Paulson: Action on Fannie, Freddie Was Necessary The federal government today announced its plans for a takeover of the troubled mortgage finance companies Fannie Mae and Freddie Mac. While U.S. officials had hoped to avoid a bailout, the deterioration of the two companies could no longer be ignored.

Paulson: Action on Fannie, Freddie Was Necessary

Paulson: Action on Fannie, Freddie Was Necessary

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In Depth: Planet Money Blog

The federal government Sunday announced a historic plan to rescue the troubled mortgage companies Fannie Mae and Freddie Mac.

The government will take over the companies and will pump as much capital into their balance sheets as they need to keep them solvent.

U.S. officials made clear Sunday that they had no choice but to act — and to act quickly. Treasury Secretary Henry Paulson said Fannie Mae and Freddie Mac are so large and so interwoven in the nation's financial system that letting them fail would cause turmoil in financial markets both here and abroad.

"A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today," Paulson said.

Those actions amount to a government seizure of two of the pillars of the U.S. housing market. Under the plan announced Sunday, the government said it would begin acquiring shares of the companies. It will also set up a temporary credit facility to lend them money if they need it.

The Treasury Department can do this because Congress voted in July to let the department invest in the companies if necessary. U.S. officials had hoped that such a move would be unnecessary, and that the financial markets would stabilize on their own. But economist Vincent Reinhart of the American Enterprise Institute said the companies' position has deteriorated so much that their troubles could no longer be ignored.

"Their portfolio — because the real estate market has cratered so significantly — their portfolio is suspect. It needs more capital. So ultimately, the secretary has to write ... that blank check," Reinhart said.

The plan unveiled Sunday will also change the way Fannie Mae and Freddie Mac are managed. They will be placed in a conservatorship and will be run by their regulator, the Federal Housing Finance Agency. The companies' CEOs will be replaced, though both have been asked to stay on to help with the transition. Instead of answering to shareholders, the companies will answer to the government.

"Conservatorship will give the enterprises the time to restore the balances between safety and soundness and mission, to be able to provide affordable housing, and stability and liquidity to the mortgage markets," said James Lockhart, director of the Federal Housing Finance Agency.

U.S. officials said they see this plan as temporary, and that they hope to see Fannie Mae and Freddie Mac get smaller down the road.

They'll be able to keep buying up more mortgages until next year. But then U.S. officials hope they'll begin to pare down the number of mortgages they buy and let the private sector take over the role they play.

Officials also note that the uncertainty around the companies has helped drive up mortgage rates higher than they would otherwise be. If the situation stabilizes, they say, rates should start to come down.

Economist Sung Won Sohn of California State University says that may be true, but there are also big risks to what the Bush administration is doing. He says that however much this ends up costing, the U.S. government is essentially agreeing to take on more debt.

"Market's perception is that U.S. Treasury is now backing ... Fannie and Freddie. We're talking about trillions of dollars of debt, and that on top of the trillions of dollars the U.S. Treasury has on its own," Sohn said.

Sohn said that will make many foreign investors more nervous about buying up U.S. Treasury bills, which can only push up interest rates and make it more expensive for the U.S. to borrow money.

But as this financial crisis has unfolded, U.S. officials have been forced to think on their feet. They say that the situation is so dire right now, that they have had little choice but to take this kind of aggressive action — and deal with the consequences later.