What's The Future For Fannie & Freddie?

Fannie Mae and Freddie Mac play a central role in the U.S. mortgage market. Federal officials had hoped that the takeover of the companies would begin to bring some stability to the battered housing industry. They weren't disappointed.

The rate on the 30-year fixed mortgage fell by half a percentage point on Monday.

"This is definitely a positive step on Monday," says Bill Gross, who heads the powerful bond firm Pimco. "We'll see what happens going forward, but if the Treasury buys mortgages like they're promising to do, I would think that mortgage rates could come down even lower."

Nervous Investors

But the interest rate paid for Treasury bills went up — a sign that investors are nervous about the large debt burden the government is taking on. Throughout the financial markets there were just as many questions as answers today about the future of the two companies.

U.S. officials portrayed the takeover as temporary. But they also left no doubt they want to see a fundamental rethinking of how Fannie and Freddie operate. Among other things, they want to see the companies scale down their huge portfolios of mortgage-backed securities.

Christopher Whalen of Institutional Risk Analytics says that by amassing all these securities, the companies have grown richer and more powerful. But Whalen notes that Fannie and Freddie typically have to borrow to pay for them.

"So they're not adding anything to the marketplace," he says. "They're actually competing with private banks and investors for those dollars they borrowed. There's absolutely no purpose to it. It's simply to generate earnings for the public shareholders."

Back To Basics

Whalen says he'd like to see the companies return to the original mission of buying mortgages from lenders in an effort to make the housing market more liquid. But Jonathan Koppell, who directs the Millstein Center for Corporate Governance at Yale University, says any effort to alter the size or mission of the companies is bound to face opposition from Democrats in Washington.

"The congressional committees that oversee Fannie Mae and Freddie Mac have made it clear that they have a strong interest in seeing the companies perform this role of extending credit to as many Americans as possible," he says.

Already today there were some grumblings from Democratic congressional leaders about some parts of the Bush administration plan. Sen. Christopher Dodd of Connecticut, who chairs the Senate Banking Committee, was asked what the effort to reduce the companies' portfolios might mean for the overall housing market.

"That's a great question and it certainly ought to be one of the top five or six questions that get asked at our hearing," he says. "And I've had others in the private sector raise that question already."

The Risk Factor

Dodd says the important question for Congress to consider is not how big the companies' portfolios are, but how risky they are. And he says Fannie's and Freddie's investments have traditionally been safe.

One thing is certain: Deciding the companies' future will take some time. Although the Bush administration has made its preferences clear, the real fate of Fannie and Freddie will be in the hands of the next administration.

Paulson: Mortgage Takeover Key For Economy

Treasury Secretary Henry Paulson speaks at a news conference on Sunday. i i

Treasury Secretary Henry Paulson speaks at a news conference announcing a federal takeover of Fannie Mae and Freddie Mac on Sunday. Brendan Hoffman/Getty Images hide caption

itoggle caption Brendan Hoffman/Getty Images
Treasury Secretary Henry Paulson speaks at a news conference on Sunday.

Treasury Secretary Henry Paulson speaks at a news conference announcing a federal takeover of Fannie Mae and Freddie Mac on Sunday as Federal Housing Finance Agency Director James B. Lockhart looks on.

Brendan Hoffman/Getty Images

In Depth: Planet Money Blog

The federal takeover of Fannie Mae and Freddie Mac is aimed at preventing a "serious risk to the financial system," which is "critical to our overall economy," Treasury Secretary Henry Paulson tells NPR.

The Bush administration on Sunday said it was taking over Fannie Mae and Freddie Mac, the troubled mortgage companies that play a key role in the U.S. housing industry. The administration said it would funnel billions of dollars in taxpayer money into the companies to help keep them afloat.

In July, when Congress gave the administration authority to take over the two mortgage giants, Paulson said he had no plans to use that power. But on Sunday, Paulson said in an interview with NPR's John Ydstie, "there's a number of things that have changed."

"First, we got into Fannie and Freddie and we learned that there was a capital deficiency that needed to be addressed," Paulson said. "And No. 2, markets are increasingly jittery here and around the world. And investors are starting to more frequently ask the questions, 'How do we make a long-term equity investment in Fannie Mae and Freddie Mac if we don't know what they're ultimately going to look like?' "

The Congressional Budget Office has estimated that a takeover of Fannie and Freddie could cost taxpayers $25 billion, and other analysts have forecast a higher amount.

Asked why it was necessary to put taxpayers at risk, Paulson said, "Well, our objective here is to prevent a serious risk to the financial system which would hurt all taxpayers because our financial system is just critical to our overall economy. Anybody that wants to have a car loan, a mortgage, any kind of credit, needs a strong financial system."

"We've structured this very carefully to protect the taxpayers. And, to the extent taxpayers are going to put preferred stock into this entity, it will be structured so that the first losses will be borne by the existing shareholders."

Paulson said the shareholders are "hopefully not being wiped out, but this will take time. But if things work well and housing prices stabilize and, over time, our economy does better, the shareholders have the hope of having their share prices appreciate. And that is certainly true of the preferred shareholders also."

Asked how the public will know if the rescue plan is working, Paulson said, "I think the average American should look to the availability of mortgage finance, and hopefully if this works, over time you're going to continue to see an abundant supply of mortgage financing that is reasonably priced."

"Another key indicator is, over time, the economy will stabilize and the financial institutions in the United States will do better, because it is our view that at the heart of the current economic challenge we have in the United States is a housing correction."

Paulson was asked how long the government takeover will last and how officials will ensure that such a crisis involving government-sponsored entities doesn't happen again.

"Well, [that] is the major question. It's one I focused on," Paulson said. "Because although the short-term objective is to stabilize and help us ride through this housing correction, these organizations had major structural flaws.

"In the future, we're going to need to clarify whether there is clearly a government guarantee or whether there is no government guarantee. We're going to have to decide whether we want to have government support for private profit. We're going to have to decide how to deal with systemic risks.

"And you ask how long. I'm hoping it can be done in the next couple of years."

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