Treasury near GSE bailout plan: report

WASHINGTON/NEW YORK (Reuters) - The U.S. Treasury Department is close to finalizing a plan to buttress mortgage finance companies Fannie Mae and Freddie Mac, The Wall Street Journal reported on Friday.

A combination image showing (clockwise from top L) Treasury Secretary Henry Paulson, Senator Harry Reid, Senator Christopher Dodd and Representative Barney Frank. REUTERS/Shannon Stapleton (Top L)/Joshua Roberts (Top R)/Carlos Barria (bottom R)/Jonathan Ernst (bottom L)

Citing people familiar with the matter, the Journal said the plan was expected to involve a creative use of authority the Treasury won in late July to pump capital into the two government-sponsored enterprises if it believed it was necessary.

The report said the plan, which could be announced as early as this weekend, includes changes to senior management at both companies.

Shares of the GSEs, the largest providers of money to U.S. home mortgages, have plunged about 80 percent since mid-May as investors speculated steep losses from the housing slump would soon create shortfalls in capital needed for them to stand on their own. Conventional wisdom has been that an investment by Treasury would explicitly back the companies’ $1.6 trillion in debt, but leave their shares worthless.

“People have priced in an equity infusion that would wipe out shareholders,” said Chuck Gabriel, managing director at Washington-based consultants Capital Alpha Partners. “On the other hand, they have come to understand you wouldn’t have such an event without the GSEs agreeing to it.”

The housing bill signed into law by President George W. Bush requires the companies agree to a Treasury backstop, he said.

Shares of Fannie Mae and Freddie Mac, which had rebounded since August 21 on speculation a government intervention might be averted, plunged in after-hours trading in New York. Fannie Mae stock fell 16.9 percent to $5.85, while Freddie’s shares declined 7 percent to $4.74.

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Analysts at Citigroup, Merrill Lynch and Goldman Sachs since mid-August have issued reports saying the companies had plenty of capital to operate for the near term, ushering calm to markets that had been anticipating a Treasury move.

Despite relative stability, the major rating companies since August 22 all cut their preferred stock ratings of the two GSEs on expectations that the share declines had cut access to capital, increasing the need for emergency financial support.

Yield spread premiums on the companies’ senior debt narrowed as traders bet government funding would cut their risks. The companies never lost their access to capital markets where they raise money for U.S. housing.

The biggest buyers of the debt have grown more cautious, however. Foreign central banks accelerated their parings of “federal agency” debt from their holdings in custody at the Federal Reserve in the past week, which marked the seventh straight reduction.

Russia has continued reducing its holdings of agency debt, Alexei Ulyukayev, first deputy chairman of Russia’s central bank, said on Friday.

The two companies own or guarantee almost half of the country’s $12 trillion in outstanding home mortgage debt.

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An emergency plan approved by Congress in late July gave Treasury the authority to offer an undetermined amount of credit to the two companies, or take an equity stake in them if they ran into trouble. The hastily arranged plan was announced by Treasury Secretary Henry Paulson before Asian financial markets opened on July 13.

Treasury spokeswoman Brookly McLaughlin declined to comment on the Journal report. Fannie Mae and Freddie Mac spokesmen also declined to comment.

The Fed, which gave the companies the right to borrow from its discount window if necessary, declined comment.

Earlier, McLaughlin had told Reuters the department was “making progress on our work” with Morgan Stanley, the Federal Housing Finance Agency, which regulates the two companies, and the U.S. Federal Reserve.

The Treasury had hired Morgan Stanley on August 5 to advise it on whether the companies were adequately capitalized and help it determine how it would use its new powers to support them if needed.

The newspaper report also said a Treasury plan could include senior management changes. Fannie Mae last week shook up its ranks by announcing the departure of three executives, while leaving Chief Executive Officer Daniel Mudd supported by the board.

Management changes may come, “maybe as a quid pro quo” for backstop funding, Capital Alpha’s Gabriel said.

Additional reporting by Dena Aubin, Kristina Cooke and Julie Haviv in New York, and Dmitry Sergeyev in Sochi, Russia; Editing by Leslie Adler