Fannie, Freddie may avoid U.S. bailout

By Patrick Rucker - Analysis

WASHINGTON (Reuters) - Fears a government takeover would wipe out shareholders at U.S. mortgage finance companies Fannie Mae (FNM.N) and Freddie Mac (FRE.N) battered the price of their stock last month, but a rescue may yet be avoided.

Fannie Mae and Freddie Mac are the nation's two largest sources of housing finance and the pass-through point for 70 percent of new mortgage-backed securities.

Washington policy-makers have increasingly relied on the two government-sponsored enterprises, or GSEs, to support the housing market after Wall Street banks, hit by rising loan default rates, lost its appetite for mortgage debt. The failure of the two mortgage giants would further darken the already heavy clouds hanging over the economy.

As foreclosures have mounted, both companies have seen their capital eroded and analysts have fretted they could fail without government aid.

However, a new perspective is taking hold among many observers, who now believe Fannie Mae and Freddie Mac can pull through the crisis under their own power using the billions of dollars they have socked away to cover mounting losses.

While they have suffered a combined $14 billion in losses over the past four quarters, they still have more than $80 billion in capital on hand.

BAILOUT CONCEIVED

A bailout plan hatched in July, and approved by Congress, gave the U.S. Treasury authority to take a large stake in either company if needed to avoid a collapse. The Treasury could also lend them an indeterminate amount of cash.

In the weeks since that emergency plan was conceived, some media reports and analysts have suggested an effective nationalization of the companies was all but certain.

Barron's magazine helped push the share prices of the two companies to 20-year lows with a report in its August 18 edition that said government officials believed the companies would be unable to raise needed capital. It cited a Bush administration insider as saying that if that proved to be the case, the Treasury was likely to go ahead with its refinancing plan.

Fannie Mae's and Freddie Mac's preferred shares, generally considered safe and widely held by banks, have been hit by a series of credit ratings downgrades in the past several weeks. On Monday, Fitch Ratings cut them to BBB-, the lowest investment grade. They are trading at just a fraction of face value.

Investor sentiment improved last week, however, as some Wall Street analysts concluded the housing slump would not break the companies and that Treasury had no desire to orchestrate a bailout.

In a report on Thursday last week, Lehman Brothers said Fannie Mae does not need to tap investors for more capital despite the billions in losses it has taken.

Separately, Merrill Lynch concluded that out-sized fears of government action had driven shares of Fannie Mae and Freddie Mac to bargain levels. "Shares are overly discounting a possible catastrophic event," it said in a research note.

Still, most analysts agree Fannie Mae and Freddie Mac face an uncertain fate and say investors should tread with caution.