U.S. proposes plan to help troubled mortgage giants

Posted on July 14, 2008. Filed under: -- Economic Week In Review | Tags: , , , |

U.S. proposes plan to help troubled mortgage giants

Officials would get power to inject billions of federal dollars into Fannie Mae, Freddie Mac through investments and loans.

Monday, July 14, 2008

WASHINGTON — The Federal Reserve and the Treasury Department announced steps Sunday to shore up mortgage giants Fannie Mae and Freddie Mac, whose shares have plunged as losses from their mortgage holdings threaten their financial survival.

The moves also are intended to send a signal to nervous investors worldwide that the government is prepared to take steps to prevent the credit market troubles that started last year from engulfing financial markets and further weakening the economy and housing markets.

The Fed said it granted the Federal Reserve Bank of New York the authority to lend to the two companies “should such lending prove necessary.” They would pay 2.25 percent for any borrowed money — the same rate given to commercial banks and big Wall Street firms.

The Fed said that should help the companies’ ability to “promote the availability of home mortgage credit during a period of stress in financial markets.”

Treasury Secretary Henry Paulson said the department is seeking expedited authority from Congress both to expand its current $2.25 billion line of credit to each company should they need to tap it and to make an equity investment in the companies if needed.

“Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies,” Paulson said Sunday. “Their support for the housing market is particularly important as we work through the current housing correction.”

The companies own or guarantee more than $5 trillion of home loans — about half of all the mortgage debt that is outstanding in the United States.

Treasury’s plan also seeks a “consultative role” for the Fed in any new regulatory framework eventually set up by Congress for Fannie Mae and Freddie Mac.

The White House said in a statement that President Bush directed Paulson to “immediately work with Congress” to get the plan enacted.

Investors may not be as sanguine, however, said Chris Johnson, an investment manager and president of Johnson Research Group in Cleveland. Stocks of financial institutions “are going to get clobbered,” he said. “It is a situation where regulators and the government are trying to play catch-up, and that means everything is not discounted in the stock prices yet.”

The Dow Jones industrial average on Friday briefly fell below 11,000 for the first time in two years, and Johnson expects shares of investment banks and regional banks could fall as investors react to the developments.

The announcement marked the latest move by the government to bolster confidence in the mortgage companies. A crucial test of confidence will come today, when Freddie Mac is slated to auction a combined $3 billion in three- and six-month securities.

Fannie Mae was created by the government in 1938 as a way to give more Americans the chance to own a home by giving financial institutions an outlet to sell mortgage loans they originated. That freed up cash for more home loans. Fannie Mae moved from government to public ownership in 1968; Freddie Mac was started two years later.

Sunday’s announcements are likely to raise anew criticism that the government should have moved sooner to rein in the two companies, especially since investors assumed they would be bailed out if they got into trouble.

The government denied it, but what was seen by investors as an implicit guarantee of support allowed Fannie Mae and Freddie Mac to borrow at rates only slightly higher than the Treasury and lower than what their banking competitors paid.

“This really blows away the notion of an implicit guarantee,” independent banking consultant Bert Ely said of the Treasury’s plan to ask Congress to allow it to make equity investments in Fannie Mae and Freddie Mac. “It suggests a greater concern about how these companies are doing. It says the problems are deeper.”

The Fed’s offer of money is viewed as a temporary backstop until Treasury can get its plan in place.

Paulson’s goal is to get his plan attached to a sweeping housing-rescue package. The Senate and House have each passed bills, and a final package has to be hammered out. The centerpiece of the legislation is to help strapped home-owners avoid foreclosure, but it also contains provisions to revamp oversight of Fannie Mae and Freddie Mac.

Confronted by record foreclosures, the Fed is also ready to give home buyers more protection from the types of shady lending practices that have contributed to the housing crisis.

Chairman Ben Bernanke and his central bank colleagues were expected to approve a plan today that would crack down on dubious lending practices that have hurt many of the riskiest borrowers.

Proposed rules made public in December would restrict lenders from penalizing risky borrowers who pay loans off early and bar lenders from making loans without proof of a borrower’s income, among other measures.



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