Fannie, Freddie Shares Soar After Restraints Loosened

By David S. Hilzenrath
Washington Post Staff Writer
Saturday, March 22, 2008

For years, federal regulators have cast Fannie Mae and Freddie Mac as a potential threat to the financial system -- dangerously large, lacking in regulatory restraints and consumed with enriching themselves.

This week, regulators embraced the two federally chartered companies as potential saviors and gave them license to do business with even looser restraints. Facing a deepening crisis, the government gave Fannie Mae and Freddie Mac authority to operate with thinner financial cushions, which could increase their mortgage-related investments by a combined $200 billion.

How much the government's action will help borrowers remains to be seen, but already the benefit to the companies has been dramatic. Share prices for each firm have risen by more than half since Monday, reversing weeks of precipitous decline.

Investors' reactions reflected more than just the economics of this week's announcement. Wall Street interpreted the action as evidence that the government has changed its attitude toward the companies in a way that will protect their franchise for years to come, analysts said.

Until the announcement, "it was North Korea, Fannie Mae, Iran -- the enemies," analyst Gary Gordon of Portales Partners said, caricaturing the Bush administration's view of Fannie Mae and Freddie Mac. "Now all of a sudden they're recognizing that the latent benefit of Fannie and Freddie was that they were backup buyers when other investors weren't buying."

It was easier for the government to ignore the potential value of backup buyers when the housing bubble was growing and there was no shortage of demand for mortgage-related investments.

The administration's reversal on Fannie Mae and Freddie Mae "will set a precedent that will last for a long time," said Kenneth Posner, who follows the companies for Morgan Stanley.

While the government chartered Fannie Mae and Freddie Mac to promote homeownership and a stable mortgage system, the companies are traded on the New York Stock Exchange and serve shareholders as well as the public.

The companies have two main businesses. They package mortgages into securities for sale to investors, guaranteeing to pay the investors if the borrowers default. They also buy mortgages and mortgage-backed securities for their own investment portfolios, thereby giving lenders money to make more loans.

Largely because investors assume the government would bail out Fannie Mae and Freddie Mac if they got in trouble, the companies are able to borrow cheaply to finance their investments. For the same reason, the securities they guarantee historically have commanded a premium price. (On Wall Street, Fannie Mae and Freddie Mac securities are known as "agency securities," though the companies are not government agencies.)

In essence, Fannie Mae and Freddie Mac profit by monetizing their unusual status as government-sponsored enterprises, or GSEs.

The companies are imperfect instruments of public policy because their economic interests often conflict with their public mission. For example, funding mortgages for people with low incomes and poor credit histories or bailing out subprime borrowers facing imminent foreclosure may not be the most fiscally prudent use of their resources.

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