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Q&A | Mortgages

Officials weigh rescue as mortgage giants reel

NEW YORK — Alarmed by the growing financial stress at the nation's two largest mortgage finance companies, senior Bush administration officials are considering a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, people briefed about the plan told the New York Times on Thursday.

The companies, Fannie Mae and Freddie Mac, have been hit by the tsunami of mortgage foreclosures. Shares of the government-chartered mortgage finance giants plummeted Thursday and are trading at levels last seen in the early 1990s.

What are Fannie Mae and Freddie Mac?

Congress created Fannie in 1938 and Freddie in 1970 to keep money flowing into the home-loan market by buying up mortgages and bundling them into securities for sale to investors worldwide — thereby making home ownership affordable for low- and middle-income Americans. While they were created by Congress, their stocks trade on the New York Stock Exchange and they play a vital role in the U.S. mortgage market, especially since the subprime mortgage market's collapse. The companies issued about three-quarters of all new mortgage-backed securities in the second quarter of 2008, up from under 40 percent in 2006, and now hold or guarantee about $5.3-trillion in home-loan debt. They buy hundreds of billions of dollars in mortgages from lenders, repackage them as securities and then either hold them in their portfolios or sell them to investors.

What might Freddie and Fannie's woes mean for the housing market?

If Freddie and Fannie are unable to borrow, they will not be able to purchase mortgages from commercial lenders. In turn, that would make it more expensive and difficult, if not impossible, for home buyers to obtain credit, freezing the U.S. housing market. Even healthy banks are reluctant to tie up scarce capital by offering mortgages to low-risk home buyers without Fannie and Freddie taking the loans off their books.

Why are they in trouble?

Their shares are plummeting and their borrowing costs are rising because of investor worries that they will suffer losses far larger than the $11-billion they have already lost in recent months. As housing prices decline further and foreclosures grow, the markets are worried that Fannie and Freddie themselves may default on their debt. Fannie Mae stock tumbled nearly 14 percent Thursday to close at $13.20, its lowest price in three decades. Freddie Mac stock fell 22 percent to $8; its shares have lost nearly 90 percent of their value during the past year.

What set off the current crisis?

The tumult started with a cautionary analyst's report, one that might have caused few ripples in normal times, but these are not normal times. Within minutes, the price of the companies' shares were plunging, sending shock waves through the financial markets, the economy and Washington.

Is the government obliged to bail them out?

The Treasury Department has long worked on plans for what to do if a large financial firm such as Fannie or Freddie failed, but the government isn't obligated to assist in a financial emergency. Still, there is a widespread perception that they would be bailed out if there is a collapse, though officials involved in the discussions emphasized that no action was imminent.

What could the government do?

Under a 1992 law, Fannie or Freddie could be put into conservatorship if their top regulator found that either one is "critically undercapitalized." A conservator would have sweeping powers to overhaul them, but would not have the authority to close them. Under a conservatorship, the companies' shares would no longer trade, and any losses on mortgages, which could be staggering, would be paid by taxpayers. It would be the second time in four months that the Bush administration has stepped in to engineer a rescue to prevent the financial system from collapsing. Last March, it forced the sale of Bear Stearns to JPMorgan Chase to avert a bankruptcy of that venerable investment house.

The administration has also been exploring the option of seeking legislation that would offer an explicit government guarantee on their $5-trillion of mortgage debt. But that is a far less attractive option, they said, because it would effectively double the size of the public debt.

Information from the Associated Press and New York Times was used in this report.

Officials weigh rescue as mortgage giants reel 07/10/08 [Last modified: Friday, July 11, 2008 8:18pm]

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