Does A Bailout Loom For Fannie Mae, Freddie Mac?

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The mortgage-finance giants Fannie Mae and Freddie Mac took another hit on Wall Street Thursday, after a former Fed official suggested the companies may need a government bailout. Others are weighing in, too.


From NPR News, this is ALL THINGS CONSIDERED. I'm Melissa Block.


And I'm Michele Norris. Not a day goes by without more evidence of the shrinking economy, from lending organizations in trouble to shrinkage on our grocery shelves.

In a moment, we'll find out how makers of soap, ice cream and cereal are reducing the size of their products without reducing the cost. Also, we'll hear from people who are driving less. No surprise. That's thanks to high gas prices.

BLOCK: First, the precarious position of Fannie Mae and Freddie Mac. Those are the two private government-chartered companies that own or guarantee nearly half of all the nation's mortgage debt. Their stock values are plummeting. Fannie Mae is down nearly 80 percent from its price a year ago, and now, as NPR's Jim Zarroli reports, there's talk that a taxpayer bailout may be necessary.

JIM ZARROLI: Fannie Mae and Freddie Mac play a pivotal role in the U.S. mortgage business, and so it was perhaps inevitable that they've become swept up in the housing industry turmoil.

On Monday, shares of the companies fell after an analyst warned that a pending accounting rule change would leave the companies undercapitalized. Government regulators quickly disputed that, but the tone was set.

Today, the Wall Street Journal reported that the Bush administration is developing contingency plans for the collapse of the companies, and shares fell even more. On Capitol Hill, Treasury Secretary Henry Paulson tried to voice some reassuring words about the companies.

Secretary HENRY PAULSON (United States Department of Treasury): They play an important and vital role in our economy and housing markets today, and they need to continue to play an important role in the future. Their regulator has made clear that they are adequately capitalized.

ZARROLI: But at the same time, former Fed Governor William Poole warned that the companies were insolvent and may need a government bailout, and that sent share prices tumbling even further. The likelihood of a government bailout of the companies was something being talked about more and more today. Economist Mark Zandi of Moody's and advisor to Republican presidential candidate John McCain said the companies may need to issue more shares of stock to raise money. That would dilute the value of existing shares, but Zandi also says it's unlikely the government will allow the companies' troubles to go much further.

Mr. MARK ZANDI (Moody's Unless you're a shareholder, I wouldn't be worried because there's no chance the federal government would allow these institutions to fail, to stop doing business. It would just be catastrophic for the system, for our economy. It's just not going to happen.

ZARROLI: The companies' troubles even became fodder for the presidential race. An advisor to Democrat candidate Senator Barack Obama said it was critical to maintain a flow of capital for the companies. Senator McCain told reporters that Fannie Mae and Freddie Mac, quote, will not fail. We cannot allow them to fail, unquote.

Later, McCain backed off the comments a bit, insisting that the two companies' troubles could still be addressed.

Senator JOHN McCAIN (Republican, Arizona): At this time I don't think that there's a requirement for a government bailout, so we will have to discuss the options that are available in order to keep it viable, and that's what I would hope that we could do with various experts and people of knowledge throughout the country.

ZARROLI: By the end of the day, a spokesman for Fannie Mae insisted that the company maintains the capital to fulfill its mandate and keep doing business, but the concerns about the company seemed unlikely to ease anytime soon. The impact of their troubles could be seen in shares of the troubled investment bank Lehman Brothers, which fell sharply today.

One factor driving its stock down was said to be the significant exposure it faces to Fannie Mae and Freddie Mac. Jim Zarroli, NPR News, New York.

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Q&A: Behind Fannie's And Freddie's Stock Slides

Questions swirling about whether housing financing giants Fannie Mae and Freddie Mac would need a federal bailout sent shares of the two companies tumbling on Thursday. Fannie Mae closed at $13.20, a decline of 13.8 percent for the day. Freddie Mac closed at $8, down 22 percent. Both stocks are at historic lows, with steep declines overall from a year ago — Fannie is down 78.5 percent and Freddie is down 86.1 percent.

The Wall Street Journal reported Thursday that the Bush administration was developing contingency plans for the collapse of the companies. Treasury Secretary Henry Paulson testified on Capitol Hill in an effort to calm investor anxiety about Fannie and Freddie. "They play an important and vital role in our economy and housing markets today, and they need to continue to play an important role in the future," Paulson told legislators. "Their regulator has made clear that they are adequately capitalized."

Mark Zandi, chief economist for Moody's and an adviser to Republican Sen. John McCain's presidential campaign, told NPR that the companies may need to issue more shares of stock to raise money. That would dilute the value of existing shares, he said. "Unless you're a shareholder I wouldn't be worried because there is no chance that the federal government would allow these institutions to fail — to stop doing business. It would just be catastrophic for the system, for our economy. It's just not going to happen," Zandi said.

Here's a look at the role the two firms play in the housing market.

What are Fannie Mae and Freddie Mac?

Fannie Mae and Freddie Mac were chartered by Congress as government-sponsored enterprises, or GSEs, which gives them a quasi-governmental status. Both are in the same business: They buy home loans from lenders, then hold them in their portfolios or repackage them into bonds — known as mortgage-backed securities — that are traded on Wall Street. Fannie Mae was created in 1938; its smaller rival, Freddie Mac, was established in 1970.

What role do they play in the housing market?

Fannie and Freddie are the largest buyers of home loans in the nation. As such, they provide liquidity to housing markets. This enables banks, mortgage companies and savings and loans to keep making home loans. Consumers benefit, too: Greater liquidity means there is more money with which financial institutions can make home loans, and they can offer those loans at lower rates.

Fannie and Freddie's role is particularly important nowadays: With the credit market drying up, the firms are often the "buyer of last resort" for a mortgage at a time "when a broad-based buyers' strike threatened to paralyze the markets," says Bruce W. Harting, an analyst at Lehman Brothers, in a research note. Any threat that they might fail, he says, "could trigger a meltdown in credit markets that would make the movements in credit markets that we've seen over the last year look like a modest hiccup."

Why did shares of Fannie and Freddie plunge so far on Monday?

Shares of the two firms have been dropping for months as the housing downturn has worsened. But Monday's slide was prompted in part by a report from Harting in which he indicated that the Financial Accounting Standards Board was contemplating an accounting rule change that would have boosted the amount of capital the two companies have to keep on hand. Fannie would have to add $46 billion to its reserves; Freddie would need to add $29 billion.

The large sums spooked investors, who worried about the firms' abilities to raise that kind of cash in the current tight credit market. And the sell-off began.

Harting's report noted that the changes were "unnecessary." "It's in no one's interest for the GSEs to be saddled with overwhelming capital requirements at a time when the market needs the GSEs to buy mortgages, and when the capital markets and the economy are in very fragile states," he wrote.

Are these companies in financial trouble?

In June, the Office of Federal Housing Enterprise Oversight (OFHEO), the primary federal regulator for Fannie and Freddie, said the two companies were "adequately capitalized" — in other words, they had enough cash on hand to keep doing business.

OFHEO Director James Lockhart told reporters that Freddie and Fannie did not deserve the beating they got in the market Monday. "If you look at the financials of these two companies, how they are prudently growing their books of business ... it was hard to imagine what happened yesterday," he said.



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