Speaking in New York, Paulson disclosed that he had been consulting congressmen from both the Senate banking committee and the House committee on financial services and was “confident they recognise the demands of the current situation and will act to complete work on this legislation this week”. The new legislation, unveiled on July 13, hinges on three core proposals. Under the first, the Treasury will seek to increase the existing $2.25 billion line of credit extended to both of the government-sponsored enterprises (GSEs), without setting any limit on the amount they can borrow. Secondly, a new regulatory agency will be established to supervise the work of the GSEs, replacing the Office of Federal Housing Enterprise Oversight and granting the Federal Reserve “a consultative role” in setting capital requirements and other prudential standards for Fannie and Freddie. Lastly, new authority will be provided to allow the Treasury to purchase GSE equity. This would be a further means of boosting capital reserves that have been stung by the large losses both institutions have suffered, as they have continued to guarantee and securitise new mortgages following the wholesale abandonment of the mortgage-backed securities (MBS) market over the past year by all but a handful of issuers. This final proposal is particularly important in light of the severe fall in equity prices that the GSEs have experienced in the past year. From a high of $69.30 a share on August 22, 2007, Fannie Mae stock hit bottom at $7.07 a share on July 15. The fall was even sharper for Freddie Mac, tumbling from $64.80 a share on August 22 to just $5.26 on July 15. The speed of the falling share prices has only increased since mid-2007, as both Fannie and Freddie guaranteed and securitised increasing volumes of mortgages in a market panic that saw all MBSs as toxic loss-making investments, regardless of how strong the credit underlying the structure was. Between the third quarter of 2007 and the first quarter of this year, Fannie and Freddie recorded losses of $7.19 billion and $4.65 billion respectively. Shareholder confidence has been further undermined by a series of preferred stock offerings issued by both GSEs in the course of the past eight months, designed to boost the firm’s capital base, but with the inevitable side effect of disgruntling existing shareholders who fear the value of their holdings will be diluted. Despite the ongoing fears over the GSEs' capitalisation, both firms have seen a slight change in their capital base through 2008. As of March 31, Fannie’s core capital stood at $42.6 billion, somewhat less than the $45.3 billion it held in reserve as of December 31, 2007. Over the same period, however, Freddie’s capital base inched up slightly to $38.3 billion from $37.8 billion at the end of 2007. Although last week's stock plunge was in direct reference to Paulson’s confirmation that the Treasury would support the GSEs directly, at least some analysts feel the market overreacted and that the issue of capitalisation is a moot point given the implicit understanding that has always existed that the government would intervene to save Fannie and Freddie if necessary. Between the two of them, the GSEs guarantee $5.3 trillion in US mortgages, having to hold just 54 basis points in capital against those commitments and 3% capital against any mortgages or MBSs the firm’s decide to retain within their own portfolio. “The capital the GSEs hold simply serves as a cushion for losses they suffer before the government has to step in. Nobody seriously thought that in an emergency the capital they hold would be sufficient and neither did the government. There has always been an unspoken guarantee and even though it is now out in the open, it really doesn’t change circumstances all that much,” claimed Don Brownstein, chief executive of Structured Portfolio Management, a Connecticut-based hedge fund specialising in relative value strategies in the residential MBS market. “If either Fannie or Freddie were to become insolvent it would not represent the end of either firm because the government would see to it that all their guarantee work would get done. As far as their guarantor business goes, Fannie and Freddie are effectively nationalised already, since these enterprises are, to all intents and purposes, simply the institutions that process the insurance business on behalf of the government,” Brownstein added.Difficult questions remain to be answered, however, including whether the GSEs will be able to attract private bids for preferred stock offerings with the spectre of government intervention hanging over them, and whether the firms will be able to draw down the amount of guarantor business they are processing in an attempt to provide more breathing room to solidify their capital position.