Paulson cool to shield Fannie/Freddie investors: report

WASHINGTON (Reuters) - U.S. Treasury Secretary Henry Paulson is insisting that if Fannie Mae and Freddie Mac need rescuing, the plan should not benefit shareholders of the giant mortgage finance firms, the Wall Street Journal said on Saturday.

Citing people familiar with the matter, the newspaper said a possible intervention by the Bush administration to help the government-sponsored mortgage enterprises could happen as early as Monday morning.

That is around the time Freddie Mac is due to sell $3 billion worth of short-term debt, a barometer of market appetite for its securities.

A Treasury Department spokesman called the article "thinly sourced speculation" but declined to elaborate.

Paulson indicated on Friday the administration had no plans to nationalize the congressionally chartered but privately owned companies, which finance nearly half of U.S. homes.

Shares of Fannie Mae and Freddie Mac, trading at a fraction of their value a year ago, fell sharply this week as fears mounted they would not have enough capital to make it through the worst U.S. housing crisis since the Great Depression.

Home foreclosures, falling prices, tighter credit for buyers and the overall state of the U.S. economy have become major issues in the campaign for the presidential and congressional elections in November.

Fannie Mae and Freddie Mac said on Friday their finances were sound enough to withstand the housing crisis and government officials scrambled to make statements to restore confidence in them.

The abrupt erosion of the share values of the two companies raised the specter of a government rescue operation similar to the sale in March of failing investment bank Bear Stearns.

One analyst said the crisis of confidence points to risks associated with having two large private firms play such a central role in U.S. housing markets.

"What they do is more needed than ever," said Richard Bove, an analyst with Labenburg Thalman. "Get rid of them and create new structures that will perform their functions more efficiently, with more accountability and without the distraction of the equity markets."

The Wall Street Journal said Paulson does not want to help shareholders of Fannie Mae and Freddie Mac because it would create "moral hazard" -- encouraging greater risk-taking because of an expectation of a government safety net.

Paulson took a similar stance during the Bear Stearns intervention, arguing the government's role in facilitating the firm's sale was needed to prevent broader economic carnage but that its shareholders should be hit financially.

BONDHOLDERS BENEFIT

But any intervention could benefit bondholders by strengthening perceptions of government backing of the firms.

"Equity holders would suffer greatly while the position of senior debt holders would actually be enhanced by the more explicit government support," JPMorgan analysts Alex Roever and Cie-Jai Brown wrote in a note to clients.

The New York Times and the Wall Street Journal reported this week that the government has discussed plans to deal with the failure of either company, including a federal takeover.

Appetite for Freddie Mac's debt due to be sold on Monday could be a critical indicator of investor confidence next week.

"The deal will do OK because it's pretty clear the debt will be good," said Andrew Harding, head of taxable fixed income at Allegiant Asset Management in Cleveland. "The probability of government intervention is very, very high."

Russia, a holder of about $100 billion of U.S. agency debt, including securities of Fannie Mae and Freddie Mac, said on Saturday it had no immediate plans to reallocate.

Paulson indicated on Friday a bailout was unlikely. He said the administration's main focus was supporting the agencies "in their current form as they carry out their important mission."

Connecticut Sen. Chris Dodd, who heads the Senate Banking Committee, said on Friday the Fed was considering allowing Fannie Mae and Freddie Mac to borrow directly from the central bank.

The anxiety surrounding the health of the financial system was heightened all the more late on Friday when U.S. banking regulators swooped in to take over mortgage lender IndyMac Bancorp Inc, marking one of the largest bank failures in U.S. history and the fifth bank to close this year.

Freddie Mac said it had options to manage capital, such as cutting its dividend, and was not on the threshold of conservatorship. Fannie Mae said it had access to "ample sources of liquidity," noting it had issued more than $24 billion in debt this week.

(Reporting by Mark Felsenthal and Al Yoon in New York; Editing by John O'Callaghan)