House Helps Fannie and Freddie

In passing a rescue bill for Fannie Mae and Freddie Mac, the House left out the conditions that critics had sought

By BusinessWeek Staff and Wire Reports

The House dealt Fannie Mae (FNM) and Freddie Mac (FRE) a "Get Out of Jail Free" card on July 23, passing a bill that authorizes the Treasury Dept. to extend the mortgage-finance giants a lifeline without any of the conditions that the companies' critics had demanded. The bill now heads to the Senate, where passage is expected within days. President Bush earlier dropped his threat to veto the legislation, so it should be signed into law soon.

Shares in Fannie Mae and Freddie Mac climbed on July 23 on news of a deal, closing the day at twice their levels of July 15, when pessimism about their prospects was at a peak. Fannie Mae rose 1.59, to 15, while Freddie Mac climbed 1.10, to 10.80.

Paulson's plea

The bill would let the Federal Housing Administration back up to $300 billion in new loans so homeowners who cannot afford their house payments could try to escape foreclosure by refinancing into more affordable mortgages. Lenders would have to agree to take a substantial loss on the existing loans, and in return, they would walk away with at least some payoff and avoid the often-costly foreclosure process.

The plan also includes about $15 billion in housing tax breaks, including a credit of up to $7,500 for first-time buyers, and increases the statutory limit on the national debt by $800 billion, to $10.6 trillion.

Fannie Mae and Freddie Mac either own or insure about 40% of the residential mortgages in the U.S., and their share of recent loans is even higher because other loan securitizers have been knocked out of the business by the credit crunch. But their shares came under attack when investors worried that losses on their portfolios and guarantees would force them to raise impossibly large sums of money by issuing shares.

The House accepted Treasury Secretary Henry Paulson's request to let his department extend unlimited amounts of credit to Fannie and Freddie if need be. It also authorized Treasury to buy shares in the companies to bolster their capital bases. Paulson had argued forcefully that making the line of credit unlimited and having authorization to buy their shares would discourage short sellers from mounting attacks on the companies. He likened it to a bazooka that scares off enemies even if it's never used.

"Why the Stocks Are Ripping"

The House bill doesn't require Fannie and Freddie (known as GSEs, or government-sponsored enterprises) to eliminate, or even reduce, their dividends to shareholders even if they draw on the government's line of credit. That's left to the discretion of the Treasury Dept. Treasury also can't compel them to issue more shares. And if it buys preferred shares in them, it doesn't get seniority over other holders.

"It sounds like the GSEs got what they wanted again," said Paul Miller, an analyst with Friedman Billings Ramsey in Arlington, Va. "They got a big backstop and they got language that the Treasury doesn't necessarily have to stop them from paying dividends or cap compensation. That's why the stocks are ripping."

Earlier in the day, Paulson said that agreement on a sweeping housing rescue bill will send a strong message to investors around the world and will be key to helping the nation turn the corner on the housing crisis. He said the bill had some "wasteful" provisions, such as a $3.9 billion measure to provide federal help for homeowners facing foreclosure. But Paulson added that he had urged President Bush to drop his veto threat over this provision because of the other important elements in the bill that would provide support to Fannie Mae and Freddie Mac.

On July 22, the Congressional Budget Office gave a rough estimate of $25 billion as the potential cost to taxpayers of the support effort for Fannie and Freddie. It said costs could be zero if markets stabilize and the two institutions do not have to draw on the federal support, but noted there is a small chance the two institutions could lose $100 billion.

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