Feds Form Conservatorship for Fannie, Freddie

Treasury Secretary Henry Paulson Jr. announced Sunday that the Treasury Department and Federal Housing Finance Agency would step in to act on behalf of Fannie Mae and Freddie Mac. A conservatorship has been formed that will manage taxpayer investment in the two giants, among other steps.In July, Congress had given the department power to bolster the two. “Since that time,” Paulson stated over the weekend, “we have closely monitored financial market and business conditions and have analyzed in great detail the current financial condition of the GSEs – including the ability of the GSEs to weather a variety of market conditions going forward. As a result of this work, we have determined that it is necessary to take action. Of particular alarm has been the recent revelations that their capital requirements have been underestimated. As a result, said the secretary, “today, I concluded that it would not have been in the best interest of the taxpayers for Treasury to simply make an equity investment in these enterprises in their current form.” The steps announced by the collaboration between FHFA, the U.S. Treasury, and the Federal Reserve, he stressed, reflect the “unique” roles of these two institutions. “They operate solely in the mortgage market and are therefore more exposed than other financial institutions to the housing correction. Their statutory capital requirements are thin and poorly defined as compared to other institutions. Nothing about our actions today in any way reflects a changed view of the housing correction or of the strength of other U.S. financial institutions,” he emphasized. The plan calls for four steps to be taken. First, a conservatorship has been formed within which taxpayer money will be committed to the GSEs. New CEOs supported by new non-executive chairmen have taken over management of the enterprises. Former vice-chairman of Merrill Lynch Herb Allison will lead Fannie Mae; former vice-chairman of US Bancorp David Moffett will helm Freddie Mac. Departing CEOs, Dan Mudd and Dick Syron, will stay on for a period to help with the transition. Treasury has taken three additional steps to complement FHFA’s move to place both enterprises in conservatorship. First, Treasury and FHFA have established preferred stock purchase agreements, contractual agreements between the Treasury and the conserved entities.Treasury will ensure that each company maintains a positive net worth. With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers. Additionally, under the terms of the agreement, common and preferred shareholders bear losses ahead of the new government senior preferred shares.This does place common shareholders last in terms of claims on the assets of the enterprise. That said, the federal agencies are assessing the exposures of banks and thrifts to Fannie Mae and Freddie Mac–as some smaller institutions have holdings that are significant compared to their capital. The second step being taken is the establishment of a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. This facility is intended to serve as an ultimate liquidity backstop and will be available until December 2009. Finally, to further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS. Treasury will begin this new program later this month, investing in new GSE MBS. Paulson concluded by stating that. Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe. “This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today,” he advised. In the weeks to come, I will describe my views on long term reform. I look forward to engaging in that timely and necessary debate. -30-