US government moves to take over Fannie and Freddie

US Treasury secretary prepares to bring Fannie Mae and Freddie Mac under government control.

US Treasury secretary Henry Paulson is preparing to announce plans to bring Fannie Mae and Freddie Mac under government control, seeking to halt the crisis of confidence in the companies that make up almost half the US mortgage market. Mr Paulson met yesterday with Daniel Mudd and Richard Syron, the chief executives of Fannie Mae and Freddie Mac, respectively, to brief them on the decision to put the companies into a conservatorship, where they would be removed from their jobs, according to a person briefed on the discussions. A public announcement is expected today.

The decision is a reversal of the Treasury chief's repeated comments to lawmakers in July that he was not likely to use taxpayer funds to prop up the federally chartered firms that were hit by US$14.9 billion (Dh54.7bn) in losses this year. The shares of both companies have fallen since Mr Paulson won powers to inject unlimited funds into the companies, and their borrowing costs rose. Pacific Investment Management, the manager of the world's biggest bond fund, and other large investors may put in their own money once the Treasury decides to inject government funds, said Bill Gross, a fund manager at Pimco in California.

"They have to open their wallet," said Mr Gross, predicting that the Treasury will act this weekend before the Federal Housing Finance Agency (FHFA) releases an assessment of Fannie's and Freddie's capital. Mr Paulson met with Ben Bernanke, the chairman of the Federal Reserve, James Lockhart, the director of FHFA, Mr Syron and Mr Mudd in Washington. The Treasury plans to brief Democratic presidential candidate Barack Obama's campaign team and has contacted Republican contender John McCain's staff about its intentions.

The meetings come a month after Mr Paulson hired Morgan Stanley to advise on any use of taxpayer funds to recapitalise Fannie and Freddie, which account for almost half of the $12 trillion mortgage market. A government takeover would be the latest attempt to blunt the impact of the year-long credit crisis, after the Fed provided financing for Bear Stearns's takeover by JPMorgan Chase. Washington-based Fannie and Freddie dropped in after-hours trading. Fannie fell $2.25, or 32 per cent, to $4.79 and Freddie slumped $1.40, or 27 per cent, to $3.70.

The Washington Post, citing unnamed sources, reported that the government would make quarterly injections of funds as the companies' losses warranted, avoiding a large upfront taxpayer cost. Debt and preferred shares would be protected, and common stock would be diluted but not wiped out. The New York Times said most or all of both the common and preferred shares would be worth little or nothing. "We are making progress on our work with Morgan Stanley, FHFA and the Fed," said Brookly Mclaughlin, a spokesman at the Treasury, while declining to comment on any specific plans. Stefanie Mullin, an FHFA spokesman, declined to comment, as did Mark Lake at Morgan Stanley.

Mr Bernanke participated in yesterday's meetings because the central bank was given a consultative role in overseeing Fannie's and Freddie's capital under legislation approved in July. Mr Paulson's decision won the approval of Mr Bernanke and Mr Lockhart, the person briefed on the discussions said. The FHFA has the authority to place Fannie and Freddie into conservatorships or receiverships under the law. The legislation that President George W Bush signed on July 30 also gave the Treasury the power until the end of next year to extend unlimited credit to, or make equity purchases in, the firms.

Under a conservatorship, the authorities would aim to preserve Fannie and Freddie assets, rather than dispose of them, the law says. The FHFA was scheduled to release its assessment of the companies' capital levels as early as this week as part of a quarterly appraisal of their finances. Analysts have speculated that the Treasury would wipe out common shareholders, while seeking to shield preferred stockowners from total loss. Fannie and Freddie preferred shares are typically owned by banks and insurance companies. Their $5.2tn of debt outstanding is held by investors including Asian central banks, and would probably be guaranteed, analysts said.

"Treasury's main concern is the debt markets, and if it was to say that it will do whatever is necessary to keep Fannie and Freddie running, the better it is for their funding," said Alex Pollock, a fellow at the American Enterprise Institute in Washington and the former president of the Chicago Federal Home Loan Bank. The two companies need to sell billions of dollars of bonds each month to pay off maturing debt, and had continued to issue securities last week. Fannie and Freddie have reported $14.9bn in net losses for the past four quarters as loan delinquencies rose. Fannie had $47bn of capital as of June 30, according to company filings. The company is required by its regulator to hold $37.5bn. Freddie's capital stood at $37.1bn, compared with a requirement of $34.5bn, filings show. * Bloomberg