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Paulson Engineers U.S. Takeover of Fannie, Freddie

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  • Paulson Engineers U.S. Takeover of Fannie, Freddie

    Paulson Engineers U.S. Takeover of Fannie, Freddie (Update2)

    By Rebecca Christie and Dawn Kopecki

    Sept. 7 (Bloomberg) -- The U.S. government seized control of Fannie Mae and Freddie Mac after the biggest surge in mortgage defaults in at least three decades threatened to topple the companies making up almost half the U.S. home-loan market.

    ``It is necessary to take action,'' Treasury Secretary Henry Paulson, who engineered the takeover along with Federal Housing Finance Agency Director James Lockhart, said in Washington today. ``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.''

    The FHFA will take over Fannie and Freddie under a so-called conservatorship, replacing their chief executives and eliminating their dividends. The Treasury will purchase up to $100 billion of senior-preferred stock in each company as needed to maintain a positive net worth. It will also provide secured short-term funding to Fannie, Freddie and 12 federal home-loan banks, and purchase mortgage-backed debt in the open market.

    The takeover of Fannie and Freddie is the biggest step yet in officials' efforts to grapple with a yearlong credit crisis that has caused more than $500 billion of losses and writedowns. The government is taking an increasing role in financial markets, after the Federal Reserve six months ago provided $29 billion of financing to prevent Bear Stearns & Cos.'s collapse.

    Treasury Gets Stock

    Under the plan, the Treasury will receive $1 billion of senior preferred stock in coming days, with warrants representing ownership stakes of 79.9 percent of Fannie and Freddie. The government will receive annual interest of 10 percent on the initial investments.

    As a condition for the assistance, Fannie and Freddie will have to reduce their holdings of mortgages and securities backed by home loans. The portfolios ``shall not exceed $850 billion as of December 31, 2009, and shall decline by 10 percent per year until it reaches $250 billion,'' the Treasury said.

    ``The government wasn't going to allow them to muddle through this mess,'' said Paul Miller, an analyst at Friedman Billings Ramsey & Co. in Arlington, Virginia. ``No way were they going to be able to do that because the market was going to freeze up.''

    New CEOs

    Herbert Allison, 65, former chief executive officer of TIAA- Cref, will take over as Fannie's new CEO. David Moffett, 56, who was vice chairman of US Bancorp, will head Freddie, Lockhart said. They will work with existing management, he added.

    Fannie CEO Daniel Mudd, 50, and Freddie CEO Richard Syron, 64, will serve in a transition period as consultants.

    While common stockholders of Fannie and Freddie won't be eliminated under the conservatorships, they will be last in line for any claims, Paulson said. Preferred shareholders will be second in absorbing losses, he said.

    Banks and insurance companies have typically purchased the two companies' preferred shares. The Federal Reserve and three other bank regulators said that they will work to ``develop capital restoration plans'' with the ``limited number'' of smaller institutions that hold Fannie and Freddie shares as a significant share of their capital.

    By ensuring that Fannie and Freddie maintain positive net worth, the Treasury will provide ``additional security'' to the owners of Fannie and Freddie bonds and ``additional confidence'' for the holders of their mortgage-backed securities, it said.

    Global Interest

    The Treasury noted that Fannie and Freddie securities are held by central banks and ``investors around the world.''

    Lockhart added that interest and principal payments will continue to be made on the companies' subordinated debt.

    The Treasury will hire independent asset managers to purchase and run the portfolio of mortgage-backed securities it will buy. The program goes beyond just helping Fannie and Freddie, as it aims ``to broaden access to mortgage funding for current and prospective homeowners,'' according to the Treasury.

    ``There is no reason to expect taxpayer losses from this program, and it could produce gains,'' the department said.

    Lockhart said today's action was prompted by a judgment that the companies ``cannot continue to operate safely and soundly and fulfill their critical public mission without significant action to address our concerns.''

    Paulson's decision, taken after consulting with Federal Reserve Chairman Ben S. Bernanke, followed a review that found Washington-based Fannie and McLean, Virginia-based Freddie used accounting methods that inflated their capital, according to people with knowledge of the decision.

    Morgan Stanley Role

    Paulson, 62, hired Morgan Stanley a month ago to probe the companies' finances. The investment bank concluded that the accounting, while legal, enabled Freddie, and to a lesser extent Fannie, to overstate the value of their reserves, according to the people who declined to be identified because the findings were confidential.

    The FHFA will aim to ``preserve and conserve'' the companies' assets and property and put them ``in a sound and solvent condition,'' according to a fact sheet distributed by the Treasury. There is ``no exact time frame'' for when the conservatorship will end, the statement said.

    Fannie and Freddie own or guarantee almost half of the $12 trillion in U.S. home loans and the government had been leaning on the companies to help pull the economy out of the housing crisis.

    Shares Plunged

    Concern over the companies' capital pushed their borrowing costs to record levels over U.S. Treasuries, sent their common and preferred stocks tumbling and boosted mortgage rates. Fannie is down about 66 percent in New York Stock Exchange trading since the end of June. Freddie has fallen about 69 percent.

    The Treasury briefed Democratic presidential candidate Barack Obama yesterday and has contacted Republican contender John McCain's staff. Officials also discussed the plans with House Speaker Nancy Pelosi, Senate Majority Leader Harry Reid, Senate Banking Committee Chairman Christopher Dodd and House Financial Services Committee Chairman Barney Frank.

    Fannie was created by the government in 1938 as part of President Franklin D. Roosevelt's New Deal. Freddie was chartered in 1970 to compete with Fannie.

    As losses on the mortgages grew late last year, the companies recorded $14.9 billion in combined net losses, eating into their capital. Fannie raised $14.4 billion since November and Freddie sold $6 billion of preferred securities. Plans for a $5.5 billion sale were delayed as the company's fortunes sank.

    Capital Levels

    Fannie had $47 billion of capital as of June 30, according to company filings. The company is required by its regulator to hold $37.5 billion. Freddie's capital stood at $37.1 billion, compared with a requirement of $34.5 billion, filings show.

    Fannie's market capitalization is now $7.6 billion, down from $38.9 billion at the end of last year. Freddie's has fallen to $3.3 billion, from $22 billion over the same period.

    Bernanke participated in the meetings because the central bank was given a consultative role in overseeing Fannie's and Freddie's capital under legislation approved in July.

    The FHFA was scheduled to release its assessment of the companies' capital levels as early as last week as part of a quarterly appraisal of their finances.

    "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx