The Republican administration and Democratic-run Congress now are facing the possibility that once-stable mortgage giants Fannie Mae and Freddie Mac could need a bailout or even go under.
WASHINGTON — The last thing the country needed in these economically trying times was another financial crisis. But it got one.
The Republican administration and Democratic-run Congress now are facing the possibility that once-stable mortgage giants Fannie Mae and Freddie Mac could need a bailout or even go under. These institutions own or guarantee over $5 trillion of home loans — roughly half of all the mortgage debt in the United States.
Their default would send shock waves through already-distressed financial markets, drive the U.S. economy further into recession territory and make it even harder for people to obtain mortgages or refinance their homes.
Under that dark cloud, politicians of both parties rallied behind the two companies Friday, expressing confidence. The companies issued assurances that they are financially sound.
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On Friday, shares of Freddie Mac closed at $7.75, down more than 45 percent for the week. Fannie Mae settled at $10.25, a 30 percent slide for the week.
Friday morning, the share prices of both companies fell by about 50 percent, with Freddie Mac trading at $3.89 at one point. After all the public statements, however, the shares of both regained some ground. Freddie Mac finished the day down 3.1 percent, and Fannie Mae was off 22.4 percent.
The stocks are at their lowest levels in 16 years. Freddie’s is down 88 percent from its high in 2006, and Fannie’s is off 85 percent from a year ago.
The Dow fell below 11,000 for the first time in two years in trading Friday, before ending down 128 points at 11,100.54.
President Bush and Treasury Secretary Henry Paulson sought to ease concerns that Fannie and Freddie were headed for insolvency or a government takeover.
“Today, our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission,” Paulson said. “We are maintaining a dialogue with regulators and with the companies.”
Bush told reporters that Paulson had briefed him and “assured me that he and [Federal Reserve Chairman] Ben Bernanke will be working this issue very hard.”
Congress set up the companies to ensure that money for home loans would be available. They buy mortgages, turn them into securities and sell them to investors. They also hold some mortgages in their own portfolios.
“These are companies with a solid business plan. They are fundamentally well-run companies, but are the victims of the broad financial downturn. There’s been a huge loss of value there,” said Peter Morici, an economics professor at the University of Maryland and former chief economist at the U.S. International Trade Commission.
“My feeling is that, as long as they can meet their obligation, they shouldn’t be taken over.”
They have no explicit government backing despite their charter, but there was always an assumption that the government would bail them out if necessary.
While most of the mortgages they hold are fixed-rate loans to borrowers with good credit, the housing downturn has been so severe that they have sustained gigantic losses in their loan portfolios due to foreclosures — about $11 billion over the past few months — and may report more big losses in August.
And because their stock prices have plunged so far, they are hard-pressed to raise fresh capital on their own.
Former St. Louis Fed President William Poole this week said Fannie and Freddie were already technically insolvent — the comment helped drive the turmoil.
Under a 1992 law, if either becomes heavily undercapitalized, it can be placed into a “conservatorship,” a partial federal takeover. But analysts said this week the companies would need to lose another $30 billion to $40 billion apiece for that to happen.
Or, the Federal Reserve could aid the two companies via its emergency lending program, a plan Senate Banking Committee Chairman Christopher Dodd mentioned Friday.
Senior Bush administration officials are making a contingency plan for conservatorship if the problems worsen, according to officials briefed about the plan.
Under a conservatorship, shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers.
The government officials said that the administration had also considered calling for legislation that would offer an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies. But that is a far less attractive option, they said, because it could effectively double the size of the public debt.
The officials involved in the discussions stressed that no action was imminent and that Fannie and Freddie are not considered to be in a crisis situation. But in recent days, enough concern has built among senior officials for them to hold a series of meetings on contingency plans.
“There’s no good news here for the housing market or for the broader economy,” said Mark Zandi, chief economist at Moody’s Economy.com. He doesn’t think the two companies are yet at the point of default. “Yet, the pessimism is so dark, it can become self-fulfilling.”
Information from The New York Times, The Washington Post and Bloomberg was used in this report.