Investor Jitters Deflate Fannie, Freddie Shares
Drop to 20-Year Low Follows Speculation About a Rescue

By Jeffrey H. Birnbaum
Washington Post Staff Writer
Thursday, August 21, 2008

Shares of Fannie Mae and Freddie Mac tumbled more than 20 percent yesterday, hitting their lowest levels in nearly two decades, as investors fled out of fear that a government initiative to save the ailing mortgage giants could render their stock worthless.

The stock sell-off came a day after Freddie Mac was forced to pay an unusually high interest rate on five-year notes to entice investors to purchase its debt.

While the companies continue to insist that their fundamental finances are sound, investor confidence in Fannie Mae and Freddie Mac has taken a pounding this week as speculation about a federal government bailout has gained pace in the news media and among market analysts.

"Perception creates its own reality," said Howard Shapiro, an industry analyst for Fox-Pitt Kelton Cochran Caronia Waller. "I don't think we can rule out a government intervention. Fannie and Freddie are crucial to stabilizing the housing market, and the housing market is crucial to stabilizing the banks and the financial services industry."

Concerns about the financial condition of the mortgage lending giants prompted lawmakers last month to grant the Treasury Department emergency authority to prop the companies up with a cash infusion, either through loans or by buying stock. Treasury Secretary Henry M. Paulson Jr. has said he does not plan to use the power.

But if he does, Treasury officials have stressed they would seek to protect taxpayer money even if that means existing shareholders are forced to take a loss.

Shares of District-based Fannie Mae fell 27 percent, to $4.40, yesterday, and those of McLean-based Freddie Mac declined 22 percent, to $3.25. This week alone, both companies' shares dropped 44 percent in very heavy trading.

A year ago, Fannie Mae shares were selling in the $70-a-share range. Freddie Mac was trading in the $65-a-share range. Fannie Mae's market value, based on its stock price, has plummeted 88 percent, or $34 billion, this year to $4.73 billion. Freddie Mac's value has dropped by $20 billion, or 90 percent, to $2.1 billion.

The companies have reported a combined $14.9 billion of net losses over the past year.

A growing chorus of industry analysts are predicting that the government will have to intervene to prevent further deterioration of the firms, which own or guarantee half of the nation's mortgage debt.

"Given where the prices are trading at, I don't see anything but a government bailout at this point," Paul Miller of Friedman, Billings, Ramsey Group said in an interview. "The market is telling you that the government is going to step in. It's almost a self-fulfilling prophesy."

Miller, a prominent analyst who follows the companies, had previously said he doubted that the government would have to step in.

The companies continued to assert yesterday that no such bailout by the government was needed.

"They haven't offered anything. We haven't asked for anything. I don't anticipate that we will do that," said Fannie Mae chief executive Daniel H. Mudd during an interview yesterday on National Public Radio.

Sharon McHale, a Freddie Mac spokeswoman, sounded a similar note, saying, "We don't need it and don't believe we will ever need it."

Treasury and Freddie Mac officials met yesterday in what an industry official said was one in a series of regular consultations between the company and the government. People close to the companies who were not allowed to speak publicly because of the sensitivity of the matter said that Treasury officials gave no sign they planned to intervene.

Treasury officials declined to comment except to say that regular conversations have been going on.

Bill Gross, who manages the world's biggest bond fund at Pacific Investment Management, told CNBC yesterday that he expected a large government bailout. Gross said the Treasury would probably be forced to buy as much as $30 billion of preferred shares in both Fannie Mae and Freddie Mac by the end of next month.

Fannie Mae has about $120 billion of debt maturing through Sept. 30, while Freddie Mac has $103 billion, according to figures provided by the companies and data compiled by Bloomberg News. If either company is unable to roll over this debt, the government could be forced to step in.

McHale said that Freddie Mac foresaw no difficulty with the rollover of debt and that all types of borrowing, not just Freddie Mac's, include a richer premium in pricing these days. "Our access to those markets remains strong," she said.

On Tuesday, Freddie's Mac's five-year notes were priced to yield 4.172 percent, which was 1.13 percentage points higher than Treasury notes. Normally, the spread between the two is smaller.

Yesterday, Fannie Mae sold $1 billion of three-month notes at a yield of 2.5 percent and another $1 billion of six-month notes at a yield of 2.81 percent, the company reported. These yields were the worst in nearly a month.

But while shareholders might be wiped out during a government rescue, bond holders could fare better, financial analysts said.

The two firms, which dominate the market for U.S. mortgages, have been reeling as concerns mount that the companies might not have enough capital to cover losses because of the rising number of bad home loans. If Fannie Mae or Freddie Mac collapsed, it could cripple the U.S. housing market, dealing a staggering blow to the wider economy and saddling the federal government with massive debts if it chose to seize control of either firm.

Both companies say they have enough capital to weather the severe downturn in the housing market.

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