U.S. Places Fannie Mae and Freddie Mac Into Conservatorship

Treasury, Fed, and Housing Finance regulator take four-point move to rescue mortgage lenders

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On Sunday, Sep. 7, Treasury Secretary Henry Paulson announced that the Treasury Department, in collaboration with the Federal Reserve and the new independent regulator, the Federal Housing Finance Agency (FHFA), had moved to place into conservatorship Fannie Mae and Freddie Mac, the troubled government-sponsored enterprises (GSEs) that have been under pressure due to the housing credit crisis. FHFA Director Jim Lockhart said in a separate announcement that in an effort to "restore the balance between safety and soundness and mission, FHFA has placed Fannie Mae and Freddie Mac into conservatorship," which he defined as a "statutory process designed to stabilize a troubled institution with the objective of returning the entities to normal business operations." FHFA will act as the conservator to operate the GSEs until they are stabilized.

"They operate solely in the mortgage market," Paulson said in the prepared announcement, "and are therefore more exposed than other financial institutions to the housing correction." Paulson said that an examination of Fannie and Freddie's financials over the prior four week, particularly their capital requirements, had led the regulators to decide that a "simple equity investment would be insufficient," especially "given the condition of financial markets today." So instead, Treasury and FHFA has put the GSEs into conservatorship, which does not eliminate the common stock of the GSEs, but does place common shareholders last in their claims on the lenders' assets. The agreement also mandated the following four steps:

  1. The GSEs will modestly increase their mortgage-backed securities portfolios through the end of 2009, and "in 2010 their portfolios will begin to be gradually reduced at the rate of 10% per year...eventually stabilizing at a lower, less risky size."
  2. Treasury and FHFA have established preferred stock purchase agreements, under which Treasury will "ensure that each company maintains a positive net worth" that will support market stability, with the government now acknowledging that "we have a responsibility to both avert and ultimately address the systemic risk now posed by the scale and breadth of the holding of GSE debt and MBS," which are held by central banks and investors in the U.S. and around the world which assumed that debt was risk free.
  3. Treasury is forming a new secured lending credit facility--which Paulson called an "ultimate liquidity backstop"--which, combined with the preferred share purchase agreements, should allow the "GSEs to be in a stronger position to fund their regular business activities in the capital markets." The facility will expire in December 2009.
  4. Treasury itself will begin a temporary program to purchase new mortgage-backed securities from Fannie Mae and Freddie Mac through December 2009. This step will help ensure mortgage availability and affordability.

Paulson made it clear that "there is no reason to expect taxpayer losses from this program, and in fact, it could produce gain." However, he noted that while they are in conservatorship the GSEs "will no longer be managed with a strategy to maximize common shareholder returns," and that "the ultimate cost to the taxpayer will depend on the business results of the GSEs going forward." Fannie Mae CEO Dan Mudd and Freddie Mac CEOs Dick Syron have been let go, though they will stay for an undefined period to help new CEOs "supported by new non-executive chairmen" through the transition.

Those new CEOs are Herb Allison, a former president of Merrill Lynch who most recently led the TIAA-CREF pension fund, at Fannie Mae, while David Moffett, a former U.S. Bancorp executive who in 2007 joined the private equity firm The Carlyle Group, will be CEO of Freddie Mac.

Paulson attributed the "need for today's action primarily to the inherent conflict and flawed business model embedded in the GSE structure," as well as the "ongoing housing correction," and called on the next Congress and Administration to "decide what role government in general, and these entities in particular, should play in the housing market."

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