Mortgage Giants' Aid Faces GOP Skepticism
Bush, Paulson Urge Congress to Pass Bill

By Jeffrey H. Birnbaum and David S. Hilzenrath
Washington Post Staff Writer
Wednesday, July 16, 2008

Some lawmakers expressed doubts yesterday about the wisdom of the federal government's plan to prop up mortgage finance giants Fannie Mae and Freddie Mac, with one Republican senator complaining it was tantamount to writing a "blank check" to save the troubled companies.

Treasury Secretary Henry M. Paulson Jr. is seeking permission from Congress to temporarily increase the amount the companies can borrow from the Treasury and enable the government to invest directly in the firms if conditions worsen. In addition, the Federal Reserve has said it would allow Fannie Mae and Freddie Mac to borrow from its so-called discount window on an emergency basis, at least until the Treasury plan is enacted. So far, no such borrowing has occurred.

The often-outspoken Sen. Jim Bunning (R-Ky.) railed against the plan during a hearing before the Senate Banking Committee. "When I picked up my newspaper yesterday, I thought I woke up in France. But, no, it turned out it was socialism here in the United States and very -- going well," he said, raising his voice. "The Treasury secretary is now asking for a blank check to buy as much Fannie and Freddie debt, or equity, as he wants."

Bunning said he would do "do everything I can to stop it."

Many in the Senate expect lawmakers to move on the legislation soon. But the banking panel's ranking Republican, Richard C. Shelby (Ala.) expressed reservations and is said to be contemplating changes. House Majority Leader Steny H. Hoyer (D-Md.) raised the prospect of holding hearings first before taking up the measure next week.

Paulson defended the plan as a "bazooka" that federal officials could hold in reserve but would probably not have to use because it was so potentially potent. Its mere existence, he testified, should give confidence to the financial markets that the government was standing behind the firms.

"Let me stress that there are no immediate plans to access either the proposed liquidity or the proposed capital backstop," Paulson told the committee. "If either authority is used, it would be done so only at Treasury's discretion, under terms and conditions that protect the U.S. taxpayer and are agreed to by both Treasury" and the mortgage finance companies.

President Bush added his voice of support for the plan and the companies during a news conference of his own yesterday.

"I appreciate the positive reaction this plan has received from many members of Congress. I urge members to move quickly to enact the plan in its entirety, along with the good oversight legislation that we have recommended for both Fannie Mae and Freddie Mac," Bush said. "We must ensure they can continue providing access to mortgage credit during this time of financial stress."

The president's comments came as investors worry that whatever protection the government extends to creditors of the companies will not benefit their shareholders. In addition, Moody's Investors Service yesterday downgraded the preferred stock of the two companies. Moody's said potential losses at Fannie Mae now look worse than Moody's previously expected, and it said developments have reduced Freddie's ability to raise $5.5 billion of new capital as it had planned to cushion the blow from future losses.

As a result, shares of Fannie Mae and Freddie Mac fell steeply again yesterday, following the pattern of the past week. Fannie Mae stock dropped 27 percent, or $2.66, to $7.07, and Freddie Mac declined 26 percent, or $1.85, to $5.26 a share. Both companies' shares have lost more than 80 percent of their value this year.

The Securities and Exchange Commission yesterday sought to reduce the volatility in the companies' stock prices by limiting the ability of traders to profit from a decline in the companies' shares. SEC Chairman Christopher Cox told the banking panel that his agency will require traders to hold shares of the two companies, as well as brokerages, before they can execute a so-called short sale.

In a short sale, sellers are betting a stock's price will fall. They borrow shares from another investor and sell them. Eventually they must buy shares to replace the ones they borrowed, so they make money if the price has fallen in the interim, but lose money if the stock price rises. The type of short sale that was prohibited by SEC yesterday is "a naked short sale," in which investors effectively sell stock that was never borrowed.

Cox said the SEC will soon draft rules to apply the ban more broadly across the financial markets.

In his testimony before the Senate Banking Committee, Paulson urged lawmakers to adopt the administration's plan quickly. He said leaving the amount of potential aid unlimited was intended to reassure financial markets. "If you've got a bazooka and people know . . . you may not need to take it out," Paulson said. "By increasing confidence, it will greatly reduce the likelihood it will ever be used."

Paulson also said that if the government decides to invest in the companies, the investment would have to be on terms that would protect taxpayers. But he said it was premature to spell out the terms.

Sen. Christopher J. Dodd (D-Conn.), chairman of the Banking Committee, suggested Paulson's view might be a Catch-22. By sending private investors the message that taxpayers would come first, he implied, the government could make it harder for Fannie Mae and Freddie Mac to raise money from private investors. "We've got to think this through," he said.

Sen. Chuck Hagel (R-Neb.) asked at the hearing whether the companies' management should be held accountable. Paulson said he was "not looking for scapegoats."

But Fed Chairman Ben S. Bernanke said management changes could be raised as a condition if the Treasury injects money into the firms.

Barney Frank (D-Mass.), chairman of the House Financial Services Committee, has said he wanted to move the bill through the House this week. Aides said he plans to make minor changes to the Treasury plan, such as requiring the firms to delay paying dividends to shareholders if they partake of Treasury's funds.

House Republicans urged caution. "It would be irresponsible for Congress to provide the proposed new authority without doing due diligence on the mechanics of the Treasury proposal and its potential implications for taxpayers," House Minority Leader John A. Boehner (R-Ohio) and Minority Whip Roy Blunt (R-Mo.) said in a statement. "Hearings should be scheduled to give taxpayers the answers and assurances they deserve."

Staff reporter Lori Montgomery contributed to this report.

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