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Government Seizes Mortgage Giants

POSTED: September 08, 2008, 12:00 pm

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The nation’s home mortgage crisis hit a new low Sunday as a government takeover of two mortgage finance firms was announced. Secretary of the Treasury Henry M. Paulson, Jr. joined Jim Lockhart, Director of the Federal Housing Finance Agency (FHFA) to announce a federal takeover of mortgage giants Fannie Mae and Freddie Mac.

Secretary Paulson announced, “Based on what we have learned about these institutions over the last four weeks – including what we learned about their capital requirements – and given the condition of financial markets today, I concluded that it would not have been in the best interest of the taxpayers for Treasury to simply make an equity investment in these enterprises in their current form.”

The takeover comes after weeks of speculation that the federal government would have to step in to prevent the wholesale collapse of the two home mortgage firms. Both companies have been swept up in the wave of mortgage defaults and home foreclosures that is devastating the nation’s housing market, particularly impacting homeowners with risky alternative rate mortgages (ARM’s). The latter have been susceptible to the fluctuations of the economy and rising interest rates. Many first time homeowners unknowingly agreed to the risky financial instrument only to find that they could not afford the monthly mortgage payment when interest rates ballooned. Particularly hard hit has been Black homeowners and the working class.

In announcing the takeover the Bush administration has yielded to increasing public pressure to intervene in the mortgage crisis. With the presidential election less than 60 days away, the White House entered the fray as the economy is looming large as a pivotal election issue. Almost immediately the bailout was supported by Democratic candidate Senator Barack Obama and criticized by Senator John McCain, the Republican nominee.

Both Fannie Mae and Freddie Mac are government sponsored enterprises (GSE’s). These are financial service corporations created by Congress to increase the flow and availability of credit to targeted populations. The Federal National Mortgage Association (Fannie Mae) was chartered in 1938 and the Federal Home Loan Mortgage Corporation (Freddie Mac) was chartered in 1970. Fannie Mae and Freddie Mac are privately owned but publicly chartered.

In announcing the takeover Secretary Paulson acknowledged the unique role of these institutions. He said, “They operate solely in the mortgage market and are therefore more exposed than other financial institutions to the housing correction. Their statutory capital requirements are thin and poorly defined as compared to other institutions. Nothing about our actions today in any way reflects a changed view of the housing correction or of the strength of other U.S. financial institutions.”

FHFA Director Jim Lockhart explained, “Over the last three years OFHEO, and now FHFA, have worked hard to encourage the Enterprises to rectify their accounting, systems, controls and risk management issues. They have made good progress in many areas, but market conditions have overwhelmed that progress. The result has been that they have been unable to meet their affordable housing mission. Rather than letting these conditions fester and worsen and put our markets in jeopardy, FHFA, after painstaking review, has decided to take action now.”

Lockhart described the series of steps that led up to FHFA’s decision to takeover Fannie Mae and Freddie Mac. Among those steps was removing the portfolio caps on each company and reducing their capital requirements in return for the firms’ commitments to raise significant capital and to keep capital levels in excess of requirements. Neither step did much to improve the outlook of both companies. FHFA released its annual report to Congress, raising concerns over their supervision and the risk the deteriorating mortgage credit environment posed to each company.

The FHFA Director announced, “In order to restore the balance between safety and soundness and mission, FHFA has placed Fannie Mae and Freddie Mac into conservatorship. That is a statutory process designed to stabilize a troubled institution with the objective of returning the entities to normal business operations. FHFA will act as the conservator to operate the Enterprises until they are stabilized.”

Secretary Paulson indicated the Department of Treasury was taking three steps to address the crisis at Fannie Mae and Freddie Mac. Treasury and FHFA have established Preferred Stock Purchase Agreements between the Department of Treasury and the two mortgage companies. These agreements will provide Fannie Mae and Freddie Mac greater security as Treasury will make certain they maintain a positive net worth. The arrangement is also meant to make certain that shareholders of the companies ultimately bear the greatest risk. In addition a new secured lending credit facility will be created and a new program to aid mortgage affordability.

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