On Sunday, September 7, 2008, James Lockhart, the Director of the Federal Housing Finance Agency (“FHFA”), announced that he was placing Fannie Mae and Freddie Mac into the FHFA’s conservatorship because “the companies cannot continue to operate safely and soundly and fulfill their critical public mission.” In conjunction with the conservatorships of the two government sponsored enterprises (“GSEs”), Secretary of the Treasury Henry Paulson announced three primary actions by the Department of the Treasury to help stabilize Fannie and Freddie and the broader financial markets. The three actions, discussed below, include a purchase by the Treasury of mortgage-backed securities (“MBS”) guaranteed by Fannie and Freddie, a new liquidity tool to lend directly to Fannie and Freddie if needed and the government becoming a senior preferred shareholder of Fannie and Freddie. As a result, the government will own approximately 79.9% of the common stock of each company on a fully diluted basis. These actions are permitted or facilitated by recent passage of the Housing and Economic Recovery Act of 2008. 1/
Of particular interest to financial institutions holding Fannie and Freddie stock, both common and preferred equity holdings will remain in place. Common shareholders will lose their voting rights under the conservatorships, however, as noted by Secretary Paulson, "While conservatorship does not eliminate common stock, it does place common shareholders last in terms of claims on the assets of the enterprise." He further stated, "Similarly, the conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses."
In a Fact Sheet regarding the action and in Mr. Lockhart’s statement announcing the conservatorship, 2/ Mr. Lockhart stressed that Fannie and Freddie will continue to pay its obligations during the conservatorship, the conservatorships should be temporary and there are no current plans to liquidate the two GSEs. Under their charters from Congress, Fannie Mae and Freddie Mac can only be fully dissolved by and Act of Congress.
The three primary actions of the Department of Treasury are designed to help stabilize the GSEs, and the mortgage markets in general. 3/ First, the Department of Treasury entered into Preferred Stock Purchase Agreements with each of Fannie and Freddie whereby Treasury will ensure that each GSE maintains a positive net worth by contributing cash capital (up to $100 billion each). In return, the Department of Treasury immediately receives $1 billion of senior preferred stock of each GSE, and warrants for the purchase of common stock of each GSE at an exercise price of one - one thousandth of a cent, representing approximately 79.9% of the common stock of each company on a fully diluted basis.
Second, the Department of Treasury established a new secured lending credit facility which will be available to Fannie Mae and Freddie Mac, as well as the Federal Home Loan Banks (“FHLBs”). However, Secretary Paulson stated he did not believe any of the FHLBs would need to tap this source of liquidity, as they have maintained stronger financial positions than Fannie and Freddie. This facility is intended to serve as an “ultimate liquidity backstop.” The credit facility is structured in a somewhat similar fashion to the liquidity facility the Federal Reserve has provided to primary dealers. Though the Federal Reserve Bank of New York will administer parts of the program as fiscal agent for the Treasury, it will be solely Department of Treasury funds used in the new credit facility. Authority for these credit facilities expires in December 2009.
Third, and also under temporary authority which will expire in December 2009, the Department of Treasury will purchase Fannie Mae and Freddie Mac MBS in the open market. Initially the Treasury will purchase approximately $5 billion in GSE MBS, with additional purchases able to be made when deemed appropriate. According to the Department of Treasury Fact Sheets issued together with Secretary Paulson’s statement, the primary objectives in the management of these investments in GSE MBS will be to promote market stability, ensure mortgage availability, and protect the taxpayer. Secretary Paulson stated that the Treasury Department’s MBS purchase program will aid mortgage affordability by assisting the GSEs as they are expected to now moderately increase the size of their portfolios over the next 15 months, as opposed to the shrinking of the balance sheets the two GSEs had undertaken in order to attempt to meet their capital requirements.
In summing up the actions, Secretary Paulson emphasized that these were temporary steps, giving policymakers, especially the next Congress and administration, a “time out where we have stabilized the GSEs while we decide their future role and structure.”
Impact on Banks and Thrifts
In the long term, it is at least the hope that the Fannie and Freddie conservatorships, and the related actions of the Department of Treasury, will stabilize the housing market and ultimately benefit banks and thrifts. However, in the short term, banks and thrifts that hold common or preferred shares may face some difficulties. In light of the beneficial capital treatment given to GSE preferred shares (20% risk-weighting under the capital adequacy guidelines), a large number of banks and thrifts hold significant equity positions in the GSEs. The conservatorships do not eliminate all value of the GSEs’ common and preferred shares, but given the dilutive effect of the Department of Treasury’s investment in the GSEs, and the conservator holding all voting rights of the common stock, an impairment of Fannie Mae and Freddie Mac common and preferred shares no longer seems in doubt. Similar issues appear to be less likely for GSE MBS and debt.
On Sunday, September 7, 2008, the Federal Banking Agencies (the Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Office of Thrift Supervision) issued a joint statement regarding GSE exposure in light of the conservatorships. 4/ The Agencies reminded institutions that investment in preferred stock and common stock with readily determinable fair value should be reported as available-for-sale equity security holdings, and that any net unrealized losses on those securities are deducted from regulatory capital. The Federal Banking Agencies said that they believed only a limited number of smaller institutions have holdings of Fannie and Freddie common and preferred shares that are significant compared to their capital. The Federal Banking Agencies also said they are prepared to work with institutions to develop capital-restoration plans pursuant to capital regulations and prompt corrective action provisions. The Agencies encourage depository institutions to contact their primary federal regulator if they believe that losses on their holdings of Fannie Mae or Freddie Mac common or preferred are likely to reduce their regulatory capital below “well capitalized” levels.