Earlier this summer, Congress gave the Treasury Department the authority to inject capital into Fannie Mae and Freddie Mac, and stand behind their debt. At the time, Treasury Secretary Henry Paulson said he had no plans to use the powers. The hope was that the financial markets would gain confidence in the companies, and the housing and mortgage markets would stabilize.
They haven't, and according to a number of reports published on Saturday, it now appears the government is poised to take control of the mortgage giants.
Charles Calomiris, professor of financial institutions at Columbia University, says it's the right move to make at this point.
"The intent is to keep these things operating," he says. "That is, to keep the mortgage flow continuing, and that's essential because Fannie Mae and Freddie Mac have constituted such a huge share of that mortgage flow; and with the credit crunch in the private banking sector, it's all the more important."
According to news reports, Daniel Mudd, the chief executive of Fannie Mae, and Richard Syron, his counterpart at Freddie Mac, were summoned separately to the offices of their new regulator, the Federal Housing Finance Agency, on Friday. There, chief regulator James Lockhart, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Paulson informed them of the plan, which represents a sweeping government intervention in the financial markets.
According to the reports, they were told, among other things, that they would be dismissed, and that the government would take over operation of the companies. In addition, the government would inject capital as needed to offset losses on bad mortgages the companies hold or guarantee.
According to the reports, investors who own common stock in the companies could be virtually wiped out, or at least see their stock value diluted, but holders of preferred shares and company debt may be protected. It's possible all of this could cost U.S. taxpayers tens of billions of dollars, or more.
Calomiris argues it's worth the risk.
"I'm pretty optimistic about the taxpayer exposure. I don't think it's gonna be that large," he says. "Of course, even if it were tens of billions of dollars, the cost in terms of the overall condition of the economy that would result from not intervening would be much greater."
An unveiling of the plan could come as early as this weekend, but the Treasury has declined to comment on the reports.