- might put at least a temporary floor under troubled financial markets. The government action came as worries heightened over shrinking capital at the companies, with the congressionally chartered companies suffering combined losses of nearly $14 billion in the last four quarters.


U.S. Treasury Secretary Henry Paulson, who made a number of television appearances Monday, said he could not estimate how big a burden this would mean for taxpayers until the extent of declines in the mortgage market were fully known.

Freddie and Fannie, which serve a government mission to support housing, were put in a conservatorship that allows their stock to keep trading but puts common shareholders last in line in any claims.

With bond holders likely to be long-term beneficiaries of the take-over, the yield premium on agencies' debt against Treasury bonds narrowed by at least 20 basis points, traders said. Bond prices move inversely to their yield.

"This is the biggest event in my 21 years in the business," said Arthur Frank, director and head of mortgage-backed securities research at Deutsche Bank.

The bailout will trigger one of the largest ever payments in the credit default swap market, analysts said. This is the first time a company in the benchmark investment-grade credit derivative index has had a credit event, JPMorgan analyst Eric Beinstein said in a report.

The government bond market, meanwhile, suffered as investors reasoned the bailout would vastly increase the amount of debt needed to fund the government's obligations over the medium term. Yields on two-year Treasury notes jumped nearly a half percentage point on the news.

Under the government takeover plan announced Sunday, the Treasury took $1 billion in preferred senior stock in each company, but its equity stake could reach as much as $100 billion in each and would be senior to both existing preferred and common shares. The Treasury will also receive warrants to buy up to 79.9 percent of the common stock.


In July, Paulson had hatched a plan to shore up the firms with a promise of fresh loans and a government injection of capital if either company was pushed to the brink of collapse.

But talks on an aid package ended abruptly in the past few days and policy-makers decided to seize the firms, industry sources with knowledge of the events said.

U.S. President George W. Bush said the action was necessary because the troubles at Fannie Mae and Freddie Mac, which have $1.6 trillion in debt outstanding, posed "an unacceptable risk to the broader financial system and our economy."

The normal powers of the companies' directors and officers will be held by the conservator, the Federal Housing Finance Agency that is their regulator, until the businesses are restored to "safe and solvent" financial health.

In addition, the top executives were ousted. Freddie Mac chief executive Richard Syron and Fannie Mae's CEO Daniel Mudd were replaced by David Moffett, a former top official at US Bancorp and Herb Allison, a former top official at both Merrill Lynch and pension fund TIAA-CREF.

The Treasury also will buy mortgage-backed securities Fannie and Freddie issue starting this month, and extend a credit line to them that will be in place through the end of next year.

Even with all these provisions, analysts said the potential pitfalls were numerous.

"This euphoria might fade, because Fannie and Freddie are not the problem," said Christopher Low, chief economist at FTN Financial. "Their woes are a symptom of a worldwide contraction in credit that may not be cured by the decision."

(Reporting by Pedro Nicolaci da Costa and Julie Haviv, Editing by Chizu Nomiyama)


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