Despite Lifelines, Concerns Linger on Mortgage Giants

By Jeffrey H. Birnbaum and Neil Irwin
Washington Post Staff Writers
Tuesday, July 15, 2008; D01

The federal government's assistance plan for Fannie Mae and Freddie Mac steadied the financial markets yesterday but failed to end concern about the future of the mortgage finance giants.

The plan, announced Sunday evening after an intense weekend of behind-the-scenes negotiations, arrested the steep declines that the companies' stock had been experiencing over the past week. The government's backing also allowed Freddie Mac to successfully sell $3 billion in debt securities, a sign that investors still had confidence in the firms, analysts said.

On Capitol Hill, congressional leaders from both parties expressed broad support for the arrangement worked out by the Treasury Department and the Federal Reserve. Senior House lawmakers said they planned to include help for the plan as part a housing relief bill Thursday and send it to the Senate, which is preparing to approve the measure next week.

Still, the companies' condition remained under close scrutiny and even their top officers said they understood that difficult times were ahead. "I hope that we will look back on this announcement and say this was a very important moment in breaking the back of a lot of market fears," Daniel H. Mudd, Fannie Mae's chief executive, said in an interview yesterday. "But it's way too early to say that, and we must remain vigilant."

A Goldman Sachs analyst predicted yesterday that the companies could face substantial future losses on their $5.3 trillion of mortgage guarantees and investments. The analyst, Daniel Zimmerman, said the companies are particularly vulnerable to loans made as recently as last year and in states with exceptionally troubled housing markets.

Meanwhile, the steps the government could take to stabilize Fannie Mae and Freddie Mac may have their own economic downsides. Lending the companies lots of money or investing heavily in them could increase federal borrowing and boost inflation. Alternatively, if the firms are forced to sell off a lot of their mortgage-related investments to cover losses, they could wind up lowering the value of such securities, indirectly raising mortgage rates and putting downward pressure on home prices.

For now, the government's actions appear to reduce the danger that any short-term problems at Fannie Mae or Freddie Mac would disrupt the mortgage market.

"The federal government has done what it can to assure that Fannie and Freddie are too big to fail," said Walter N. Schmidt, senior vice president of FTN Financial Capital Markets.

Such assurances did little to allay shareholders' worries that they would lose out if the government decides it needs to buy an unspecified ownership in the firms, as the Treasury Department has proposed. Shares of Fannie Mae yesterday fell 5.1 percent from their deeply depressed level at the end of last week, and shares of Freddie Mac declined 8.3 percent.

Some large shareholders said they took solace in the fact that the companies are still investor-owned.

"It's not a takeover, not a nationalization," said an analyst whose company is among the 10 largest investors in Fannie Mae and Freddie Mac, and who spoke on the condition of anonymity because the firm does not comment publicly on its holdings. "The government has to come out and calmed investors."

Lawmakers said they wanted to get the housing bill to the president soon. "I do think there's a reason for speed," said Barney Frank (D-Mass.), chairman of the House Financial Services Committee.

But he and other congressional observers said that some Republican lawmakers, particularly in the Senate, are likely to oppose the effort, perhaps holding it up temporarily.

In recent weeks, a handful of Republicans have used Senate rules to slow down the housing package. And yesterday, one of those senators, Jim DeMint (S.C.), released a statement skeptical of the Treasury proposal. "Congress should not use this 'crisis' to rush the government into the mortgage business," the statement said.

A crucial Republican leader, Sen. Richard C. Shelby (Ala.), yesterday declined to comment directly on the legislation. "We're in ongoing discussions and reviewing the details," said Shelby spokesman Jonathan Graffeo.

Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.) said early yesterday that he was thinking about offering the Treasury initiative as a separate bill. But in a conference call with reporters later in the day, Dodd said he had reconsidered and that it made sense to add the initiative to the larger housing package.

Dodd said Treasury Secretary Henry M. Paulson Jr., Federal Reserve Board chairman Ben S. Bernanke and Securities and Exchange Committee Chairman Christopher Cox will appear before Dodd's committee this morning to answer questions about the initiative.

The story behind the weekend's dramatic announcements started late last year. Bush administration officials and Federal Reserve leaders were encouraging Fannie Mae and Freddie Mac, in private conversations and sometimes publicly, to raise more capital to ensure they could continue funding vast numbers of home loans even as other mortgage funding dried up.

But the companies were reluctant to do so, fearing that the value of their shares would decline.

Starting at the end of last month, when the companies' shares started plummeting, Paulson and Fed officials became increasingly worried -- not about the losses to shareholders, but that investors could lose faith in the trillions of dollars of debt the firms had outstanding if the stock prices got too low.

Paulson started daily conversations on the subject with his staffers, trying to firm up contingency plans. These included talks with the Treasury's acting undersecretary Anthony Ryan, assistant secretary David Nason and deputy assistant secretary Jeremiah Norton. Robert K. Steel, Paulson's right-hand man on these matters for the past two years, was already in talks to become chief executive of Wachovia, a position he accepted last week, and removed himself from most of the activity.

When the firms' shares fell by nearly 50 percent Friday morning and a sense of panic began to creep into world markets, their fears -- that buyers in the multitrillion-dollar bond markets would cease lending money to Fannie Mae and Freddie Mac, potentially causing a global crisis -- seemed closer to reality.

Those losses were stanched with a series of statements from Paulson, President Bush and congressional leaders. But by Friday evening, officials at the Treasury Department and the Fed had concluded that more concrete action would likely be necessary to ensure calm.

Treasury and company officials worked through the day Saturday, late into the night, and again on Sunday. They developed details of plans that had been on the shelf in vague terms for months. At Fannie, at least, contingencies were prepared in case the government decided not to act and the company had to protect itself on its own.

Frequent conference calls went on among Paulson, Bernanke, Cox, New York Fed President Timothy F. Geithner and top company officials. The leaders agreed they needed to assuage fears in the marketplace while not forcing the companies to take government money.

Paulson and Geithner called Wall Street executives to assess investor sentiment. Some in the markets expected everything to be fine, others predicted deepening problems and a few predicted a burgeoning crisis in the week ahead. That uncertainty led them to conclude that they needed to act. They faced a tricky balance. Do too much, and they could unnecessarily expose the government to financial risks and make markets even more fearful. Do too little, and they could find themselves without the tools to prevent a crisis.

The balance they struck: They decided to ask Congress for a wide new authority for the Treasury secretary to negotiate new government lending or even for the government to buy stock in the companies -- but to use that authority only if conditions worsen. Paulson would have the flexibility to negotiate favorable terms for taxpayers, should that situation arise.

Paulson worked Capitol Hill, speaking to 15 congressional leaders over the weekend. On Saturday evening at about 8 p.m., with Paulson at his Cathedral Heights home in Northwest Washington, staff talked him through the details of the proposals on a conference call, and he decided to move forward.

He called the chief executives of Fannie Mae and Freddie Mac, described the proposals to them and asked them to take the ideas to their boards of directors. He did not want authority for the government to invest in the companies if the firms would not be open to such a transaction.

Late Sunday morning, the chief executives called back to say they were on board. Early that afternoon, Paulson called Bush to get his blessing. At 3 p.m., Paulson, Bernanke, Cox and Geithner held a conference call and agreed to proceed.

At 6:10 p.m., Paulson walked down the steps in front of the Treasury building at 1500 Pennsylvania Ave. NW, stood behind a lectern and read a statement to assembled TV cameras. He took no questions.

Staff writers David S. Hilzenrath, Lori Montgomery, Christopher Twarowski and Jordan Weissmann contributed to this report.