The Federal Rescue of Fannie and Freddie: In a Startling Weekend Turn of Events, the Federal Government Took the Two Giant Government-Sponsored Enterprises into Conservatorship. the Bold Move Seems to Be a Sign of the Times

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In a historic move, the newly created Federal Housing Finance Agency (FHFA), after what it called "a painstaking review," took control of mortgage giants Fannie Mae and Freddie Mac on Sunday, Sept. 7, by placing them into conservatorship. The boards of both Fannie and Freddie consented to the move, according to James B. Lockhart, director of FHFA, the successor organization to the Office of Federal Housing Enterprise Oversight (OFHEO). At the same time, the federal government purchased 79.9 percent ownership of each of the government-sponsored enterprises (GSEs) with the purchase of senior preferred stock for $1 billion for each company. Thus, both Fannie and Freddie became overwhelmingly owned by the federal government. This purchase of preferred equity in the two enterprises also dramatically reduced the value of the once high-flying common shares to 25 cents for Fannie and 39 cents for Freddie. The government takeover ended three months of mounting market nervousness over the ability of the two GSEs to fulfill their mission in providinghousing finance in the face of mounting losses in their retained portfolios of mortgages and mortgage bonds.

The chief executive officers at the two firms--Daniel H. Mudd at Fannie and Richard Syron at Freddie--were replaced with two new executives. Herbert M. Allison, formerly chairman, president and chief executive officer with TIAA-CREF, is Fannie Mae's new president and chief executive officer. David M. Moffett, formerly vice chairman and chief financial officer with U.S. Bancorp, is Freddie Mac's chief executive officer. Both Mudd and Syron agreed to a government request to stay on to help with the transition, while current senior management teams remained in place at both enterprises.

At the same time, the Department of the Treasury took several additional measures to provide financial backstops to significantly shore up the financial condition of the GSEs to ensure they could continue playing their vital role in the housing market.

In addition to its initial $1 billion capital injection, Treasury announced a program to provide, as needed, capital invested as preferred stock to ensure that the companies maintain positive net worth. Treasury has agreed to provide, if it should prove necessary, up to $100 billion of capital for each GSE to ensure that liabilities do not exceed assets in each company.

Treasury also announced agreements with each GSE to purchase mortgage-backed securities (MBS) from new Fannie and Freddie MBS issues in the open market. Treasury further agreed to provide a secured credit lending facility to provide liquidity to each entity, if needed, until the end of 2009.

The rationale for the move

Why was the move necessary? Lockhart explained the reasoning at a news conference as follows: "During the turmoil last year, [Fannie Mae and Freddie Mac] played a very important role in providing liquidity to the conforming mortgage market. That has required a very careful and delicate balance of [the] mission [of providing lower-cost housing finance] and [the] safety and soundness [of each GSE]. A key component of this balance has been their ability to raise and maintain capital," Lockhart said.

Indeed, the two GSEs' share of all new mortgages had reached 84 percent of all originations by the second quarter of 2008, according to Inside Mortgage Finance (see Figure 1), helping make up for the absence of the private-label MBS market and a sharp retrenchment in mortgage lending by portfolio lenders. (By comparison, the GSE share of mortgage originations stood at 45.6 percent in the second quarter of 2007 and 37.4 percent for all of 2006, according to Inside Mortgage Finance.

Figure 1 Fannie Mae's and Freddie Mac's Total Mortgage Business
(Purchases Plus Securitizations) as a Percent of Total New Originations

1990  41.5%

1991  43.2%

1992  50.6%

1993  51.5%

1994  37.3%

1995  36.1%

1996  38. …