Freddie, Fannie shares sink on bailout concerns

July 11, 2008 2:29 PM EDT
WASHINGTON – Shares of Freddie Mac recovered from a gut-wrenching plunge Friday on speculation that the mortgage company could soon see its finances stabilized with access to emergency Federal Reserve lending.

Shares of Freddie Mac’s larger government-sponsored sibling Fannie Mae remained down more than 20 percent.

Shares of both companies, which have been trading at levels last seen in the early 1990s, recovered somewhat after Treasury Secretary Henry Paulson, President Bush and lawmakers scrambled to reassure the market about the companies’ health.

In a Capitol Hill news conference, Sen. Christopher Dodd, D-Conn., the Banking Committee chairman, raised the prospect that the companies could be given access to emergency Federal Reserve lending.

Dodd, who spoke Friday to Fed Chairman Ben Bernanke and Paulson, said the two are “looking at various options” for propping up the firms if they ultimately need help. Those include giving them access to the Fed’s emergency lending “discount window,” Dodd said. Earlier this year, the Federal Reserve took the unprecedented step of offering direct loans to investment banks.

Freddie Mac’s shares rose 5 cents to $8.05, after earlier plummeting falling to $3.89. Fannie Mae’s shares fell $2.89, or 21.9 percent, to $10.31 in late-afternoon trading, after sinking as low as $6.68 earlier in the day.

Paulson sought for the second-straight day to calm investors panicked about out the financial state of Fannie Mae and Freddie Mac, saying the agency aims to keep the mortgage finance companies “in their current form” without a government takeover.

The financial health of the companies is of critical concern to Washington policymakers because of the crucial role Fannie and Freddie play in the housing market.

The pair hold or guarantee more than $5 trillion worth of mortgages. That’s roughly half of the $9.5 trillion debt of the United States. The fear is that a failure of one or both would wreak havoc on the nation’s financial system and the broader economy.

Paulson’s comments came amid reports that the government was considering a plan to take over one or both of the companies and place them in a conservatorship.

The Treasury chief said his department is “maintaining a dialogue with regulators and with the companies.” The companies’ main regulator will continue to work with the Fannie Mae and Freddie Mac “as they take the steps necessary to allow them to continue to perform their important mission,” Paulson said.

“I think everybody’s just holding their breath in expectation that something substantive from the government will happen today or over the weekend,” said Karen Shaw Petrou, managing partner of consulting firm Federal Financial Analytics in Washington.

The companies’ troubles are more a result of market perceptions than a changed financial picture at the two companies, Petrou said.

“External reality doesn’t warrant such an action, but external reality seems no longer to matter,” she said.

Under a 1992 law, if either company fell into financial trouble, the government could take over their operations by placing it in a conservatorship. That process could be used to keep operations going at Fannie and Freddie, but shareholders would likely see their investments erased, and the companies’ ability to support the mortgage market could be reduced.

“Typically when this happens the business is a shell of its former self,” said Louisiana State University banking professor Joseph Mason. “Shareholders aren’t going to like it, managers and directors aren’t going to like it, but it’s not about whether they like it.”

Wachovia Corp. economist Jay Bryson said the two mortgage giants could face a replay of the near-collapse in March of investment bank Bear Stearns Cos. A lack of market confidence could make it difficult for Fannie and Freddie to raise funding through debt sales, he said.

“It becomes a liquidity issue, rather than a solvency issue,” Bryson said.

Representatives from Fannie and Freddie had no immediate comment.

Fannie and Freddie play a crucial role in providing funding for home loans by buying up mortgages and packaging them as investments. If they are unable to operate, the implications could be dire.

“Without them, our economy would collapse,” Piper Jaffray analyst Robert P. Napoli said in a note to clients. Napoli lowered his target on Freddie to $9 per share from $28, and on Fannie to $15 per share from $30.

On Thursday, the Office of Federal Housing Enterprise Oversight – the companies’ chief regulator – said both remain “adequately capitalized,” after Paulson and Bernanke sought to calm investors jitters in testimony on Capitol Hill.

Reassurances by government officials do not appear to be working.

“We doubt anyone will listen as fear is so high,” Napoli said.

Congress created Fannie in 1938 and Freddie in 1970 to keep money flowing into the home-loan market by buying up mortgages and bundling them into securities for sale to investors worldwide – thereby making home ownership affordable for low- and middle-income Americans.

But under a 1992 law they are required to hold only a fraction of what is mandated for commercial banks as a financial cushion against risk.

Friedman, Billings, Ramsey & Co. analyst Andrew Parmentier said in a note to clients that the question of capital-raising plans at either company remains a “moving target … (but) it is clear to us that government action would be undertaken to ensure that the institutions would not fail.”