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U.S. near deal on Fannie, Freddie

Section: Daily Dispatches

Options Include Injecting
Capital in Mortgage Giants;
Management Shakeup Coming

By Deborah Solomon and Damian Paletta
The Wall Street Journal
Saturday, September 6, 2008

WASHINGTON -- The Treasury Department is close to completing a plan to help shore up mortgage giants Fannie Mae and Freddie Mac, according to people familiar with the matter.

The plan is expected to involve a creative use of Treasury's authority to intervene in the two companies, which it won earlier this year. One option under serious consideration would be to put the companies into the conservatorship of their regulator, the Federal Housing Finance Agency, said two people familiar with the matter. That would amount to a government takeover.

The plan also could involve a capital injection into Fannie and Freddie, people familiar with the matter said. This could happen gradually on a quarter-by-quarter basis, rather than in a single move, said one of these people.

A management shakeup at both companies is likely, according to one person familiar with the plans. Daniel H. Mudd, chief executive of Fannie Mae, and Richard Syron, his counterpart at Freddie Mac, are expected to step down from their posts eventually.

An announcement could come as early as this weekend. Some details are still being worked out, which means terms of the arrangement could change.

Any move by Treasury would represent perhaps the most significant intervention by the government in the financial industry since the housing bust touched off turmoil in the credit markets a little more than a year ago. From the $168 billion economic-stimulus package in February through the bailout of investment bank Bear Stearns Cos., the Bush administration and the Federal Reserve have taken an increasingly aggressive stance in responding to what has become one of the worst financial crises in decades.

Fannie and Freddie are vital cogs in the U.S. housing market. Their troubles have threatened to worsen the bursting of the housing bubble, which has led to a surge in foreclosures. A Treasury intervention could help Main Street borrowers by keeping interest rates on mortgages lower than they would be in the event of continued instability.

The Treasury's emergency powers to backstop Fannie and Freddie, which it won as the result of legislation passed by Congress in July, last until the end of 2009. A decision about their future role could be handed off to the next administration and the next Congress.

The woes of Fannie and Freddie mark a remarkable comedown for two of Washington's most powerful and feared institutions, known for their financial clout and no-holds-barred lobbying prowess. Fannie and Freddie shares, which were up during the regular session Friday, dropped 25% and nearly 20% respectively in the after-hours session.

Treasury's likely plan is supported by Federal Reserve Chairman Ben Bernanke and James Lockhart, chief of the Federal Housing Finance Agency, according to people familiar with the matter. On Friday afternoon, Messrs. Syron and Mudd were summoned to a meeting at the offices of the agency. Also attending were Mr. Bernanke and Treasury Secretary Henry Paulson.

The meetings Friday were in part aimed at getting Messrs. Mudd and Syron to agree to the plan, though their approval was not necessary, these people said.

Mr. Mudd arrived for the meeting at 2:50 p.m., flanked by the company's general counsel, Beth Wilkinson, and Rodgin Cohen of Sullivan & Cromwell, one of the country's top banking lawyers. A few minutes later, Mr. Bernanke followed.

"We are making progress on our work," said Treasury spokeswoman Jennifer Zuccarelli, who declined to comment further. Spokesmen for Fannie and Freddie declined to comment on the expected Treasury moves.

In July, Treasury won authority to intervene in the two companies, but it didn't say how or when it would act. Since then, federal officials have been working with bankers at Morgan Stanley to figure out how to prop up the mortgage giants.

Freddie and Fannie own or guarantee more than $5 trillion of mortgages. They have suffered combined losses of about $14 billion over the past four quarters as they make provisions for a wave of defaults. Investors worried that a government bailout would wipe out the value of existing stock, and those fears have sent the shares down about 90% from a year ago. Many U.S. banks as well as foreign governments own stock or debt in the two giants, meaning their financial woes could cause broad problems beyond the housing market.

Mr. Paulson's push to win authority was meant to reassure investors that the government wouldn't allow Fannie Mae and Freddie Mac to fail. But some believe it ultimately forced Treasury's hand. The federal government's involvement complicated the companies' already-difficult task of raising capital through the sale of common or preferred shares. Investors were leery of buying either while the government's intentions were unknown, because they feared the newly issued shares might become worthless as the result of federal action.

Bill Gross, chief investment officer of Pacific Investment Management Co., the large Newport Beach, Calif., bond manager, said in an interview Friday he believes private investors would buy new shares in Fannie and Freddie only if the Treasury acts first to bolster their capital. "Investors are saying, 'We want to see [the Treasury] in there with us,'" Mr. Gross said. The Treasury will have to "swim in the pool, not just be a lifeguard," he added.

Among the issues with which Treasury has been wrestling is whether to make an investment at such a low price that shareholders are effectively wiped out. Mr. Paulson is cautious about any plan that appears to benefit shareholders because he doesn't want the government to be seen as bailing out investors who for years profited from the companies' success.

The two companies were chartered by Congress to support the housing market, and therefore were seen as having the backing of the government. That allowed them to borrow funds at favorable rates close to those of U.S. Treasurys, even though they are both profit-making entities answerable to shareholders.

Sen. John McCain, the Republican nominee for president, has said his goal is to make the companies "go away" and to push for regulation that "limits their ability to borrow, shrinks their size until they are no longer a threat to our economy, and privatizes and eliminates their links to the government." Sen. McCain supported giving Treasury the authority to backstop the firms but has said any use of taxpayer funds should be combined with an ouster of management and a ban on lobbying by the companies.

Sen. Barack Obama, the Democratic nominee, has said the companies are a "weird blend" and that "if these are public entities, then they've got to get out of the profit-making business, and if they're private entities, then we don't bail them out."

In a sign that some action was imminent, Freddie Mac changed its bylaws Thursday in a way that investors said could pave the way for Treasury or another large investor to take a controlling stake. Previously, Freddie Mac had a bylaw that prevented an investor with a stake of 20% or greater from voting without the approval of the other shareholders. It eliminated that restriction. Freddie Mac's board also put its protracted search for a chief executive on hold, according to people familiar with the situation.

Freddie Mac directors began interviewing CEO candidates last spring and hoped to pick someone by early September. The board was ready to offer the job to David Vitale, a longtime Chicago banking executive and the former head of the Chicago Board of Trade, according to a person familiar with the matter. Mr. Vitale had agreed to take the job and Freddie Mac ran its selection by its regulator but had not received a response.

In recent weeks, Treasury officials have been reaching out to foreign central banks and other overseas buyers of securities or debt sold by the two companies, to reassure them of the creditworthiness of these instruments.

In one such conversation, at the end of August, the Treasury sought to reassure the Bank of Mexico, according to a person familiar with the matter, of the soundness of agency securities held by the bank. Treasury officials have also had similar conversations with Japanese investors who are buyers and holders of agency debt.

Despite turmoil in their shares, Fannie and Freddie have had little or no difficulty selling or rolling over their senior debt, though they have had to pay rates that include higher premiums over yields on Treasury bonds.

The timing of Treasury's announcement could have been coordinated to land between the end of the Democratic and Republican party conventions and the convening of a congressional session next week.

Congress created Fannie as a government agency in 1938, during the Great Depression, to buy government-insured mortgages from lenders, providing them fresh money to make more loans. Fannie continued to function as a government-run agency during the 1940s and 1950s, even as it took steps toward privatization. In 1968, President Lyndon Johnson decided to turn Fannie into a shareholder-owned company.

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