September 7, 2008 The New York Times

U.S. Unveils Takeover of Two Mortgage Giants

The Treasury Department on Sunday seized control of the quasi-public mortgage finance giants, Fannie Mae and Freddie Mac, and announced a
four-part rescue plan that included an open-ended guarantee to provide as much capital as they need to stave off insolvency.

At a news conference on Sunday morning, the Treasury secretary Henry M. Paulson Jr. also announced that he had
dismissed the chief executives of both companies and replaced them with two long-time financial executives. Herbert M. Allison, the former chairman of TIAA-CREF, the huge pension fund for teachers, will take over Fannie Mae and succeed Daniel H. Mudd. At Freddie Mac, David M. Moffett, currently a senior adviser at the Carlyle Group, the large private equity firm, will succeed Richard F. Syron. Mr. Mudd and Mr. Syron, however, will stay on temporarily to help with the transition.

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, Mr. Paulson said. 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.

Mr. Paulson refused to say how much capital the government might eventually have to provide, or what the ultimate cost to taxpayers might be.

The companies are likely to need tens of billions of dollars over the next year, but the ultimate cost to taxpayers will largely depend on how fast the housing and mortgage markets recover.

Fannie and Freddie have each agreed
to issue $1 billion of senior preferred stock to the United States; it will pay an annual interest rate of at least 10 percent. In return, the government is committing up to $100 billion to each company to cover future losses. The government also receives warrants that would allow it to buy up to 80 percent of each companys common stock at a nominal price, or less than $1 a share.

Beginning in 2010, the companies must also pay the Treasury
a quarterly fee - the amount to be determined - for any financial support provided under the agreement.

Standard & Poor
s, the bond rating agency, said Sunday that the governments AAA/A-1+ sovereign credit rating would not be affected by the takeover.

Mr. Paulson
s plan begins with a pledge to provide additional cash by buying a new series of preferred shares that would offer dividends and be senior to both the existing preferred shares and the common stock that investors already hold.

The two companies would be allowed to
modestly increase the size of their existing investment portfolios until the end of 2009, which means they will be allowed to use some of their new taxpayer-supplied capital to buy and hold new mortgages in investment portfolios.

But in a strong indication of Mr. Paulson
s long-term desire to wind down the companies portfolios, drastically shrink the role of both Fannie and Freddie and perhaps eliminate their unique status altogether, the plan calls for the companies to start reducing their investment portfolios by 10 percent a year, beginning in 2010.

The investment portfolios now
total just over $1.4 trillion, and the plan calls for that to eventually shrink to $250 billion each, or $500 billion total.

Government support needs to be either explicit or nonexistent, and structured to resolve the conflict between public and private purposes, Mr. Paulson said. We will make a grave error if we dont use this time out to permanently address the structural issues presented by the G.S.E.s, he added, a reference to the companies as government-sponsored enterprises.

Critics have long argued that Fannie and Freddie were taking advantage of the widespread assumption that the federal government would bail them out if they got into trouble. Administration officials as well as the Federal Reserve have argued that the two companies used those implicit guarantees to borrow money at below-market rates and lend money at above-market returns, and that they had become what amounted to gigantic hedge funds operating with only a sliver of capital to protect them from unexpected surprises.

That covenant in the agreement responds to many in the Bush administration and in the private sector who had argued for years that Fannie and Freddie posed
systemic risks to the economy because they had acquired more than $5 trillion in assets with only the thinnest of capital cushions to shield them from losses.

Treasury officials had little choice but to step in. With the credit markets still in a tailspin and investors reluctant to buy up mortgages with even a hint of risk, Fannie Mae and Freddie Mac guarantee about 70 percent of all new home loans, according to James B. Lockhart, the director of the Federal Housing Finance Agency.

Mr. Paulson said the Treasury Department would provide as much money as needed to keep the companies
capital reserves from falling below the levels that would trigger rules that automatically put them into receivership.

In addition, the Treasury Department will create a
Secured Lending Credit Facility, a back-up source of borrowing in the event the companies cannot borrow enough money on the open market to finance their main business of buying mortgages and reselling them as pools of mortgage-backed securities.

In a possibly unprecedented move into the private markets, the Treasury Department will also buy billions of dollars in Fannie and Freddie mortgage securities on the open market. This move is likely to make it much easier for the companies to finance somewhat riskier loans.

Mr. Lockhart said the dividends on the two companies
common and preferred shares would be eliminated, but that the shares would remain outstanding. The principal and interest payments on their subordinated debt, however, will continue to be made.

Conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses, Mr. Paulson said.

The Federal Reserve chairman Ben S. Bernanke, who participated in the private discussions by government officials in devising the bailout plan, issued a statement praising the move.
These necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets, Mr. Bernanke said. I also welcome the introduction of the Treasurys new purchase facility for mortgage-backed securities, which will provide critical support for mortgage markets in this period of unusual credit-market uncertainty.

The crisis surrounding the mortgage-finance giants seeped into the presidential campaigns, with Senator John McCain, the Republican nominee, saying on CBS
s Face the Nation that he supported the Treasury move, but he also implicitly criticized the Bush administrations oversight. I think that weve got to keep people in their homes. Theres got to be restructuring, theres got to be reorganization, and theres got to be some confidence that weve stopped this downward spiral, Mr. McCain said.

Its hard, its tough, but its also the classic example of why we need change in Washington. Its an example of cronyism, special interest, lobbyists. A quasi-governmental organization, where the executives were making hundreds of ? hundred some billion dollars a year, while things were going downhill, going to hell in a handbasket, Mr. McCain said, adding that the two companies need more regulation, more oversight, more transparency, more of everything, and frankly, a dramatic reduction in what they do.

Senator Joseph Biden, the Democratic nominee for vice president, said on NBC
s Meet the Press that he spoke to Mr. Paulson last night, and that the Treasury secretary laid out his three principles for the rescue plan. One, you have to make sure that you help homeowners and stabilize, at the same time, financial institutions. Secondly, you got to make sure that youre not bailing out shareholders vs. the taxpayers. And the third thing you got to do is make sure that theyre still in a position to be able to continue to lend, because there is a need for them to continue to have this elasticity of being able to deal with the market.

Now, what Ive heard the outline of, I am ? I want to wait till I see all the detail, but if it meets those three principles, then I think it has a great chance of succeeding. And as I understand it, whatever proposal Secretary Paulson is going to make is a proposal to get us over this hump of instability and uncertainty. Its not an official reorganization. It will be left to the next administration and the Congress to make those judgments.

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