Fears that the government will be forced to rescue Fannie Mae and Freddie Mac could become a self-fulfilling prophecy.

Share story

WASHINGTON — Fears that the government will be forced to rescue Fannie Mae and Freddie Mac could well become a self-fulfilling prophecy.

Shares of the government-chartered mortgage-finance giants plummeted Thursday and are trading at levels last seen in the early 1990s. If the prices don’t recover, it will be harder for the companies to raise more money through stock sales to compensate for losses from the housing bust.

Investors are afraid their stakes will vanish if the government is forced to rescue the companies.

“The government has to step in and do something,” said Paul Miller, an analyst for Friedman, Billings, Ramsey.

Freddie Mac shares fell $2.26, or 22 percent, to $8, after sinking as low as $6.75 Thursday. Shares of Fannie Mae fell $2.11, or 13.8 percent, to $13.20, after earlier falling to $11.70.

Testifying on Capitol Hill, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke sought to calm jitters about the two companies’ health.

They are “working through this challenging period,” Paulson told lawmakers.

Asked whether such companies could pose a risk to the U.S. financial system, Paulson replied: “In today’s world, it is not helpful to speculate about any financial institution and systemic risk.”

James Lockhart, director of the Office of Federal Housing Enterprise Oversight, said after the close of trading that the companies’ capital levels are “well in excess” of government requirements.

“If they need additional support, Congress will act quickly,” Sen. Charles Schumer, D-N.Y., said in a statement.

The two companies are coping with worries that they won’t be able to withstand soaring losses from foreclosures and home-loan defaults.

Fannie Mae raised $7.4 billion in May to fortify its balance sheet. Freddie Mac plans to raise $5.5 billion but has to wait because its stock is not yet registered with the Securities and Exchange Commission.

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 homeownership affordable for low- and middle-income Americans.

Today the two hold or guarantee $5.3 trillion in home-loan debt, though under a 1992 law they must hold only a fraction of what is mandated for commercial banks as a cushion against risk.

Some say those capital requirements should be far higher and believe Congress should mandate banklike standards.

“These guys were skating on such thin ice that, when the stress came, we’re starting to see some cracks,” said Johns Hopkins University fellow Thomas Stanton.

While the government isn’t obligated to assist Fannie or Freddie, there is a widespread perception they would be bailed out. The idea they are “too big to fail” enables the two companies to borrow relatively cheaply on global markets by issuing top-rated mortgage-backed securities.

Fannie and Freddie play a vital role in the U.S. mortgage market, one that has grown dramatically over the past year after the subprime-mortgage market’s collapse.

The companies issued about three-quarters of all new mortgage-backed securities in the second quarter of 2008, up from under 40 percent in 2006, according to trade publication Inside Mortgage Finance.

If fears about their health continue to grow — causing the cost of routine debt sales to soar even further — the Fed and Treasury Department would likely provide emergency support to ensure the companies can continue to buy loans, said banking consultant Bert Ely.

Still, some question whether such anxieties are justified.

“It’s way overblown,” said mortgage consultant Howard Glaser. “Psychology is the major problem here.”

Glaser said the companies’ government regulator could give them more flexibility, and reduce the need to raise money, by loosening capital requirements.

The Treasury Department has long worked on plans for what to do if a large financial firm failed, but a department spokeswoman declined to comment on whether such plans have been accelerated.

In a sign of some improvement in the credit crisis, Wall Street firms for the first time didn’t borrow from the Federal Reserve’s emergency lending program, and commercial banks also scaled back.

Investment firms didn’t draw such loans for the week ending July 9. They borrowed $1.7 billion the previous week, down from $6.1 billion the week before that. Such borrowing rose as high as $38.1 billion in early April.

Associated Press reporters Jeannine Aversa and Charles Babington contributed to this article.