Wednesday, September 10, 2008

It's Official: Fannie Mae & Freddie Mac On Welfare...

Government Takes Control of Fannie Mae, Freddie Mac
Bail-Out Will Redistribute Management To FHFA, Treasury, And Federal Reserve

by Marcia A. Wade

Sept. 8, 2008 -- The federal government yesterday took control of mortgage giants Freddie Mac and Fannie Mae in a dramatic attempt to shore up the nation's weakened housing market.

"Through the four actions we have taken today, [the Federal Housing Finance Agency] and Treasury have acted on the responsibilities we have to protect the stability of the financial markets, including the mortgage market, and to protect the taxpayer to the maximum extent possible," Treasury Secretary Henry M. Paulson said Sunday. Over the next 30 days, the Treasury Department will be purchasing nearly $5 billion in mortgage bonds. Many expect that this will cause interest rates to decrease. Additionally, dividends on both common and preferred shares will be eliminated in an effort to conserve $2 billion. The Treasury Department will also buy preferred stock in Fannie and Freddie to provide security to debt holders and bolster housing finance.

Paulson said that he could not in good conscience provide an equity subsidy to the banks in their current form at the expense of taxpayers. The conservatorship, which began today, will eliminate the positions held by Fannie CEO Dan Mudd and Freddie CEO Dick Syron, but they will remain on board for a period of time to help with the transition. The FHFA will assume control of the board, and the vast majority of key professionals will remain in their jobs.

Together Freddie and Fannie own or back about $5.3 trillion in mortgages, which is about half the nation's mortgage debt. The two government-sponsored enterprises were established to help create affordable mortgages and increase the availability of mortgage financing.

The situation to bail out Fannie and Freddie became evident last week when Freddie Mac was not able to sell mortgage bonds at a reasonable market value. The two enterprises have lost billions of dollars from high-risk bonds composed of defaulted home loans. Increased foreclosures over the past year have made it difficult for Fannie and Freddie to sell the debt and raise capital.

Jim B. Lockhart III, director of the FHFA, says yesterday's action was attributed to a flawed business model embedded in the government sponsored enterprise (GSE) structure and to the ongoing housing correction.

"I have long said that the housing correction poses the biggest risk to our economy," Lockhart says. "It is a drag on our economic growth, and at the heart of the turmoil and stress for our financial markets and financial institutions. Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing."

David Moffett, former CFO of U.S. Bancorp and senior adviser at the Carlyle Group, a private-equity firm, has been chosen to head up Freddie Mac. Herbert M. Allison, a former TIAA-CREF executive, was named chief executive officer of Fannie Mae.

The Treasury is hoping to help policymakers chart a course to resolve the systemic risk created by the inherent conflict in the GSE structure and minimize the near term costs to the taxpayer.

"The taxpayers will have to come up with some of this bailout," says Joy Jamison, president of the National Association of Black Mortgage Brokers. "It helps to destabilize the market and that is very important to us because it will allow us to continue the programs in the community. Those would have been affected the most." According to Jamison, consumer confidence will get a boost. "People are afraid in the market right now. They are afraid to buy and do refinances. They will look to buy houses again and will help to energize folks and bring this whole market back.

"Half of the loans in this country are backed by Fannie Mae and Freddie Mac," Jamison says. "It affects all of the industries. They are all down right now-the appraisal and title industries, mortgage insurance, and individual mortgage companies."

In recent months, the housing crisis has shattered many banks and reduced the amount of consumers seeking mortgages. The Federal Reserve reported recently that consumer borrowing grew at a rate of just 2.1% in July, the slowest pace since a 1.9% rise last December.

Since the announcement was made, Wall Street has responded favorably. The Dow Jones industrials gained more than 150 points, and there was a rally among banks with exposure to mortgages.

Samuel D. Melvin, a mortgage planner at Dessert State Mortgage, says that although taxpayers will see an initial increase in taxes, they will receive dual benefits from the seizure, first as a decrease in new mortgage interest rates and also first with lower mortgage interest rates, and secondly with government making a profit on their investment.

"Whenever the government steps in, there's an initial cost to the taxpayer. These activities will add to the federal budget deficit since the U.S. Treasury will use borrowed funds for this arrangement," Melvin says. "But because there is typically a positive spread between the borrowed funds and the yield on the Freddie/Fannie bonds, the government earns a profit on the difference."

The Treasury's temporary authorities will expire at the end of next year and the GSE portfolios will begin to gradually run off. Fannie and Freddie will then begin to pay the government a fee to compensate taxpayers for the on-going support provided by the Preferred Stock Purchase Agreements.

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Copyright © 2008 Earl G. Graves, Ltd. All Rights Reserved.

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