Fannie, AIG Struggling After Federal Takeover

Fannie Mae, a federally chartered company based in the District, reported a $29 billion loss for the quarter. The firm said yesterday that the government's assistance "may prove insufficient." (By Bill O'leary -- The Washington Post)
Buy Photo

In October, the government announced a series of steps to protect loans made to banks and big corporations. These loans to private banks, the company reported, may have become "more attractive investments" than loans to Fannie Mae, historically one of the safest investments. Although investors have long assumed that the government stands behind Fannie Mae, this guarantee is no longer as strong as those now explicitly provided to some other financial companies.

Fannie Mae uses loans to buy up mortgages and mortgage bonds. "The U.S. government does not guarantee, directly or indirectly, our securities or other obligations," the company said.

As the financial markets took a sharp turn for the worse in October, the government introduced a variety of protections for financial institutions. The Treasury Department, Fannie Mae and its regulator, the Federal Housing Finance Agency, initiated a series of discussions about what else the government could do to support the mortgage market.

Fannie Mae had begun taking steps to make home loans more affordable, such as buying more mortgage bonds to put money into the market and eliminating fees it charged to insure loans. But the company was having trouble raising affordable, long-term funding in the debt markets -- the money it uses to buy mortgages. As a result, mortgage rates were rising. That was the opposite of what government officials intended when they took over Fannie Mae and Freddie Mac.

The government could provide more support for Fannie Mae by buying the company's debt or making it easier for the company to get loans or capital directly from the Treasury.

But Paulson wasn't interested in renegotiating the terms of the department's agreement with Fannie Mae, according to sources who spoke on condition of anonymity because they were not authorized to disclose the discussions.

"We have occasional discussions with [Fannie Mae and Freddie Mac] and FHFA as we monitor the mortgage market and look to address the housing correction," said Treasury spokeswoman Michele Davis. "We have received no recommendations from Fannie Mae."

Peter J. Wallison, a former Treasury official and a fellow at the American Enterprise Institute, said the government was being foolhardy in failing to do more for Fannie Mae. "What is the reluctance on the part of Treasury to put money into Fannie and Freddie? We know they're going to lose money. So what?" he said. "Their objective is to help the housing market."

Some financial experts have suggested that the government go even further and fully nationalize firms like Fannie Mae and Freddie Mac, allowing them to borrow at the same low rates the U.S. government can.

In contrast to Fannie Mae, AIG won a new relief package after the initial bailout aggravated the company's difficulties.

AIG, which has recorded $43 billion in losses on home mortgages, was facing bankruptcy in September when the government stepped in. To raise capital to pay back the government's initial loan, the chief executive appointed by the Treasury, Edward M. Liddy, planned to sell off some AIG subsidiaries, such as life insurance and airplane-leasing firms.

But the falling stock market made that difficult by depressing the value of the company's shares. Meanwhile, the freeze in credit markets made it even harder for AIG to remain liquid and pay off debts. AIG was forced to put up billions of dollars to cover derivatives it had sold to investors.

"It was obvious to me from Day One that the terms of that arrangement were really quite punitive in terms of the interest rate and the commitment fee and the shortness of it," Liddy said in a Bloomberg Television interview yesterday. "I started really about a week after I got here trying to renegotiate."

Under the new plan, the government will inject $40 billion into AIG, a move similar to what it has done with U.S. banks. In addition, the government will help unload $52.5 billion in troubled assets on AIG's books while reducing the amount of the original loan and cutting its interest rate.

"In September, when AIG had to be rescued, we did not have authority to purchase equity," said Davis, the Treasury spokeswoman. If the Treasury's financial bailout program had already been created, she added, "we would have purchased equity at that time."