Cash Management

Treasury Lifeline for Fannie, Freddie

The government proposes a financial backstop for the failing home mortgage lenders.
Marie LeoneJuly 14, 2008

Over the weekend, the Treasury Department stepped in to bailout the sputtering mortgage lenders Fannie Mae and Freddie Mac. On Sunday, Treasury Secretary Henry Paulson announced a plan to bolster the two quasi-government companies, known as government sponsored agencies (GSE).

Fannie Mae and Freddie Mac “play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies,” noted Paulson in a statement. The GSEs have both domestic and international investors, and hold home mortgages in the United States totaling more than $5 trillion.

The bailout comprises three parts. Working with the Federal Reserve, the Securities and Exchange Commission, and the Office of Housing Enterprise Oversight — which regulates Fannie Mae and Freddie Mac — the Treasury Department is asking Congress to approve a “liquidity backstop” that temporarily increases the line of credit the GSEs currently have with Treasury. Paulson noted that the Treasury department would determine the terms and conditions for accessing the line, and the amounts to be drawn.

Further, to ensure that the lenders have sufficient capital, the plan includes temporary authority for the Treasury Department to purchase equity in either of the companies. Finally, the plan calls for the Federal Reserve to play a “consultative” role for setting capital requirements and other “prudent standards.” The deal must be approved by Congress before it implemented.

The announcement, made earlier enough to precede the opening of the Asian financial markets, was supported by the OFHEO and the trade group the American Securitization Forum. Reform of Fannie and Freddie has long been a White House goal—especially since they were caught misstating earnings a few years ago, according to the Economist, a sister publication of CFO.com.

Last week, the share prices of Freddie Mac and Fannie Mae dropped precipitously after a Lehman Brothers report suggested that if accounting rules were strictly applied the GSEs would have to raise an aggregate $75 billion.

The rescue follows the controversial bailout of Bear Stearns, the private investment bank that collapsed under the weight of too much exposure to the toppling subprime mortgage market. In that case, the government stepped in to backstop and arrange a buyout of Bear Stearns by JPMorgan Chase.

In another government rescue, announced on Friday, the Federal Deposit Insurance Corp. took control of IndyMac BanCorp, because it was questionable whether the bank could meet its depositor’s demands. IndyMac is the largest regulated thrift to fail with about $19 billion in total deposits.