Treasury Injects Liquidity Into Fannie, Freddie

Three-pronged plan designed to keep GSEs functioning normally

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Acting to avert bankruptcy for the nation's two biggest home loan lenders, Congress approved an emergency "rescue package" over the weekend of July 12-13 that gives the Treasury Department the ability to inject billions in investments and loans to Fannie Mae and Freddie Mac.

Under the three-pronged plan, Treasury Secretary Henry Paulson said in a statement that the plan includes a temporary increase in the line of credit the two government sponsored enterprises (GSEs) have with Treasury. Also, to ensure the GSEs have access to sufficient capital, he said, "the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed." Use of either the line of credit or the equity investment, he said, "would carry terms and conditions necessary to protect the taxpayer."

Third, to protect the financial system from systemic risk going forward, Paulson said, "the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards." The Federal Reserve is also allowing Fannie and Freddie to access its discount loan window.

Matt McGrath, a principal with Evensky & Katz Wealth Management in Coral Gables, Florida, says the government is "taking every means possible to help them [Fannie and Freddie] through a liquidity situation to ensure their business continues as normally as possible." Because Fannie and Freddie are the centerpiece of the housing markets, "it's necessary that these entities, Fannie and Freddie, do function, and the government would much rather do that via assistance than a full-fledged takeover." The real issue at stake, McGrath says, is liquidity. If the government can help Fannie and Freddie "survive the liquidity crisis, they can get them on track for the long-term, reassess the risk of their portfolios, and the underwriting going forward." That being said, "certainly areas for folks to be cautious would be for anyone that does individual equity selection, there's going to be a lot of concern about the stocks for Fannie and Freddie, because regardless of how this works out, the stockholders would be the first ones to take it on the chin."

The markets, no doubt, are also digesting the Federal Deposit Insurance Corporation's (FDIC) takeover of another lender, IndyMac bank of Pasadena, California, which put the FDIC on the hook for as much as $8 billion in depositor losses. IndyMac, which was spawned by Countrywide Financial Corp. in 1985 and spun off in 1997, was not even a major source of subprime mortgages, according to Venable LLP, a law firm with offices in Washington and Los Angeles. Rather, Venable says "the company's specialty was Alt-A loans, alternative mortgages that let borrowers forego income verification and other traditional documents required to demonstrate their creditworthiness."

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