Morgan Stanley Tapped To Assess Fannie, Freddie
Treasury Asks Bank to Examine Vulnerabilities

By Jeffrey H. Birnbaum and David Cho
Washington Post Staff Writers
Friday, August 15, 2008

The Treasury Department tapped investment bank Morgan Stanley to assess how vulnerable the troubled mortgage giants Fannie Mae and Freddie Mac are to further economic stresses and how much capital they would need to weather them, according to documents released yesterday.

One of Morgan Stanley's primary tasks is to project likely credit losses at the companies given different assumptions about the performance of the housing market. Fannie Mae and Freddie Mac have already been buffeted by the soaring rates of defaults and foreclosures.

The bankers will examine whether the firms are accurately judging their financial strength and what steps the Treasury might have to take to rescue them in an emergency, people familiar with the contract said. The people spoke on condition of anonymity because they said it would be inappropriate to discuss contract matters.

Last month, the Treasury won new powers to lend the companies money or buy their stock to keep them from going under. Fannie Mae and Freddie Mac, which own or guarantee half the nation's mortgages, are vital to the health of the nation's housing market.

Morgan Stanley is part of a team of elite experts from Wall Street assembled in recent weeks by the Treasury to address the spreading financial turmoil. The group includes Ken Wilson, an influential investment banker who retired from Goldman Sachs to become the Treasury's point person in dealing with crises in the financial markets. W. Scott Frame, an expert on Fannie Mae and Freddie Mac, has been detailed from the Federal Reserve's Atlanta branch to supplement the Treasury's analysts.

The hiring of a prominent Wall Street firm for such a mission is unusual and underscores how seriously Treasury Secretary Henry M. Paulson Jr. is taking the possibility that the Treasury might have to provide assistance to Fannie Mae and Freddie Mac. Paulson has repeatedly said that he did not expect to use the Treasury's emergency powers to keep the mortgage firms afloat.

Paulson asked John J. Mack, the chief executive of Morgan Stanley, to bid for the contract soon after the Treasury obtained authority from Congress to lend or invest in the mortgage firms to prevent a meltdown of the companies, according to people close to the engagement.

Morgan Stanley delivered a PowerPoint presentation on July 28 about its capabilities in analyzing complex transactions, especially those that involve mortgage-backed securities of the kind Fannie Mae and Freddie Mac deal in.

The Treasury signed a contract with the firm Aug. 5, and Mack said Morgan Stanley was "honored" to have been asked to take on the assignment.

Morgan Stanley is not being paid a fee for its work, and the maximum payment for expenses, $95,000, is less than what a first-year investment banker at the firm would make.

Whether it gains other benefits from being allowed a detailed look inside Fannie Mae and Freddie Mac is unclear. Morgan Stanley laid out its potential conflicts of interest to the Treasury in its July proposal, but the Treasury redacted much of that section at Morgan Stanley's request from the documents disclosed yesterday. The contract bans Morgan Stanley from doing business with the mortgage firms until March of next year, two months after its contract expires.

The contract requires Morgan Stanley to receive information "in a secure location with access limited to only those [Morgan Stanley] employees with a 'need to know.' " Asked about the "secure location," a spokeswoman for Morgan Stanley declined to comment. The contract also requires the firm to "dispose of" all information it receives from the Treasury when its assignment concludes.

Morgan Stanley's team is headed by top-ranking executives including Robert Scully, a member of the company's office of the chairman, and Ruth Porat, who leads the firm's global financial institutions group. Morgan Stanley declined to say how many bankers it had detailed to the effort in Washington and New York. The contract runs until Jan. 17, three days before the next U.S. president is to be sworn into office.

The investment bank is charged with providing a "sensitivity analysis on the financial profile" of Fannie Mae and Freddie Mac and also an "assessment of appropriate capital structures." In addition, the firm "will provide an analysis of the relationship between" Fannie Mae and Freddie Mac "and the broader capital markets," the contract states.

Fannie Mae and Freddie Mac have been providing reams of financial projections and reports to the Treasury as part of this wide assessment, people close to the effort said.

Paulson, a former chairman of Goldman Sachs, is accustomed to relying on top executives from his old firm to keep in touch with the markets. For most of the first part of his tenure as Treasury secretary, he leaned on Robert K. Steel, the department's undersecretary and his former number two at Goldman Sachs.

After Steel left the Treasury last month to become chief executive at Wachovia, Paulson tapped his close friend Wilson. Last month, Wilson received a phone call from President Bush, who urged him to take the job.

The connections between the men run deep. Wilson and Bush went to Harvard Business School together. Paulson met Wilson at Dartmouth College and helped recruit him to Goldman Sachs in the late 1990s.

Over the past year, a broad range of firms, including Wachovia and National City, have turned to Wilson for advice on navigating the credit crisis. As head of Goldman Sachs's financial institutions group, he also advised Bank of America on its acquisition of Countrywide Financial.

"He's somebody who already knows everybody on Wall Street," one Treasury official said. "He always knows what's going on."

Wilson will work until January for no pay and has responsibilities at the Treasury beyond Fannie Mae and Freddie Mac. He was hired as a "special government employee," a designation that does not require him to sell his personal investments as full-time Treasury officials must do.

View all comments that have been posted about this article.

© 2008 The Washington Post Company