Fannie, Freddie at the precipice

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By Patrice Hill

The Bush administration Friday struggled to stem a run on Fannie Mae and Freddie Mac that threatened to force the mortgage giants into insolvency with a pledge to preserve the companies while avoiding a government takeover.

Treasury Secretary Henry M. Paulson Jr. said the government would "support Fannie Mae and Freddie Mac in their current form as they carry out their important mission," helping to avert a rout in Fannie and Freddie shares and the overall stock market.

Mr. Paulson's pledge completed a reversal by the White House, which has opposed bailing out the mortgage giants in the past. President Bush affirmed that he now views the two agencies, which have financed 80 percent of all mortgages this year, as "very important institutions" and that the administration is "working this issue very hard" to prevent their financial ruin.

Markets brightened late in the day when Senate banking panel Chairman Christopher J. Dodd, after speaking with Mr. Paulson and Federal Reserve Chairman Ben S. Bernanke, said the Fed is considering allowing the mortgage agencies to borrow from its emergency lending window for the first time.

"There is sort of a panic going on, and that is not what ought to be. The facts don't warrant that reaction," the Connecticut Democrat said, noting that the agencies primarily buy and guarantee conservative 30-year mortgages, which are safe investments. "Fannie Mae and Freddie Mac were never bottom-feeders in the residential mortgage market."

Fannie and Freddie shares fell by 50 percent after the start of Friday's session, but at the end of a wild day of trading pared their losses and closed down 22 percent and 3 percent, respectively. The stock of both firms has lost three-quarters of its value since the beginning of the year.

The Dow trimmed losses of as much as 250 points to 128 and closed the day at 11,101.

The steep and accelerating drops in Fannie and Freddie shares make it difficult if not impossible for the mortgage giants to raise capital through new stock issues - the method of balance-sheet strengthening preferred by the Fed and the Treasury until Friday.

With markets in a panic, the government was forced to make explicit what had been only an implicit guarantee of agency obligations in years past. Stepping over the threshold was painful for a Republican administration that had vowed for years to minimize the government's exposure to the mortgage goliaths.

Any move by the Fed or Treasury to provide assistance would be unprecedented and would open up an exposure for taxpayers that is potentially enormous. Standard & Poor's Corp. earlier this year estimated that a bailout of the mortgage giants could cost the government as much as $1 trillion and could even drag down the Treasury's own gold-plated AAA credit rating.

S&P and Moody's Investors Service both said Friday they don't expect any assistance the government provides the agencies under current circumstances to be so large that it will drown the government in debt or affect its ratings. Nevertheless, yields on Treasury bonds soared Friday as investors braced for an onslaught of new government debt.

Joshua Rosner, a mortgage specialist with Graham Fisher, who is advising the Treasury, said he does not expect the government to try to take over the enterprises through nationalization or conservatorship procedures, as some press reports have said.

Instead, he expects the government to restructure the agencies, help them liquidate their bad debts and continue to guarantee payment on about $3.5 trillion of mortgage backed securities by opening up a line of credit totalling between $500 billion and $1 trillion.

"This approach would reduce the impact on the deficit, would allow the senior obligations to be met and would reduce the ultimate loss to taxpayers," he said.