Fannie Loses $2.2 Billion As Home Prices Fall

By David S. Hilzenrath
Washington Post Staff Writer
Wednesday, May 7, 2008

Fannie Mae, one of the main sources of mortgage funding and a barometer of the housing market, yesterday reported that home prices fell faster than it expected during the first quarter, contributing to a $2.2 billion loss for the company.

The company had been predicting that the toll from defaults and foreclosures would worsen this year, and yesterday it revised its forecast to predict even higher credit losses ahead.

The loss came as the strain of the recent credit crunch continued to roil the housing and finance industries. Yesterday, the Swiss banking giant UBS reported an $11 billion quarterly loss and said it would cut 5,500 jobs. Meanwhile, the Legg Mason investment firm lost more than $250 million in its fourth quarter as it set aside money to support its money-market funds.

Fannie Mae and its federal regulator responded to the deteriorating situation by announcing steps that could strengthen the company and the housing market -- or put the finance giant in an even deeper hole.

The government is relying on Fannie Mae to prop up the troubled real estate market, and the company is eager to expand its business. The challenge is to do both without making Fannie Mae the next bailout candidate.

Chartered by the government to keep mortgage money flowing, the shareholder-owned company packages mortgages into securities for sale to investors, promising to make the payments if the borrowers default. The company also buys mortgages directly. Those activities help lenders get mortgages off their books and replenish the funds needed to make more loans.

Altogether, Fannie Mae, based in the District, owns or guarantees nearly $3 trillion of mortgage-related investments and is responsible for about half the securities being issued to fund home mortgages.

The Office of Federal Housing Enterprise Oversight said yesterday that it plans to allow Fannie Mae to operate with a thinner financial cushion. That would be the second reduction in the required safety cushion since March, and the regulator said it intends to make a third reduction in September.

Tying up less capital as a cushion against losses enables the company to buy and guarantee more loans, but it could also put the company at greater risk.

OFHEO's plan to reduce the capital requirement was conditioned on completion of a plan Fannie Mae announced yesterday to raise $6 billion of new capital from investors. Chief executive Daniel H. Mudd said the company would use the added capital to shore up its financial strength, "pursue the best business opportunities we have seen" and help the housing market recover.

Those goals are potentially at cross-purposes. Holding on to the new capital would give Fannie Mae a bigger safety cushion, but spending it could leave it vulnerable to a further downturn.

The company didn't say how it would balance those objectives.

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