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WASHINGTON: The US government took over mortgage giants Fannie Mae and Freddie Mac on Sunday, placing them in a "conservatorship" to help avert a financial system meltdown from the housing crisis.
Treasury Secretary Henry Paulson announced the US regulator was seizing control of the government-chartered, shareholder-owned firms underpinning trillions of dollars of home loans.
The move constitutes a massive government intervention in the financial system in an effort to contain the damage from the worst housing slump in decades, which has rippled through the banking system and led to multibillion-dollar losses for Fannie and Freddie.
Paulson said the plan "is the best means of protecting our markets and the taxpayers from the systemic risk posed by the current financial condition" of the two government-sponsored enterprises, or GSEs, which provide liquidity for housing by selling bonds and using the proceeds to buy mortgages from lenders.
New chief executives have been installed as part of the action that Paulson said was needed in view of "the inherent conflict and flawed business model embedded in the GSE structure.
Departing CEOs Dan Mudd of Fannie Mae and Dick Syron of Freddie Mac "have agreed to stay on for a period to help with the transition," Paulson said.
Herb Allison, chairman of the retirement fund TIAA-CREF and a former Merrill Lynch executive, will be the new CEO of Fannie Mae and David Moffett, vice chairman at US Bancorp, will head Freddie Mac.
"Monday morning the businesses will open as normal, only with stronger backing for the holders of (mortgage-backed securities), senior debt and subordinated debt," said Federal Housing Finance Agency director James Lockhart.
Federal Reserve chairman Ben Bernanke, part of frantic several days of talks to come up with the rescue plan, lauded the effort.
"These necessary steps will help to strengthen the US housing market and promote stability in our financial markets," Bernanke said in a statement.
The announcement came ahead of the opening of financial markets in Asia and amid ongoing turmoil in markets in response to the housing and finance crisis.
One key element in the plan enables the Treasury and Federal Housing Finance Agency to purchase a new class of preferred stock in the firms that "will ensure that each company maintains a positive net worth," Paulson said.
The Treasury will initially purchase one billion dollars in shares in each of the firms, but will have the authority to boost that total to 100 billion dollars in each.
The new plan does not eliminate the existing common and preferred shares but means they would absorb any losses ahead of the government, Paulson said.
Another step - authorised by emergency legislation passed by Congress in July - opens up a new, unspecified, Treasury line of credit to the two firms through the Federal Reserve.
"This facility is intended to serve as an ultimate liquidity backstop," and will be available through December 2009, Paulson said.
Paulson also said the Treasury "is initiating a temporary programme" to purchase mortgage-backed securities of Fannie and Freddie, to help provide liquidity in a financial market strained by a credit crunch.
"Treasury will begin this new programme later this month ... Additional purchases will be made as deemed appropriate," Paulson said, adding that "that there is no reason to expect taxpayer losses from this programme, and, in fact, it could produce gains."
The scale of the programme "will be based on developments in the capital markets and housing markets," according to a Treasury fact sheet.
Under the plan, Fannie and Freddie will "modestly" increase their portfolios of debt through the end of 2009. Then, these will be reduced at the rate of 10 percent a year in an effort to limit "system risk" to the financial system, according to Paulson.
David Kotok, chief investment officer at Cumberland Advisors, said the new initiative "draws the line on moral hazard so the existing preferred and common shares do not get bailed out by the government."
The existing shares "most likely are worth a few pennies" but the fate will not be known for some years until the crisis is over, Kotok said.
Kotok said the plan will likely "jump start" the ability of Fannie and Freddie to pump money into the housing market and that "this will bring down mortgage rates."
"There is no quick fix," said Robert Brusca at FAO Economics. "This is not one. But it should help to stabilise markets and give the government the opportunity to use the GSEs to help extract us from this mess."
While the US government is essentially taking on more than five trillion dollars in potential liabilities, Standard & Poor's said the top credit rating of the government would not be affected.
"The US government's credit quality continues to be upheld by its high-income, highly diversified, and exceptionally flexible economy," S&P said. - AFP/de
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