The federal government moved in to help bolster Fannie Mae and Freddie Mac on Sunday with a Treasury Department proposal that sets the stage for a government-orchestrated rescue. In the short term, the plan enables the two quasi-governmental agencies to continue to borrow money at favorable rates in order to fund their operations.
Last week, concerns about the financial stability of Fannie Mae and Freddie Mac were at the forefront of investors' minds, and shares of both companies tumbled.
Here, a look at some of the factors behind the rescue operation launched this weekend.
What is the government proposing?
The Treasury Department disclosed a three-part plan to enable both companies to continue to play "a central role" in the nation's housing market in their "current form as shareholder-owned companies."
The department's plan would temporarily increase Fannie and Freddie's line of credit with the Treasury; give the Treasury Department the ability to purchase stock in either of the two companies — if it becomes necessary; and give the Federal Reserve a say in setting financial requirements and standards for the companies.
The department said it arrived at the plan after consultations with the Federal Reserve, the Office of Federal Housing Enterprise Oversight — the agency that regulates Fannie and Freddie — as well as the SEC, and Fannie and Freddie. Congress would have to approve any of the measures.
The Fed also said Sunday that the companies could borrow funds at a discounted rate — known as the "discount window" — from the Federal Reserve Bank of New York "should such lending prove necessary."
So does all of this amount to a bailout?
Right now, it's more of an effort to battle the markets' lack of confidence. Opening the discount window to Fannie and Freddie "instills confidence in investors, so investors will continue to fund Fannie and Freddie," says Frederick Cannon, chief equity strategist for Keefe, Bruyette & Woods. "I don't see them using the window."
Fannie and Freddie float bonds in the debt markets and use the money they raise to fund mortgages and guarantee mortgages. There has been no liquidity crisis for Fannie or Freddie, Cannon explains: "It's simply been a crisis of confidence in the equity." The actions over the weekend, he says, will enable the two companies to continue to support the mortgage market.
Why did the government choose to step in over the weekend?
The rescue effort was orchestrated to calm investors worldwide and to prevent the collapse of these two housing finance giants. Fannie and Freddie own or guarantee more than $5 trillion in mortgages — nearly half of all the mortgages issued in the United States.
The announcements on Sunday were intentionally made prior to the opening of the Asian stock markets and a Monday morning auction of $3 billion in securities by Freddie Mac.
Last week, Treasury Secretary Henry Paulson said no immediate bailout was necessary in an attempt to calm investors. The Treasury's proposal on Sunday reflects a shift in gears to assure investors that the companies have all the money they might need, and that there's no immediate danger of a collapse. It's also a means for encouraging the continued purchase of Fannie and Freddie's securities.
Both companies said on Sunday that they hold more than adequate capital. Freddie Mac also said it expected that its June 30 results will show that the firm has "a much greater surplus" above the minimum requirements.
What are the next steps?
The rescue provisions announced over the weekend will be added to a housing bill that is making its way through Congress. But Congress has to wrestle with a number of questions that regulators left unanswered. Fannie and Freddie are chartered by Congress, but they are public companies. What implications does this have for other private companies if the government bails out Fannie and Freddie? If the Treasury Department steps in and buys Fannie and Freddie stock, will those shares be of the same class as those held by institutional and indvidual investors, and will they be worth the same?
What are the implications of these proposals for taxpayers?
For years, advocates in Congress and in the private sector have been pushing for Fannie and Freddie to have a stronger, single regulator. Among those is FM Policy Focus, a group of financial services and housing organizations. Executive Director Mike House says the legislation in Congress now is "strong and adequate" for meeting this goal. The group also supports the Treasury's proposals, which it says "will prevent taxpayers from having to bear the burden on this."
House says the key thing is for "Congress to act expeditiously and get the legislation passed so that the market will get stabilized."
If I own a home or plan on purchasing a home, what does this mean for me?
The stability of the mortgage market — keeping money available for people to buy homes — is closely tied to Fannie and Freddie. That's because the companies presently fund a huge block of the nation's mortgages, and the cornerstone of their mission is to fund mortgages for low- and moderate-income buyers.
"My sense is that all the turmoil makes homeownership more difficult," both in terms of perceptions of homeownership and its value, says Bruce Gottschall, executive director of Neighborhood Housing Services, a Chicago-based nonprofit that assists low and moderate-income people with homeownership.
The tightening of the credit markets that has been building over the last couple of months impacts peoples' ability to borrow money to buy homes. "From our experience, those in the low and moderate income are hit hardest and earliest in terms of that availability of credit," he says.
With reporting by Jim Zarroli. The Associated Press contributed to this report.
The Treasury Department unveiled a three-part rescue plan to bolster housing finance giants Fannie Mae and Freddie Mac. The plan aims to calm jittery investors while enabling the two government-chartered companies to remain public companies.
News of a government plan to rescue Fannie Mae and Freddie Mac helped their stock prices shoot up Monday morning. At the end of the day, though, the companies' stocks both closed down more than 5 percent.
Still, bidders showed signs of new enthusiasm in a $3 billion auction of securities by Freddie Mac.
Both the Treasury Department and the Federal Reserve announced they would take a series of steps to make capital available to Fannie Mae and Freddie Mac. For instance, they'll let the companies borrow from the Fed's discount lending window, and they'll raise their lines of credit. The measures are designed to show nervous investors that the companies have access to all the cash they need to operate.
Rep. Barney Frank (D-MA), who chairs the House Financial Services Committee, spoke Monday on CNBC: "What the secretary of the Treasury has proposed is reasonable. It's a kind of reassurance to people that help will be there, even though we don't feel it will be needed."
The health of Fannie Mae and Freddie Mac is considered vital to the mortgage business. The companies are in the business of buying mortgages from banks. If they can't do that, banks will become even more reluctant to lend money for new homes than they are now. And getting a mortgage will become even harder than it is now. Whether the federal rescue plan will go far enough to satisfy investors is an open question.
Brian Bethune, chief U.S. economist at the research firm Global Insight, says Congress has to work out a lot of details, like just how much money the Treasury Department is ready to pour into the companies.
"It has to be significant. This is not a nickel and dime issue," says Bethune. "It's an issue of significant billions of dollars that needs to be infused to backstop these organizations."
He says the uncertainty about the plan may be one big reason the companies' stocks fell Monday.
James Paulsen, chief investment strategist at Wells Capital Management, says Congress needs to wrestle with the question of just what kind of companies these are. They are mandated by the government to make mortgage money available to as many homeowners as possible. But they are also publicly traded companies with shareholders, who expect them to lend wisely and keep an eye on the profits they earn. Paulsen notes that a lot of mortgage lenders aren't lending much at all right now.
"If Freddie or Fannie were totally private, they'd probably be doing the same thing. But because of their quasi-public nature, that's just exactly what we don't want right now from a public standpoint," says Paulsen. "From the social good, we want them to continue to make mortgage funds available to qualified buyers."
Beyond that, Bethune says Congress, the Fed and the Bush administration need to do more big-picture thinking about the financial system and why the companies got in trouble in the first place. He says that since this financial crisis began a year ago, officials have fallen into a pattern: They deny that problems exist and then rush in with emergency bailouts when denials don't work any longer.
"We're kind of just operating like a fire department, and when the next crisis erupts, we'll try and deal with it," he says.
Last night's bailout was designed to stem the problems that Fannie Mae and Freddie Mac face — at least on a temporary basis. If the companies are going to survive long-term, it will be up to Congress to try to figure out how they can do that.