Fannie, Freddie Takeover Explained

The housing market got worse than many people expected and as a result Fannie Mae's and Freddie Mac's capital got thinner, making them seem unstable. Foreign investors became restless and the financial credibility of the United States was on the line.

Copyright © 2008 NPR. For personal, noncommercial use only. See Terms of Use. For other uses, prior permission required.

MELISSA BLOCK, host:

This is All Things Considered from NPR News. I'm Melissa Block.

ROBERT SIEGEL, host:

And I'm Robert Siegel. Here's a passage from one wire-service story about the federal takeover of Fannie Mae and Freddie Mac. The bailout will trigger one of the largest ever payments in the credit default swap market, analysts said. This is the first time a company in the benchmark investment-grade credit derivative index has had a credit event.

I'm reading that to you because, frankly, I would have had an easier time puzzling out a paragraph of Portuguese than explaining what that meant or coming to understand it. And that's true of many statements that I've read or heard about the Treasury's rescue of the mortgage giants. So for those of you who might share a small sense of bafflement at the Fannie, Freddie takeover, our man John Ydstie is here to answer some questions that may pass for basic on Wall Street but not on my street. I won't ask you about what that meant, though.

(Soundbite of laughter)

JOHN YDSTIE: OK.

(Soundbite of laughter)

SIEGEL: But let's start with something more simple. A few weeks ago, the secretary of the Treasury, Secretary Paulson, told us that he needed the authority to do this sort of thing, but he didn't think he'd actually use it.

YDSTIE: Right.

SIEGEL: It wouldn't be necessary. Assuming that he was sincere and wrong, what happened since then?

YDSTIE: Well, I think, first of all, the housing market continued to deteriorate. It got worse than many people - most people had expected. And as a result, Fannie and Freddie's capital, their cushion against losses in the housing market, got thinner and thinner, so they were looking more and more unstable.

And then foreign investors, including governments, who hold lots of Fannie and Freddie bonds and preferred stock were getting very restless. They had invested in these securities with the belief that the U.S. government would make good on them in a pinch, so the financial credibility of the United States was on the line, and I think it was sort of put up or shut up time.

SIEGEL: Next question, then. The government says it's prepared to put up $200 billion to keep these two mortgage companies going. But the Treasury says that stockholders are not being bailed out. So who is going to get the $200 billion if it comes to that?

YDSTIE: Well, I think - let's start with the bond holders, people who lent Fannie and Freddie money. In a regular bankruptcy proceeding, those people would be the first in line to get their money, but they might only get 10 cents on the dollar. In this case, they're going to be made whole, so they'll get a bailout. The other people being bailed out are the people who bought those mortgage-backed securities that Fannie and Freddie guaranteed. They certainly would have lost money if these companies had failed.

But let's get back to the shareholders. People who own Fannie and Freddie stock will be very badly hurt. The price of their shares have already fallen 90 percent in the market in the past year. They will be deluded even further as the government obtains new shares in the companies, and dividends have been eliminated for them. These stockholders will also have to absorb any losses that might arise before taxpayers take a hit.

So not so good for shareholders, unless Fannie and Freddie manage to weather the storm and become profitable again in the future. But I'll tell you, that could take a long time.

SIEGEL: What about the two CEOs who were sent packing, Daniel Mudd and Richard Syron. Did they get golden parachutes, big compensation packages?

YDSTIE: Well, I'd say they're getting a bailout, too. Yes. They're each getting about $15 million to walk away. Some of that is stock, at least in the case of Mudd. So he could end up with a little bit less.

SIEGEL: Stock at current market value or what it used to be?

YDSTIE: Stock at current market value.

SIEGEL: Not much. What's the ultimate cost to the taxpayer likely to be here, given various scenarios, positive and negative?

YDSTIE: Well, nobody really knows for sure. The Congressional Budget Office took a crack at estimating it back when the Congress was writing legislation on this bailout. With lots of caveats, it settled on an estimate of about $25 billion, but said it could be anywhere from zero to $100 billion. The Treasury says it's now ready to put up $200 billion,but officials don't think that's the cost that it's going to be. It's really there just to convince the markets that they're serious.

SIEGEL: Well, let's say it ends up being somewhere in the $25 to $50 billion range. Where does this one rank in the annals of government bailouts?

YDSTIE: Well, when you look back to the S&L crisis, that cost taxpayers about $125 billion. That's when the government...

SIEGEL: Back when $125 billion was a lot of money...

YDSTIE: Meant something.

(Soundbite of laughter)

YDSTIE: Right. And they were bailing out 750 savings and loans at the time. That's a lot of money. And this potentially could be that much money, but I think you have to go back to the CBO estimate, maybe $25 billion or so.

SIEGEL: One of the provisions of this takeover is that after increasing their mortgage purchases in the short term, Freddie and Fannie would be forced to shrink their portfolios annually by 10 percent starting in 2010. What's the reasoning there?

YDSTIE: Well, right now, Fannie and Freddie are absolutely critical to the market. They're involved in financing at least two-thirds of the mortgages being issued in the United States right now, and the government wants them to provide even more financing to try to get mortgage interest rates lower, encourage buyers, and try to stop the fall in home prices.

But once things stabilize, they'd like to begin to shrink Fannie and Freddie so they're not so dominant in the market.

SIEGEL: Just to go back to something you said at the beginning, John, you said that foreign governments and foreign banks were among the people holding the debt of Fannie and Freddie, who were getting very anxious. Is this a case of, among others, the Chinese saying, time for you, Washington, to live up to your long, implicit guarantee? We don't want to be left holding the bag with a bunch of worthless securities?

YDSTIE: I think that's absolutely right. And we have seen the Chinese quoted saying almost as much, that it was time for the United States to step up to its obligations.

SIEGEL: John, thank you very much.

YDSTIE: You're very welcome, Robert.

SIEGEL: That's NPR's John Ydstie.

Copyright © 2008 NPR. All rights reserved. No quotes from the materials contained herein may be used in any media without attribution to NPR. This transcript is provided for personal, noncommercial use only, pursuant to our Terms of Use. Any other use requires NPR's prior permission. Visit our permissions page for further information.

NPR transcripts are created on a rush deadline by a contractor for NPR, and accuracy and availability may vary. This text may not be in its final form and may be updated or revised in the future. Please be aware that the authoritative record of NPR's programming is the audio.

Understanding The Fannie, Freddie Rescue

The U.S. government has stepped in with an ambitious plan to help rescue mortgage finance giants Fannie Mae and Freddie Mac.

The Bush administration placed the two companies into a conservatorship, replaced their CEOs and boards of directors, and announced a plan to infuse billions of dollars to prop them up as a means for reinvigorating the U.S. housing market.

Here, a look at some of the reasons the government decided to act and the implications for taxpayers.

Why did the government act now?

Treasury Secretary Henry Paulson told NPR that the primary reason for the rescue was the discovery of a "capital deficiency that needed to be addressed." In other words, they didn't have an adequate cushion against further losses in the deteriorating housing market.

Paulson said that investors have become "increasingly jittery here and around the world" and unwilling to provide added capital for Fannie and Freddie. He said the action was taken to ensure the continued availability of mortgages and to protect taxpayers. Currently, Fannie and Freddie are providing financing for more than two-thirds of all mortgages originated in the U.S.

What does this bailout plan involve?

The government is putting Fannie and Freddie into conservatorships under the control of their regulator, the Federal Housing Finance Agency. (Earlier this summer, Congress gave the administration the green light to take over the two companies if necessary.)

The four-step rescue plan, which also involves the Federal Reserve and the U.S. Treasury, calls for increasing Fannie and Freddie's portfolio of mortgage-backed securities through the end of 2009, then reducing them by 10 percent each year, starting in 2010. It would also establish a special class of shares owned by Treasury that would give preference to the government's investment over those owned by other shareholders. It would create a credit facility to lend up to $100 billion to each of the companies — as a means for encouraging continued investment in the companies. And it would begin a temporary program whereby the U.S. Treasury will invest in new mortgage-backed securities — $5 billion in the next month alone.

What's the goal of the government's takeover?

Paulson said the federal takeover was initiated to avert a "serious risk" to the financial system and keep money available for mortgages.

In the short term, the rescue is meant to help calm the markets and to offer some measure of stability to help the U.S. economy weather the housing correction. In the longer term, the goal is to keep the two companies afloat so that they can continue to support the U.S. housing market.

Fannie and the smaller Freddie own or guarantee more than $5 trillion in mortgages — almost half of all the mortgages issued in the United States. On Sunday, James Lockhart, the director of the Federal Housing Finance Agency, said the two companies' market share of new mortgages "reached over 80 percent" earlier this year, but is now falling.

Will Fannie and Freddie debt and mortgage-backed securities continue to be backed by a government guarantee?

Paulson said this is a key question that will need to be addressed in the next couple of years. Fannie and Freddie were chartered by Congress, and so historically, investors — especially foreign ones — have bought their debt because they believed it was backed by the full faith and credit of the United States, akin to Treasury bonds.

The takeover makes that guarantee explicit for the time being. Paulson said the issue of whether there should be a government guarantee would have to be resolved: "We're going to have to decide whether we want to have government support for private profit."

In recent weeks, Fannie and Freddie suffered a crisis of confidence as their stock price plummeted.

Are taxpayers at risk?

Paulson said the rescue effort was "structured very carefully to protect the taxpayers." If taxpayer dollars are used for the purchase of preferred stock, then "first losses will be borne by the existing shareholders," he said. But if the housing market continues to deteriorate, taxpayers could be on the hook. The Congressional Budget Office has estimated that a bailout of Fannie and Freddie could cost from $0 to $100 billion, with the most likely amount being $25 billion.

How might this affect homebuyers and mortgages?

The takeover buoyed investors, and mortgage rates began to drop in the financial markets after the takeover was announced. Economist Mark Zandi with Moody's Economy.com says that 30-year mortgage rates could descend to nearly 5.5 percent; the national average is now 6.35 percent.

How will consumers know whether the takeover action is working?

Paulson said the yardstick for consumers would be if there continues to be "an abundant supply of mortgage financing that is reasonably priced." In other words, if homebuyers are still able to obtain mortgages at good rates.

Will shareholders in Fannie and Freddie be wiped out or bailed out?

Paulson said in a prepared statement that because Fannie and Freddie are now in conservatorship, they will "no longer be managed with a strategy to maximize" shareholder returns — a strategy that he said "historically encouraged risk-taking." But he said if everything goes well, they might get some money back. But shareholders are last in line for any claims. So if things worsen, shareholders would likely get very little.

How could the takeover of Fannie and Freddie help stabilize the world financial system?

Many foreign central banks held Fannie and Freddie bonds in their portfolios. Some have reduced those holdings in recent months as questions about Fannie and Freddie's future have intensified. If Fannie and Freddie were not able to make good on their debt, there would be chaos in world financial markets.

With reporting by John Ydstie, Jim Zarroli, Adam Hochberg and Joshua Brockman and The Associated Press

Comments

 

Please keep your community civil. All comments must follow the NPR.org Community rules and terms of use, and will be moderated prior to posting. NPR reserves the right to use the comments we receive, in whole or in part, and to use the commenter's name and location, in any medium. See also the Terms of Use, Privacy Policy and Community FAQ.