Tags: freddie | fannie

Freddie-Fannie Lifeline Puts Taxpayers on the Hook

Tuesday, 15 Jul 2008 08:38 AM

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WASHINGTON -- Now that the federal government has thrown a lifeline to mortgage giants Fannie Mae and Freddie Mac, taxpayers could be on the hook for billions more if the crisis of confidence spreads.

There were encouraging signs Monday for the rescue plan, but also signs of concern — notably on Wall Street, where shares of the two companies slumped further -- that the plan won't be enough.

Other banks are already teetering: National City Corp. shares fell nearly 15 percent on rumors of financial trouble, even though it said it was experiencing no unusual depositor or creditor activity. And Washington Mutual Inc.'s shares fell 35 percent, to a paltry $3.23 amid worries about whether it had enough cash to handle the mortgage market downturn. WaMu said that it did.

And worried customers lined up Monday to pull cash out of their accounts at IndyMac Bank, seized on Friday by the federal government.

Some critics said they fear the Fannie-Freddie rescue effort will make more bailouts inevitable by sending a message that some institutions are too big to fail and thus encouraging risky behavior.

"It sends the wrong message to the world," said Joshua Rosner, managing director of research firm Graham, Fisher & Co. in New York.

Sung Won Sohn, an economics professor at The Smith School of Business at Cal State Channel Islands, cited soaring oil costs, a weakening economy and an unstable housing market that he said will only get worse.

"I don't think these steps are enough to arrest the deterioration," he said.

As long as more homeowners default on mortgages, losses to financial institutions will mount. Those losses already exceed $400 billion, and some analysts believe they will top $1 trillion before the housing carnage is over.

By comparison, Congress has authorized $650 billion so far to fight the Iraq war.

The Bush administration and the Federal Reserve announced an emergency rescue plan Sunday to bolster Fannie Mae and Freddie Mac, which hold or guarantee more than $5 trillion in mortgages — almost half of the nation's total.

The plan would temporarily increase a long-standing Treasury line of credit that could be provided to either company. Treasury also said it would, if necessary, buy stock in the companies to make sure they have enough money to operate.

The Fed also announced it would allow Fannie and Freddie to get loans directly from the Fed -- a privilege previously granted only to commercial banks until this March, when the Fed extended the borrowing to investment banks to deal with the collapse of Bear Stearns.

House Financial Services Chairman Barney Frank, D-Mass., predicted Congress would grant approval for the extended line of credit as part of a broader housing measure that he believes President Bush could sign by the end of next week.

In a letter to Fed Chairman Ben Bernanke and Timothy Geithner, the president of the Fed's New York regional bank, Treasury Secretary Henry Paulson said Monday that he saw any Fed loans as an interim step designed to serve as a bridge to legislation. He added the administration is pursuing legislation "urgently" with Congress to increase Treasury's lending authority to the two institutions.

Monday began with a good sign for Freddie Mac: It attracted more bidders than it had all year for one of its regular debt auctions which raised $3 billion in short-term securities.

Fannie and Freddie stock rose early in the day but gave up the gains. Fannie closed down about 5 percent, at $9.73, and Freddie closed down about 8 percent, at $7.11.

Meanwhile, hundreds of worried customers lined up Monday to pull their money out of IndyMac bank, seized by the government Friday in the second biggest bank failure in U.S. history.

The Federal Deposit Insurance Corp. estimated the IndyMac failure, the largest since the collapse of Continental Illinois in 1984, would cost between $4 billion and $8 billion out of the agency's $53 billion insurance fund.

Analysts do not expect the volume of bank failures that happened from 1990 to 1992, when 834 of them folded. But the FDIC does plan to review whether to raise the fees it charges banks to beef up its insurance fund.

Brian Bethune, chief U.S. financial economist at Global Insight, called the troubles at Fannie and Freddie a "potentially dangerous turn of events" for the U.S. economy.

He said they needed to be addressed quickly with an infusion from the government — read "taxpayers" — of as much as $20 billion in new capital for both institutions.

Right now, the Treasury can extend up to $2.25 billion in loans each to Fannie and Freddie. Officials refused to discuss what the new limit might be but dismissed one report of a $300 billion limit as too high.

Treasury officials also said directly buying Fannie and Freddie stock would be a last resort.

Substantial sums are involved in any event. Analysts say the economic risks of doing nothing are just too great.

"If the government hadn't moved and Fannie and Freddie failed, the cost to taxpayers and the overall economy would be enormous," said Mark Zandi, chief economist at Moody's Economy.com.

In Fannie and Freddie were unable to play their huge roles in financing new mortgages, the housing market would only suffer more, he said -- not to mention the turmoil for the financial institutions around the world that invest in Fannie and Freddie's debt securities.

Critics have warned for years that Fannie and Freddie had grown too large, with not enough of a financial cushion.

"They have been allowed to grow out of control to the point where they must be backed by the U.S. government," said Peter Wallison, a senior fellow at the American Enterprise Institute and a longtime critic. "We have just ... allowed ourselves to become hostage to these two institutions."

Fannie and Freddie's financial reports remain difficult to understand, even after accounting scandals that came to light five years ago forced the companies to restate several years of earnings and oust top executives.

Wall Street analysts were spooked in May when one measurement of Freddie Mac's total assets fell to negative $5.2 billion at the end of the first quarter, a huge swing from positive $12.6 billion at the end of last year.

The company downplayed the figure, saying it reflected a frozen market for mortgage investments, and said those assets would eventually rebound in value.

The next few weeks -- in which Fannie and Freddie post their second-quarter results and may attempt to raise a bigger capital cushion -- are key, Zandi said. He said in the best possible outcome is if the rescue plan helps the two companies stabilize their finances on their own without any loss of government loans.

"At the end of the day, with a little bit of luck, it won't cost taxpayers a dime," Zandi said.

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