On Sunday, August 7, Secretary of the Treasury Henry M. Paulson and Federal Housing Finance Agency (“FHFA”) Director James B. Lockhart announced that Fannie Mae and Freddie Mac were being placed into conservatorship. The action was taken because, given recent financial and mortgage market conditions, the ability of Fannie and Freddie to raise capital had been limited and there was concern about global and domestic systemic risk should either of these government sponsored enterprises fail. As Director Lockhart stated “Unfortunately, as house prices, earnings and capital have continued to deteriorate, [Fannie’s and Freddie’s] ability to fulfill their mission has deteriorated. In particular, the capacity of their capital to absorb further losses while supporting new business activity is in doubt.”
According to releases from Treasury and FHFA, the purpose of the conservatorship is to stabilize the institutions with the objective of returning the entities to normal business operations. The boards of directors of both Fannie and Freddie consented to the receivership and FHFA will serve as conservator. The conservatorship will continue until Director Lockhart has determined that the institutions have been returned to a safe and solvent condition.
Director Lockhart outlined the following elements of the conservatorship:
- Both Fannie and Freddie will open for business as normal on Monday morning
- Both will be allowed to grow their guarantee mortgage-backed securities books and continue to purchase replacement securities for their portfolios.
- FHFA as conservator will assume the power of the boards and managements of both institutions.
- The current CEOs of Fannie and Freddie were replaced but asked to stay on to aid with the transition. Both Director Lockhart and Secretary Paulson said they attributed the problems at Fannie and Freddie to an inherently flawed business model in the structures of Fannie and Freddie and to the problems in the housing market, not to their managements and boards.
- The new CEOs will be Herb Allison, who was formerly Vice Chairman of Merrill Lynch, at Fannie and David Moffett, former Vice Chairman and CFO of US Bancorp, at Freddie.
- Additional management changes are expected to be very limited.
- All Fannie and Freddie common and preferred stock will remain outstanding and continue to trade but dividends will be eliminated in an effort to conserve capital. Stockholder powers are suspended during the conservatorship. Payments on subordinated debt principal and interest will continue to be made.
- All political activities on the part of Fannie and Freddie, including lobbying, will cease immediately. Charitable activities are subject to review.
- The U. S. Treasury will provide financing and investment support to both Fannie and Freddie. That support includes three prongs. First, is an agreement to purchase preferred stock as necessary to keep both Fannie and Freddie with positive net worth. Any such preferred stock will come behind existing common and other preferred shares in bearing losses. Second, Treasury is also establishing a new secured lending facility which will be available to Fannie and Freddie (and also the Federal Home Loan Banks). The facility is intended as an ultimate liquidity backstop. Finally, Treasury is implementing a temporary program to purchase Fannie and Freddie mortgage-backed securities. This program is intended to promote the stability of the mortgage market.
The federal bank and savings association regulatory agencies issued a joint statement on Sunday reacting to the takeover of Fannie and Freddie. The statement indicated that the agencies have been assessing the exposure of insured banks and savings associations to Fannie and Freddie. The agencies concluded that, while many institutions hold Fannie and Freddie stock, only a limited number of smaller institutions have holdings that are significant compared to their capital. The agencies expressed an intention to work with those institutions to develop capital restoration plans pursuant to the agencies’ capital and prompt corrective action regulations. The joint statement also reminded institutions that all investments in preferred and common stock with readily determinable fair values should be reported as available-for-sale equity security holdings, and that any net unrealized losses on the securities are deducted from regulatory capital.