Fannie Mae and Freddie Mac takeover and conservatorship – Impacts and Outcomes

The treasury along with the Federal Reserve and Federal Housing regulator (FHFA) announced a take over via conservatorship of the government sponsored entities of Freddie Mac and Fannie Mae. Current actions will definitely provide a cushion, but long term structural reform is needed to ensure this does not happen again and tax payer bailout losses are minimized. They (the government) have protected debtors but common and preferred shareholders are going to suffer massive losses. Also, what is the future of Freddie Mac and Fannie Mae employees? Both companies have already undertaken large layoffs, but will be pressured to streamline further, with the possibility of a merger down the road. Paulson (Treasury secretary) and Lockhart (FHFA director) announced it will be business as usual on Monday for the two public companies, but I think it will be far from that as the legal ramifications from shareholders and other stakeholders commence. The one really good and decisive action that the government took was to replace the companies senior leadership and announce the appointment of 2 new and external CEO’s effective – Herb Allison for Fannie Mae and David Moffett for Freddie Mac – immediately with the past CEO’s will stay for a brief transition period. Here are some highlights of the takeover arrangement from Bloomberg.

“We have determined that it is necessary to take action,” Treasury Secretary Henry Paulson, who engineered the takeover along with Federal Housing Finance Agency Director James Lockhart, said in a statement today. “Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing.”

Lockhart said his agency has placed Fannie Mae and Freddie Mac into conservatorship. This was because the companies “cannot continue to operate safely and soundly and fulfill their critical public mission without significant action to address our concerns,” he said in a statement. “The government wasn’t going to allow them to muddle through this mess,” said Paul Miller, an analyst with Friedman Billings Ramsey & Co. in Arlington, Virginia. “No way were they going to be able to do that because the market was going to freeze up.”

Morgan Stanley, hired by the Treasury to probe the companies’ finances, concluded the accounting, while legal, enabled Freddie, and to a lesser extent Fannie, to overstate the value of their reserves, according to the people who declined to be identified because the findings were confidential. Paulson hired Morgan Stanley a month ago to advise on Fannie and Freddie. Paulson also consulted with Bank of America Corp. Chief Executive Officer Kenneth Lewis on his plan. Bernanke participated in the meetings/decision because the central bank was given a consultative role in overseeing Fannie’s and Freddie’s capital.

Paulson told Fannie Chief Executive Officer Daniel Mudd, 50, and Freddie CEO Richard Syron, 64, about his plan two days ago. The top managers of the two government-sponsored enterprises, which have operated as private shareholder-owned corporations for almost 40 years, will be forced out, two people briefed on the discussions said.

Herb Allison, formerly of TIAA-Cref, will take over as Fannie’s new CEO, while David Moffett, formerly of U.S. Bancorp, will head Freddie, Lockhart said in his statement today.

Conservatorship Aims – The FHFA will operate the conservatorship, aiming to “preserve and conserve” the companies’ assets and property and put them “in a sound and solvent condition,” according to a fact sheet distributed by the Treasury. There is “no exact time frame” for when the conservatorship will end, the statement said.

Fannie and Freddie own or guarantee almost half of the $12 trillion in U.S. home loans and the government had been leaning on the companies to help pull the economy out of the housing crisis. Fannie is down about 66 percent in New York Stock Exchange trading since the end of June. Freddie has fallen about 69 percent. On Monday it is likely that the shares will fall to less than $2 a share each.

The Treasury briefed Democratic presidential candidate Barack Obama yesterday and has contacted Republican contender John McCain’s staff. Officials also discussed the plans with House Speaker Nancy Pelosi, Senate Majority Leader Harry Reid, Senate Banking Committee Chairman Christopher Dodd and House Financial Services Committee Chairman Barney Frank.

As losses on the mortgages grew late last year, the companies recorded $14.9 billion in combined net losses, eating into their capital. Fannie raised $14.4 billion since November and Freddie sold $6 billion of preferred securities. Plans for a $5.5 billion sale were delayed as the company’s fortunes sank. Fannie had $47 billion of capital as of June 30, according to company filings. The company is required by its regulator to hold $37.5 billion. Freddie’s capital stood at $37.1 billion, compared with a requirement of $34.5 billion, filings show. Fannie’s market capitalization is now $7.6 billion, down from $38.9 billion at the end of last year. Freddie’s has fallen to $3.3 billion, from $22 billion over the same period.

Do you think it will stabilize housing and financial markets?

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