September 2, 2008 / 8:08 PM / 11 years ago

Fannie, Freddie may avoid U.S. bailout

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.

(L-R) Fannie Mae chief financial officer Stephen Swad, chief business officer Robert Levin, and chief risk officer Enrico Dallavecchia in a combination image. REUTERS/Handout

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.

Data from the Federal Reserve on Thursday suggested foreign central banks were cutting back on their holdings of GSE debt, and concern that the appetite for their debt was waning broke a rally in their shares on Friday.

DESPITE WOES, EXCESS CAPITAL

The size of the companies’ capital cushion is the source of investors’ anxiety and analysts’ relief. Those cash-like reserves have fallen as losses have climbed.

After accounting scandals earlier this decade, their regulator forced them to buttress their capital. Freddie Mac must hold 20 percent more capital than the minimum required by law while Fannie Mae must hold 15 percent more than the least capital required.

All told, Fannie Mae has $47 billion on hand and Freddie Mac holds $37 billion. While the size of any future losses are uncertain, many analysts think they have sufficient reserves.

“Our analysis suggests they have breathing room, and where they probably need to raise additional capital at some point, there is no urgency to do so,” said Citigroup analyst Bradley Ball.

Two weeks ago, a source familiar with the U.S. Treasury’s position told Reuters the administration would like to see Fannie Mae and Freddie Mac remain in private hands.

Beyond that, little is known of Treasury Secretary Henry Paulson’s thinking. Officials have been unusually tight-lipped, concerned investors would make bets based on any comments.

Last week, the Wall Street Journal editorial page chastised Paulson for giving “the impression of wanting desperately to pass these problems along to someone else.”

With the November presidential election just two months away, the Bush administration is hoping it won’t be forced into undertaking a dramatic bailout.

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