With losses mounting at the two specialist mortgage agencies – which between them have $5.4 trillion of mortgage-backed securities (MBS) and debt outstanding – Treasury secretary Henry Paulson unveiled a four-part scheme designed to restore confidence to the housing market.
“Our economy will not recover until the bulk of this housing correction is behind us,” said Paulson. “The primary mission of these enterprises will be to proactively work to increase the availability of mortgage finance, including by examining the guaranty fee structure with an eye towards mortgage affordability.”
Fannie Mae and Freddie Mae will be placed into a conservatorship, effectively giving legal control of the GSEs to the FHFA. This option was preferred to a straight equity injection, which Paulson said “would not have been in the best interest of taxpayers”.
The plan will prohibit the GSEs from participating in any political activity, including lobbying.
The Treasury will enter into a senior preferred stock agreement with the two GSEs, which could see the Treasury commit up to $100 billion in each agency to make up for any shortfall in capital. Under the terms of the agreement, the Treasury will initially receive $1 billion of stock, as well as warrants for the purchase of common stock representing ownership of 79.9% in each entity.
Although holding the stock will not entitle the Treasury to voting rights, the senior preferred stock will rank higher than existing preferred stock, common stock and capital issued by the GSEs. The senior preferred stock will also accrue 10% annual dividends, while dividend payments for other stockholders will be eliminated.
Both GSEs will pay a quarterly commitment fee to compensate the Treasury for its explicit support from March 31, 2010. Additionally, new business activities by the two GSEs will be dramatically cut. The retained mortgage and MBS portfolios of Fannie Mae and Freddie Mac must be reduced to $850 billion by the end of 2009, and then by 10% each subsequent year until a target of $250 billion is reached.
The scaling-down exercise is designed to address ambiguities in the GSE congressional charters. Both Fannie Mae and Freddie Mac have built up their portfolios largely because of what investors viewed as implied government support for their MBS and debt transactions.
“Our nation has tolerated these [ambiguities] for too long, and as a result GSE debt and MBSs are held by central banks who believe them to be virtually risk free,” remarked Paulson. “Because the US government created these ambiguities, we have a responsibility to both avert and ultimately address the systemic risk now posed by the scale and breadth of the holdings of GSE debt and MBSs.”
The second part of the scheme will see the Treasury purchase new MBSs issued by the GSEs in the open market until the end of 2009. The extent to which it does this will depend on conditions in the capital and housing markets. Paulson said the Treasury will hire independent asset managers to undertake the purchase and portfolio management of GSE-guaranteed MBSs.
Another element to the rescue plan will be the establishment of a GSE credit facility, which will provide secured funding when needed to the two agencies and federal home loan banks until the end of 2009. In exchange for funds, which will come directly through an account at the Federal Reserve Bank of New York, the GSEs must pledge eligible collateral (limited to guaranteed MBSs). The short-term loans will be available at 50 basis points over Libor.
The final part of the scheme will result in changes to senior management at both Fannie Mae and Freddie Mac. Herbert Allison, former chairman of the pension fund for teachers, TIAA-CREF, takes over from Daniel Mudd as chief executive officer of Fannie Mae. Meanwhile, David Moffet, senior adviser at the Carlyle Group, a private equity firm, will succeed Richard Syron as CEO at Freddie Mac.
Although global stock markets reacted positively to the news, with major indexes in North America, Europe and Asia posting gains of more than three percent, the common stock in both GSEs plummeted. In early New York trading, Fannie Mae stock fell 82% to $1.28, while Freddie Mac shares fell by 75% to $1.30.