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U.S. seizes mortgage titans in multibillion-dollar rescue

The move averts potential global turmoil, Treasury secretary says

September 08, 2008|Peter G. Gosselin | Times Staff Writer

WASHINGTON — The federal government executed a sweeping takeover of mortgage giants Fannie Mae and Freddie Mac on Sunday in a move aimed at expanding the pool of money available for home finance and arresting a plunge in housing prices that endangers the nation's economy.

The basic elements of the aggressive plan start taking effect immediately, but longer-term measures -- especially provisions to grow, then shrink the firms -- are likely to be targets of contention for months to come.

"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 . . . at home and around the globe," Treasury Secretary Henry M. Paulson said in announcing the government's actions.

"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," he said.

The first phase of the government's plan came Sunday as it seized control of the firms and ousted their chief executives, placing the companies under the indefinite management of their regulator, the Federal Housing Finance Agency.

The plan also calls for buying as much as $200 billion of special stock in the firms soon, standing ready to fund an expansion over the next 15 months and then shrinking operations over a number of years to wean the nation from its dependence on the massive financial might of the combined operations.

Officials would not disclose how much the government might lend the companies to expand, so it was unclear how much more taxpayer money might be needed.

Fannie and Freddie already own or guarantee $5.4 trillion in mortgages, or about half the total outstanding. In the second quarter, the companies backed 84% of all new home loans made, according to industry research firm Inside Mortgage Finance. A separate government agency, the Federal Housing Administration, insures many of the rest.

Asian stocks surged in early trading Monday after the takeover as investors concluded it would shore up global financial markets reeling from more than $500 billion in credit losses.

But even as government officials moved to take control of the troubled firms, it was clear they still faced challenges and a delicate balancing game. They must satisfy enough investors to ensure that the companies' bonds and mortgage-backed securities are considered safe bets. At the same time, they must avoid seeming to risk billions of tax dollars to bail out the firms' investors.

In perhaps the most unexpected aspect of its rescue effort, the government said that the Treasury would start buying up an undetermined quantity of the mortgage-backed securities issued by the troubled firms. And it will even permit Fannie and Freddie to temporarily ratchet up their own buying of such securities in an effort to expand the funds available for mortgages and drive down the interest rates that home buyers must pay.

Despite dramatic rate cuts by the Federal Reserve over the last year, the rate for a standard 30-year fixed-rate mortgage has remained stubbornly above 6%.

Many policy analysts had hoped the rescue would set the stage for Washington to finally divest itself of the firms and, with them, the expensive responsibility of riding to their rescue in the future. These critics complained that the takeover's structure all but assured the opposite.

"The effect will be to keep the companies alive and in government hands," said Peter J. Wallison, a former Reagan administration Treasury official who has been the firms' sharpest critic. "I just don't understand why anybody would do this."

On the other hand, longtime congressional supporters of Fannie and Freddie were surprised by Treasury's call for the firms to shrink their operations dramatically after briefly expanding them. They pledged to fight the move.

"There is no basis for that," said Rep. Barney Frank (D-Mass.), the influential chairman of the House Financial Services Committee. "This thing is not at all binding, and we'll debate that," he said of the Treasury's cutback order.

Paulson and James B. Lockhart, director of the Federal Housing Finance Agency, would not say what spurred the government to act now.

Both refused to comment on reports that investment advisors hired by Treasury had uncovered accounting irregularities at Freddie Mac that inflated the amount the company had set aside as a financial cushion in case of trouble.

But the Federal Housing Finance Agency is scheduled to issue a report this month that is widely expected to show the firms have sustained huge new losses and that one or both may be insolvent by some measures. The two already have reported losing $14.9 billion over the last year.

"I have determined the companies cannot continue to operate safely and soundly and fulfill their critical public mission . . . in supporting the residential mortgage market in this country," Lockhart said.

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