[Marxism] U.S. Rescue Seen at Hand for 2 Mortgage Giants

[Greg McDonald <sabocat59@xxxxxxx>]

September 6, 2008
U.S. Rescue Seen at Hand for 2 Mortgage Giants
By STEPHEN LABATON and ANDREW ROSS SORKIN

WASHINGTON — Senior officials from the Bush administration and the  
Federal Reserve on Friday called in top executives of Fannie Mae and  
Freddie Mac, the mortgage finance giants, and told them that the  
government was preparing to place the two companies under federal  
control, officials and company executives briefed on the discussions  
said.

The plan, which would place the companies into a conservatorship, was  
outlined in separate meetings with the chief executives at the office  
of the companies’ new regulator. The executives were told that, under  
the plan, they and their boards would be replaced and shareholders  
would be virtually wiped out, but that the companies would be able to  
continue functioning with the government generally standing behind  
their debt, people briefed on the discussions said.

It is not possible to calculate the cost of any government bailout,  
but the huge potential liabilities of the companies could cost  
taxpayers tens of billions of dollars and make any rescue among the  
largest in the nation’s history.

The drastic effort follows the bailout this year of Bear Stearns, the  
investment bank, as government officials continue to grapple with how  
to stem the credit crisis and housing crisis that have hobbled the  
economy. With Bear Stearns, the government provided guarantees, and  
the bulk of its assets were transferred to JPMorgan Chase, leaving  
shareholders with a nominal amount.

Under a conservatorship, the common and preferred shares of Fannie  
and Freddie would be reduced to little or nothing, and any losses on  
mortgages they own or guarantee could be paid by taxpayers.  
Shareholders have already lost billions of dollars as the stocks have  
plunged more than 80 percent this year.

A conservatorship would operate much like a pre-packaged bankruptcy,  
similar to what smaller companies use to clean up their books and  
then emerge with stronger balance sheets. It would allow for  
uninterrupted operation of the companies, crucial players in the  
diminished mortgage market, where they are now responsible for nearly  
70 percent of new loans.

The executives were told that the government had been planning to  
announce the decision as early as Sunday, before the Asian markets  
reopen, the officials said.

For months, administration officials have grappled with the steady  
erosion of the books of the two mortgage finance giants. A fierce  
behind-the-scenes debate among policy makers has been waged over  
whether to seize the companies or let them work out their problems.  
Even after the companies are put under government control, debates  
will continue over whether they should be independent and how they  
should operate over the long term.

The declines in the housing and financial markets apparently forced  
the administration’s hand. With foreign governments increasingly  
skittish about holding billions of dollars in securities issued by  
the companies, no sign that their losses will abate any time soon,  
and the inability of the companies to raise new capital, the  
administration apparently decided it would be better to act now  
rather than closer to the presidential election in two months.

Just five weeks ago, President Bush signed a law to give the  
administration the authority to inject billions of dollars into the  
companies through investments or loans. In proposing the legislation,  
Treasury Secretary Henry M. Paulson Jr. said that he had no plan to  
provide loans or investments, and that merely giving the government  
the authority to backstop the companies would provide a strong shot  
of confidence to the markets. But the thin capital reserves that have  
kept the two companies afloat have continued to erode as the housing  
market has steadily declined and the number of foreclosures has soared.

As their problems have deepened — and the marketplace has come to  
expect some sort of government rescue — both companies have found it  
difficult to raise new capital to absorb future losses. In recent  
weeks, Mr. Paulson has been reaching out to foreign governments that  
hold billions of dollars of Fannie and Freddie securities to reassure  
them that the United States stands behind the companies.

In issuing their quarterly financial statements last month, the two  
companies reported huge losses and predicted that home prices would  
fall more than previously projected.

The debt securities the companies issue to finance their operations  
are widely owned by mutual funds, pension funds, foreign governments  
and big companies.

Officials said the participants at the meetings included Mr. Paulson,  
Ben S. Bernanke, the chairman of the Fed, and James Lockhart, the  
head of both the old and new agency that regulates the companies. The  
companies were represented by Daniel H. Mudd, the chief executive of  
Fannie Mae, and Richard F. Syron, chief executive of Freddie Mac.  
Also participating was H. Rodgin Cohen, the chairman of the law firm  
Sullivan & Cromwell, who was representing Fannie.

Officials and executives briefed on the meetings said that Mr. Mudd  
and Mr. Syron were told that they would have to leave the companies.

Spokesmen at the two companies did not return telephone calls seeking  
comment.

The meetings reflected the reality that senior administration  
officials did not believe they could wait for some kind of financial  
tipping point, as happened with Bear Stearns, which was saved from  
insolvency in March by government intervention after its stock  
plummeted and lenders withheld their capital.

Instead, Mr. Paulson has struggled to navigate through potentially  
conflicting goals — stabilizing the financial markets, making  
mortgages more widely available in a tightening credit environment,  
and protecting taxpayers from possibly enormous losses.

Publicly, administration officials have tried to bolster the  
companies because the nation’s mortgage system relies on their  
continued ability to purchase mortgages from commercial lenders and  
pull the housing markets out of their slump.

But privately, senior officials have been critical of top executives  
at the companies, particularly Freddie Mac. They have raised concerns  
about major risks to taxpayers of a bailout of companies whose  
executives have received huge compensation packages. Mr. Syron, for  
instance, collected more than $38 million in compensation since he  
joined the company in 2003.

Although Mr. Syron promised regulators earlier this year that he  
would raise $5.5 billion from investors, he has failed to make good  
on that promise — even as Fannie Mae raised more than $7 billion. Mr.  
Syron was slated to step down from the chief executive position last  
year, but that was delayed when his appointed successor, Eugene  
McQuade, chose to leave the company.

With the possible removal of the top management and the board, it is  
no longer clear who would appoint new management.

Mr. Paulson had hoped that merely having the authority to bail out  
the two companies, which Congress provided in its recent housing  
bill, would be enough to calm the markets, but if anything anxiety  
has been increasing. The clearest measure of that anxiety has been  
the gradually widening spread between interest rates on Fannie- or  
Freddie-backed mortgage securities and rates for Treasury securities,  
making home mortgages more expensive. The stock prices of the  
companies have also plunged.

After stock markets closed on Friday, the shares of Fannie and  
Freddie plummeted. Fannie was trading around $5.50, down from $70 a  
year ago. Freddie was trading at about $4, down from about $65 a year  
ago.

With Fannie and Freddie guaranteeing $5 trillion in mortgage-backed  
securities, and a big share of those held by central banks and  
investors around the world, Mr. Paulson appears to have decided that  
the stakes are too high to take chances.

The Treasury Department is required by the new law to obtain  
agreement from the boards of Fannie and Freddie for a capital  
infusion. The exception is if the companies’ regulator, Mr. Lockhart,  
determines that the companies are insolvent or deeply  
undercapitalized it could take the companies over anyway.

Charles Calomiris, a professor of economics at Columbia Business  
School, said delaying a rescue would only increase the risks and costs.

“The last thing you want to do is give a distressed borrower more  
time, because when people are in distress they tend to take a lot of  
risks,” he said. “You don’t want zombie institutions floating around  
with time on their hands.”

Stephen Labaton reported from Washington and Andrew Ross Sorkin from  
New York. Edmund L. Andrews contributed reporting from Washington,  
and Eric Dash and Charles Duhigg from New York.


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