Fannie, Freddie fall bailout fears

August 18, 2008 6:59:43 PM PDT
Whether or not the government is actually on the verge of taking over mortgage finance companies Fannie Mae and Freddie Mac, investor fears that a bailout is imminent could turn such a worst-case scenario into reality.Amid renewed concern that shareholders will wind up with nothing if the government intervenes to bail out the troubled companies, shares in the mortgage finance giants tumbled Monday to the lowest levels in nearly two decades.

Fannie Mae's stock slid more than 22 percent, or $1.76, to $6.15 on Monday, while shares of Freddie Mac fell 25 percent, or $1.46, to $4.39.

"Some of these things become self-fulfilling prophecies because market confidence is so fragile," said Karen Shaw Petrou, managing partner of consulting firm Federal Financial Analytics in Washington.

However, a more likely scenario, analysts say, would stop short of nationalizing the two companies and would take the form of emergency loans to Fannie and Freddie from the Federal Reserve or Treasury Department.

The Treasury Department late last month gained the authority to boost Fannie and Freddie through an investment or a loan should the companies need their finances propped up due to soaring losses from bad mortgages.

The new government power, enacted by Congress after the companies shares plunged to levels not seen since the early 1990s, for several weeks quieted worries that the companies could collapse.

But investors were spooked once again, after a Barron's magazine article over the weekend, citing an anonymous Bush administration source, reported that the government is pressing the companies to raise more money to guard against losses but doesn't expect the companies to succeed.

The Barron's report said the government is likely to buy preferred stock in the companies, wiping out common shareholders.

Treasury Secretary Henry Paulson, who had spent the last week in Beijing attending the Olympics with his family, was back at work on Monday and aides said he was monitoring financial market developments as he always does.

Jennifer Zuccarelli, a Treasury spokeswoman, said the government has "no intention" of using its authority to invest in Fannie and Freddie and declined further comment.

Denials from government officials have not been soothing investors lately. "You don't pass that sort of legislation unless there's some sort of intent to use it," said Barry Ritholtz, chief executive of FusionIQ, an asset management and research firm in New York.

The housing slump and continuing distress in the mortgage markets have withered the profit margins of Fannie and Freddie, the government-sponsored companies that together hold or guarantee nearly half of all U.S. home mortgages.

In response to last month's steep slide in Fannie and Freddie's stock, the Securities and Exchange Commission banned some forms of trading that enable investors to bet that a stock's price will fall. That order, intended to prevent stock manipulation, expired early last week.

Freddie Mac, in particular, has investors and analysts fearful.

The McLean-Va.-based company earlier this year promised to raise $5.5 billion to shore up its finances but has so far not done so.

The company's sinking share price makes doing so less attractive because the value of existing shareholders' stake would be diluted.

"We're certainly poised and ready when market conditions are appropriate," Chief Financial Officer Buddy Piszel said in a recent conference call. "But there is no need for us to rush."

Government officials are likely seeking to avoid a full-fledged takeover of the companies, said Bert Ely, an Alexandria, Va.-based banking industry consultant and a longtime critic of Fannie and Freddie. More likely, he said are less-sweeping moves to calm rattled debt investors.

Those include having the Federal Reserve or Treasury Department lend money to the companies. A government purchase of shares, he said, is "the step of last resort."

The Federal Reserve declined to comment on whether Fannie Mae or Freddie Mac might have tapped its emergency lending facility.

The Fed in mid July said the mortgage giants would be permitted to draw overnight loans directly from the Fed if they needed to shore up their financial positions. There have been no indications, however, in weekly reports from the Fed that the companies have tapped such funds.

Investment banks also have been allowed to borrow from the Fed's emergency lending program since mid-March.

The Fed's decision to extend this privilege, which for years was open only to commercial banks, represented the broadest expansion of its lending powers since the 1930s. The identity of borrowers tapping the Fed's facility is not public.

Washington-based Fannie Mae and McLean, Va.-based Freddie Mac, are the nation's largest buyers and backers of mortgages. But they lost a combined $3.1 billion between April and June. Half of their credit losses came from so-called Alt-A loans, which were made to borrowers with solid credit but little proof of their incomes, or small or no down payments.

Brian Faith, a Fannie Mae spokesman, said in an e-mailed statement that the company "continues to exceed our regulatory capital requirements ... We continue to provide stability and liquidity to the housing market and we will continue to play a key role as the market recovers from this cycle."

Freddie Mac spokeswoman Sharon McHale said the Barron's article "significantly overstates Freddie Mac's financial situation" and said the company is "financially sound."


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