On Sunday, September 6, the Federal government placed Fannie Mae and Freddie Mac in conservatorship in an effort to stabilize the housing mortgage giants. Fannie and Freddie, the two government-sponsored mortgage enterprises (GSEs), are critical to the stability, strength and liquidity of the nation's housing market. According to the Federal Housing Finance Agency (FHFA), the GSEs have $5.4 trillion of guaranteed mortgage-backed securities and debt outstanding - a sum equal to the publicly-held debt of the United States. In addition, the GSEs have traditionally backed 80 percent or more of new mortgages issued in this country. In the last several months, with the continued decline in home prices and escalating mortgage default rates, Fannie and Freddie have been unable to weather the market conditions. As a result, Fannie and Freddie were unable to raise sufficient amounts of capital, and, therefore, were unable to function in their traditional roles. FHFA made its decision with the backing of both the Department of the Treasury (Treasury) and the Federal Reserve.
This article highlights the terms of the conservatorship and raises questions about the potential impact of the government takeover of the GSEs.
The Federal government's conservatorship plan involves the following key actions:
- Fannie and Freddie were placed into conservatorship with the FHFA serving as the conservator. The FHFA now effectively controls both the GSEs and may exercise the powers of the GSEs' directors, officers, and shareholders. The purpose of the conservatorship is to protect the GSEs, their assets and property, and to restore the public's confidence in each. The conservator will also operate the GSEs on a day-to-day basis with the goal of restoring the GSEs to a "safe and solvent" condition and to carry on their business. The conservatorship was not created to liquidate Fannie or Freddie.
- The Treasury and the FHFA established preferred stock purchase agreements with the GSEs to ensure each GSE maintains a positive net worth. If the FHFA determines that a GSE's liabilities have exceeded its assets under generally accepted accounting principles, the Treasury will infuse cash capital to the GSE in the amount of the shortfall. In return, the Treasury is receiving $1 billion of senior preferred stock in each GSE and warrants for the purchase of common stock of each GSE representing 79.9 percent of the common stock of each GSE. It is important to note that existing common and preferred shareholders will bear losses ahead of the new government senior preferred shares. Fannie and Freddie common stock closed at $0.99 and $0.88, respectively, on Tuesday, September 9.
- The Treasury established a new secured credit facility to provide funding on an as-needed basis to the GSEs (and certain Federal Home Loan Banks). This credit facility expires on December 31, 2009.
- The Treasury will purchase GSE-backed securities in the open market in an attempt to promote the stability of the mortgage market. This program also expires on December 31, 2009. The GSEs also will be allowed to increase their mortgage-backed securities portfolios through the end of 2009. Beginning in 2010, however, these portfolios will gradually be reduced at a rate of 10 percent per year, in hopes of reaching a total portfolio value of $250 billion dollars for each GSE.
- The CEO's of each GSE have been replaced. Herb Allison, formerly of TIAA-CREF, will run Fannie Mae on a go-forward basis, and David Moffett, formerly of US Bank, will run Freddie Mac.
- All common stock and preferred stock dividends have been eliminated, but the common and preferred stocks will continue to remain outstanding. Subordinated debt interest and principal payments will continue to be made.
- All lobbying, political giving and other political activity by the two GSEs will cease.
The following questions may help guide your initial analysis of the government's takeover plan:
- If you do business with either or both of the GSEs, how will your relationship be affected under the conservatorship? Are you prepared to adapt to the new circumstances?
- Are you a party to certain forms of credit enhancement with the GSEs (e.g., a credit default swap)? How will the conservatorship affect these arrangements?
- With the Federal government serving as the conservator of the GSEs, how are your rights impacted? Is the Federal government now your guarantor?
- If your organization does business with a company that is dependent on the GSEs, what happens to that company? How will your rights be impacted if that company fails?
- Are you a shareholder of the GSEs? Litigation has already been filed on behalf of shareholders of the GSEs. What are the rights of these shareholders?
- What are the broader market implications of the government takeover?
- Does the government's GSE takeover indicate the possibility of continued federal intervention in the coming months?
- Though potentially long-term, the FHFA and Treasury plan is intended as a stop-gap measure in advance of congressional action to reform the GSEs in the coming years. What form should they take, will they take, and how does it impact future mortgage and financial markets?
The Federal government takeover of the housing GSEs represents an unprecedented action by the government to shore-up a significant segment of the U.S. economy. With this brief list of potential issues that entities may encounter in the days, weeks and months ahead in mind, particularly during these challenging economic times, it is imperative for impacted corporations and organizations to review their rights and business operations as they pertain to the Fannie/Freddie takeover.
More information about the Federal government takeover can be found on the Treasury's Web site at the following link: http://www.treasury.gov/news/index1.html.