Takeover seen easing loan crisis

Analysts say rescue essential; Mortgage rates may go down

By Robert Gavin and Kimberly Blanton
Globe Staff / September 7, 2008
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The Bush administration's planned takeover of mortgage giants Fannie Mae and Freddie Mac should help lower mortgage rates, stem the slide of housing markets, and stabilize the US economy, analysts said.

The takeover, expected to be announced as early as today, represents one of the biggest government interventions into the private markets ever. It aims to end the uncertainty over the ability of Fannie and Freddie, which hold or guarantee about half of US mortgages, to survive the worst housing crisis since the Great Depression, analysts said.

That uncertainty, as well as billions of dollars in losses, have made investors reluctant to buy bonds that the two government-created companies use to finance mortgages, reducing the amount of money available for loans and raising rates for borrowers.

"The guy on the street is going get his mortgage cheaper," said Charles Calomiris, a professor at Columbia Business School. And for the US economy and markets, "this is the beginning of the end of the financial difficulties."

It also appears to be the end of Richard Syron's tenure as chief executive of Freddie Mac. The federal government is expected to oust Syron, the former president of the Boston Federal Reserve Bank, along with Fannie Mae chief executive Daniel Mudd. Syron, who completed two corporate turnarounds after leaving the Fed in 1994, arrived at Freddie in late 2003 to rebuild a company reeling from accounting scandals.

By most accounts, he succeeded in cleaning up the accounting mess. But like so many others connected to the housing industry, analysts said, he and his company were caught in a downward spiral of historic proportions, the length and severity of which were foreseen by few.

"Anyone who stayed in the business after 2004 was fried," said Karl Case, a Wellesley College economics professor and a housing analyst. Syron, through a spokeswoman, declined to comment.

Representative Barney Frank, the Newton Democrat who chairs the House Financial Services Committee, said the Bush administration is using powers granted to ensure the smooth functioning of Fannie, Freddie, and US mortgage markets. Those powers were approved as part of comprehensive housing legislation passed in July.

"It's very important that the role Freddie and Fannie play in supporting the housing market be maintained," Frank said. "Right now, it's particularly important that they continue to provide necessary credit for the housing market."

Details of the takeover plan are incomplete, but Fannie and Freddie would be put into a conservatorship, which would replace current executives and boards, and put the companies under government control. They would continue to function as they do now.

It is unclear what the plan might cost, but if the government has to make good on the companies' bad debts, it could amount to tens of billions of dollars.

Created by Congress to expand credit and homeownership, Fannie and Freddie are corporate hybrids, private companies owned by shareholders, but with public responsibilities, such as expanding affordable housing. Without them, mortgage credit and home sales would dry up and severely damage the US economy.

Fannie and Freddie buy mortgages from lenders, which frees up money for the lender to make new loans. The companies own or guarantee more than $5 trillion in mortgages.

Neither hold many of the risky mortgages known as subprime, which precipitated the housing collapse. But as the housing crisis worsened and defaults spread into the broader market, losses for Fannie and Freddie mounted. The companies reported more than $3 billion in combined losses in the second quarter ending in June.

The US housing market continues to deteriorate. Last week the Mortgage Bankers Association said that 6.4 percent of US mortgages are delinquent because borrowers are behind on their payments. That is the highest rate ever recorded by the association. Meanwhile, the national unemployment rate surged to 6.1 percent in August, the highest rate since 2003, which could make it difficult for more Americans to meet monthly payments.

As the outlook on the US housing market remained grim, investors became increasingly worried that losses would wipe out Fannie and Freddie. Panic selling of Fannie and Freddie stock in July forced the Bush administration to pledge to guarantee the companies' debt and Congress to give the administration the power to take over the firms, if necessary.

Analysts said that administration officials, including Treasury Secretary Henry M. Paulson Jr., had hoped the pledge would be enough to calm markets and restore confidence, without directly intervening. But investors remained jittery, making it difficult for Fannie and Freddie to raise the capital they need to cover their potential losses in the mortgage market. Concerns about the companies' ability to repay their loans has forced them to pay higher rates on the bonds they sell to finance mortgages, which means higher rates for borrowers. Mortgage rates have risen nearly 1 point since January, even though the Federal Reserve has cut its benchmark rate more than two points during the same period.

By taking over the companies, the administration would end any doubt about the government's commitment to backing Fannie and Freddie debt. That lowers the risk of the bonds, which should reduce interest rates the Fannie and Freddie pay, which in turn means lower rates for lenders and borrowers. In addition, the lower risk should attract more investors, which would put more money into the financial system, analysts said.

"It may not be the best policy step," said Mark Zandi, chief economist at Moody's in West Chester, Pa. "But it's a reasonable one to bring down mortgage rates and allow more mortgage credit, which is key to the housing market and the economy."

The biggest losers could be the companies' shareholders because a government takeover may render common stock worthless.

Boston money management firms and New York investment banks are the largest investors in both companies. Fidelity Investments, based in Boston, is Fannie Mae's fourth-largest shareholder and Freddie Mac's 12th largest. Other major investors in the companies, according to federal filings compiled by Bloomberg, include Wellington Management Co. in Boston, and JP Morgan Chase, Merrill Lynch, and Citigroup in New York.

The conservatorship would be an interim step, with the long-term future of Fannie and Freddie to be decided later, analysts say. The options include returning them to their current status as part public, part private; fully privatizing them; or making them completely public. Those decisions will be left to the next Congress and administration.

At a rally in Colorado Springs, Colo., yesterday, Sarah Palin, the running mate of Republican presidential nominee John McCain, said of Fannie and Freddie, "They've gotten too big and too expensive to the taxpayers. The McCain-Palin administration will make them smaller and smarter and more effective for homeowners who need help."

Democratic nominee Barack Obama, speaking in Terre Haute, Ind., said, "These entities are so big and they're so tied into the housing market that it is probably true that we have to take steps to make sure they don't just collapse, because the housing market, which is already weakened, would be in even worse shape if we didn't take some steps."

Robert Gavin can be reached at, Kimberly Blanton can be reached at Material from wires services was included in this report.

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