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Government Takes Over Fannie, Freddie

GSEs placed in conservatorship

September 8, 2008

By SAM GARCIA


The government has seized control of Fannie Mae and Freddie Mac. The move -- which is likely to push mortgage rates lower and provide a sense of stability for the more than 10,000 employees at both companies -- is a blow to congressional Democrats who for years have prevented the Bush administration from stepping up regulation of the two government sponsored enterprises.

Federal Housing Finance Agency Director James B. Lockhart issued an announcement Sunday that Fannie and Freddie have been placed into conservatorship -- a move approved by the boards of both companies. The regulator will oversee and operate the two companies as the conservator.

Daniel H. Mudd, chief executive officer of Fannie, and Richard F. Syron, chairman and CEO of Freddie, have both been terminated -- though both will remain through a transition. But Lockhart noted, "These individuals did not create the inherent conflict and flawed business model embedded in the enterprises' structure."

Herb Allison has been appointed CEO of Fannie. Allison was the vice chairman of Merrill Lynch and chairman of TIAA-CREF.

David Moffett has been named CEO of Freddie. Moffett was vice chairman and chief financial officer of US Bancorp.

"Their compensation will be significantly lower than the outgoing CEOs," Lockhart stated. "They will be joined by equally strong non-executive chairmen."

Aside from the replacement of the CEOs and chairmen, senior management will mostly remain in place. Around 5,800 people are employed at Fannie, while Freddie's headcount is around 5,000.

FHFA said there currently are no plans to liquidate either company.

U.S. Treasury Secretary Henry M. Paulson Jr. issued a statement indicating that the GSE structure is a flawed business model and inherently conflicted. He noted that neither their boards or managements were responsible for the flawed model or the current housing correction.

Paulson and Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System, acted as consultants to FHFA in its decision to make the move.

The U.S. Treasury has purchased senior preferred stock for which it receives senior preferred equity shares and warrants.

"It is more efficient than a one-time equity injection, because it will be used only as needed and on terms that Treasury has set," Paulson said. "At the end of next year, the Treasury temporary authorities will expire, the GSE portfolios will begin to gradually run off, and the GSEs will begin to pay the government a fee to compensate taxpayers for the on-going support provided by the preferred stock purchase agreements."

The Treasury additionally issued a secured lending credit facility. The lending facility will also be available for the Federal Home Loan Banks -- though their sound structure and superior performance over the past year makes it unlikely they will draw on the facility.

In addition, Paulson said the Treasury will temporarily purchase new GSE MBS beginning later this month.

"Since this difficult period for the GSEs began, I have clearly stated three critical objectives: providing stability to financial markets, supporting the availability of mortgage finance, and protecting taxpayers," Paulson said. "Based on what we have learned about these institutions over the last four weeks ... and given the condition of financial markets today, I concluded that it would not have been in the best interest of the taxpayers for Treasury to simply make an equity investment in these enterprises in their current form."

FHFA was established by H.R. 3221, The Housing and Economic Recovery Act of 2008, which was signed into law by President Bush in July. The "world-class" regulator replaces the GSE's current regulator, the Office of Federal Housing Enterprise Oversight, and will also regulate the Federal Home Loan Banks.

Under conservatorship, FHFA assumes the power of the GSEs' board and management -- conserving and preserving assets as the companies are brought to a sound and solvent condition. The objectives of the move are to restore confidence in the companies, enhance their ability to provide liquidity to the secondary mortgage market and mitigate the systematic risk that has contributed to market instability.

During this period, common shareholders' powers are suspended.

Fannie and Freddie will be allowed to grow their guarantee MBS books without limits. They can also continue to purchase about $20 billion per month in replacement securities for their portfolios without capital constraints.

"The GSEs will modestly increase their MBS portfolios through the end of 2009," Paulson stated. "Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size."

Common and preferred stock dividends have been suspended, though subordinated debt interest and principal payments will continue to be made. In addition, both classes of shareholders bear losses ahead of the new government senior preferred shares.

The conservatorship will end once FHFA determines that the objectives have been met -- though no time frame has been established.

Some concern was voice by the Fed and Paulson about how holdings of GSE common and preferred shares by smaller banks and thrifts might significantly impact their capital.

"The Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Office of Thrift Supervision are prepared to work with these institutions to develop capital-restoration plans," the Fed said.

FHFA Director Lockhart noted that a large drop in interest rates during the past year has not been passed on to the mortgage markets because a lack of confidence in the two secondary lenders has resulted in a widening of spreads in their mortgage-backed securities. This weekend's actions will help restore confidence and effectively push mortgage rates lower.

For years, President Bush has been trying to step up oversight of Fannie and Freddie. But he has faced opposition from congressional Democrats who were courted by GSE lobbyists and have long benefited from joint press conferences sponsored by Fannie and Freddie touting billions of dollars in mortgage financing in their districts.

As Fannie and Freddie -- both based in the Washington, D.C., area -- faltered, Bush was finally able to create a stronger regulator by compromising with Democrats on foreclosure spending in the recently passed housing legislation.

In Sunday's statement, Lockhart said, "All political activities -- including all lobbying -- will be halted immediately."

The Mortgage Bankers Association issued a statement in support of yesterday's actions.

Democratic presidential nominee Barack Obama recently weighed in on potential GSE actions.

"Any action we take must be focused not on the whims of lobbyists and special interests worried about their bonuses and hourly fees," Obama said in a statement last week. "We must ensure that any plan clarifies the true public and private status of our housing policies."


Sam Garcia worked in mortgage lending for twenty years prior to becoming publisher of MortgageDaily.com.

e-mail: [email protected]


GSE News | Fannie/Freddie Share Statistics
Fannie, Freddie and FHLB news. Coverage of government sponsored enterprise regulation, operations and litigation.


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News about commercial and residential mortgage-backed securities. Stories about ratings actions and changes to servicer ratings. Studies and reports about the performance of securitizations and problem vintages and classes. Subprime, Alt-A, home equity and j u m b o analysis.


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