JEFFREY BROWN: It was another tense day in a terrible week on Wall Street for mortgage giants Fannie Mae and Freddie Mac, as their share prices fell still further.
The companies’ market value has dropped more than 80 percent — or more than $120 billion combined — since a year ago.
President Bush was briefed by Treasury Secretary Henry Paulson this morning.
GEORGE W. BUSH, President of the United States: Freddie Mac and Fannie Mae are very important institutions. We spent a fair amount of time discussing these institutions, and he assured me that he and Ben Bernanke will be working this issue very hard.
JEFFREY BROWN: The Federal National Mortgage Association, nicknamed Fannie Mae, and the Federal Home Loan Mortgage Corporation, or Freddie Mac, were created by Congress decades ago to provide a steady stream of money for home mortgages.
They’re unusual entities, private companies traded on the stock market, but also operating as government-sponsored enterprises, or GSEs, with a widespread sense that they have the guarantee of the government behind them.
They are by far the largest providers of home loan financing, owning or guaranteeing about $5 trillion of mortgages, more than half the total outstanding.
But in the mortgage foreclosure crisis, Fannie and Freddie have lost more than $11 billion. And investors worry they’ll be unable to raise enough cash to continue buying mortgages.
According to news reports, a government takeover and other possible contingency plans are under consideration in the event of a failure.
Today, though, Treasury Secretary Paulson tried to stem such fears, with a statement that the government intended to keep Fannie and Freddie intact. Yesterday, he told members of Congress that the two companies had enough reserves to withstand mortgage losses.
HENRY PAULSON, U.S. Treasury Secretary: Fannie Mae and Freddie Mac are also working through this challenging period. They play an important and vital role in our economy and housing markets today, and they need to continue to play an important role in the future. Their regulator has made clear that they are adequately capitalized.
JEFFREY BROWN: For their part, the companies maintain they have enough capital to get through the current turmoil.
And to further explore this story, we turn first to Charles Duhigg of the New York Times.
Well, Charles, I said these are unusual entities, but fill that in for us. Why were they set up this way? And what role have they come to play in the nation’s housing market?
CHARLES DUHIGG, The New York Times: They were set up to provide greater liquidity for the mortgage marketplace. Basically what Fannie Mae and Freddie Mac do is they go to banks, and they buy mortgages, and they package them and then resell them to investors. Some of them they keep for themselves. And by doing so, they give banks fresh money to go out and make other loans with.
Over the last couple of decades, they’ve become increasingly important to how the mortgage economy works. At this point, basically today they are buying all of the mortgages that are out there. And so as a result, the way that the wheels of the mortgage economy keep on turning is because Freddie and Fannie keep on putting more money out there for banks to loan.
The troubles behind the firms' fall
JEFFREY BROWN: And I guess there's always been this question about what it means to be -- what their relationship is to the government. I guess that is being tested in a way that has never been before, right?
CHARLES DUHIGG: That's exactly right. For years, there has been this tension that everyone in the marketplace has believed that, if Freddie and Fannie ever had any real problems, that the government would step in and back them. And for years, the government has said, "No, we're not going to do that. This is a wrong assumption on your part."
Until now, it's been a theoretical conversation. But with Freddie and Fannie on the skids, there's a lot of attention being paid to see exactly how far the government's willing to go to prop them up.
JEFFREY BROWN: But you've been watching this. How exactly did they get into so much trouble?
CHARLES DUHIGG: It's a little unclear exactly what precipitated the crisis this week. Over the last couple of years, Freddie and Fannie have experienced increased competition. When the housing market was booming, everyone got into this business.
So as a result, Freddie and Fannie, to keep profits high -- because they are companies that have to answer to shareholders -- started for their own portfolio buying more and more risky loans.
As a result, when things started blowing up, just like at Bear Stearns and every other bank on Wall Street, they started experiencing losses. And as those losses started mounting, there was some concern about their future profitability.
Over the last couple of weeks, those fears have kind of started pushing the stocks down. And then this week, there were a couple of small news items that seemed to sort of set off a fire that just drove these stocks into the ground.
JEFFREY BROWN: Now, your paper reported that the government was looking at a possible takeover. How much is known about where that stands? How far along are such plans?
CHARLES DUHIGG: It's unclear exactly how far along such plans are. Secretary Paulson and Mr. Bernanke have come out and they have said that they do not see anything happening imminently. And as a result, everyone is sort of taking a deep breath to see what happens next.
We're working as hard as we can to find out exactly what is going on. We know that there is some discussion going on within the federal government over these issues, but it's unclear to us what would precipitate a takeover and whether a takeover would ever really happen. It's a very complicated thing, and it's unclear what anyone really intends to do.
JEFFREY BROWN: And one other bit of news floating around today. There were some reports, actually later denied by the Fed, about whether the Fed was ready to offer Freddie and Fannie access to the emergency discount window. Now, explain to us what that means and what good that would do for the companies.
CHARLES DUHIGG: Well, it would give the companies access to guaranteed debt. They could go, and they could borrow money at a fairly low rate, and they would be guaranteed to have access to that debt. The Fed did say that they have had no discussions about that whatsoever.
And the issue for Freddie and Fannie, debt is their lifeblood. They borrow billions of dollars every week. But the crisis that's going on right now is a stock crisis.
Throughout the week, although they've had to pay a little bit more to borrow money, there hasn't been any indication that they're going to be cut off by lenders.
What's really happening is that stock or equity, which is sort of the opposite of debt, has started fleeing the companies and, in fact, they've moved into the company's debt.
JEFFREY BROWN: All right, Charles. Stay with us if you would.
CHARLES DUHIGG: Absolutely.
Long-term effects of weakened stock
JEFFREY BROWN: I want to bring in two analysts who've been watching all this. Tom Gallagher is senior managing director of the investment firm International Strategy Investment Group, and Karen Shaw Petrou is managing partner of Federal Financial Analytics, a research and consulting firm.
Well, Karen Petrou, you have the administration, you have the Fed, you have the companies themselves all saying that this is not a crisis, and yet the stock has been plummeting. So explain to us what's going on.
KAREN SHAW PETROU, Federal Financial Analytics: Well, there isn't a real crisis. There certainly isn't anything new about Fannie Mae or Freddie Mac that we didn't know before.
The companies were and are undercapitalized. They were and are involved solely in mortgage finance, which isn't necessarily the most comfortable place to be. But there's nothing new and nothing dramatic that would create the crisis of the moment.
JEFFREY BROWN: So how do you explain it?
KAREN SHAW PETROU: Panic.
JEFFREY BROWN: Panic?
KAREN SHAW PETROU: This is a very, very scared market. It heard a noise in the closet, and it's pulled the covers up over its head, and it's not going to look out until, Mom, like the federal government, comes in and says it's OK.
JEFFREY BROWN: Tom Gallagher, how do you see it?
TOM GALLAGHER, International Strategy and Investment Group: I agree. I think, as to understanding why there's not an immediate problem, it's useful to think about two situations where there would be an emergency situation.
If the company were insolvent -- that is, if its assets were less than its liabilities -- or a solvent company can have a liquidity problem if it can't meet its short-term obligations, if it can't cover a debt payment that's coming due. These firms are a long way from both of those.
And so I think that what you saw in Washington this week was an attempt by policymakers, both in the administration and on the Hill, to offer re-assurances that, should these situations arise, they would provide an answer, but that created expectations in the markets for something immediately.
I think that the New York Times story today that you mentioned earlier really set off the market reaction today. It's true the stock price plummeted, but the price of the bonds rose because of the perception that the bondholders would be protected.
JEFFREY BROWN: But you guys watch this. I mean, I watch it from my perch. When you ask the question, "What's real and what's panic?" at a certain point, does it matter that much, Tom Gallagher?
TOM GALLAGHER: It doesn't matter to policymakers right now. I think the weak stock price can create a long-term situation that policymakers worry about. It can make the housing market a more difficult one.
If Fannie and Freddie can't raise capital, that's going to make it harder for some people to get mortgages. It will make it more expensive for those who can get them, but that's a longer term problem.
I think that means, in the short run, what they want to do is offer these re-assurances in the event that there's either a liquidity problem or a solvency problem. But, again, that's not an imminent development.
Tools of federal regulators
JEFFREY BROWN: Karen Petrou, what other tools do the federal regulators or officials have? I mean, we've talked about a possible takeover. What are the possibilities of that? And what other possibilities are there?
KAREN SHAW PETROU: Well, you mentioned and Charles mentioned that Fannie Mae and Freddie Mac are government-sponsored enterprises. There is a unique contradiction in that, because as enterprises they're owned by their shareholders, and so, when the stock price goes down, normally one option would be a takeover, a merger, some sort of investment by private shareholders.
But because they're also government-sponsored with many unique privileges, that gets really hard to do. Who owns these firms and what control that would bring them over the nation's mortgage market is a critical policy issue.
So you're really thrown back to the kind of solutions that you use for a federal entity, but then those profit shareholders, there's a real contradiction.
JEFFREY BROWN: But you're suggesting -- you said before that all these investors who are driving the stock down are waiting for just that kind of -- that dramatic action from the government. Do you think it's possible or imminent?
KAREN SHAW PETROU: At this point, it seems that either the markets will calm over the weekend or steps will need to be taken urgently to stabilize these two firms. They're just too big and too intertwined with our economy and the global financial markets to be let to fail.
JEFFREY BROWN: What do you think about that "letting it fail" argument?
TOM GALLAGHER: Well, that's -- I think, of all the people who've spoken over the last two or three days, everybody agrees that they're not going to be allowed to fail, but I think that that's the final step or in the terms of the sequence of policy actions that policymakers can take.
I think you start off with what you've seen over the last few days, attempts to re-assure. If that doesn't work, then you start to try to get commitments for somewhat more specific action.
But if you really do get to a liquidity problem, because that's the first thing that you would encounter if Fannie or Freddie couldn't meet some short-term obligations, then you bring the Fed in possibly, you bring in the Treasury Department.
I think there's an interesting possibility for Congress. Usually, you don't think of Congress acting quickly, but there's a housing bill that's in conference now that could be a way to extend or increase the lines of credit to these companies in the next few weeks.
JEFFREY BROWN: Charles Duhigg, let me bring you back in here. What would happen under a kind of conservatorship if the government steps in? What cost to the government? What cost to the taxpayers?
CHARLES DUHIGG: There's actually no necessary cost to the government or to taxpayers. It's a relatively slow and very spelled-out process, and it would take a little while for it to happen.
It's a little ephemeral at this point, because it's never happened before, but it would give the government essentially almost complete control over these companies, but would not obligate taxpayers or the government to pay anything. And, in fact, taxpayers could only be obligated by an act of Congress.
So although we're seeing a lot of crisis today and a lot of discussion of this, I think this is a slow process that's going to happen.
Secretary Paulson, Mr. Bernanke, everyone has gone to pains to say they are not going to do anything rashly and they're going to wait. And the fact of the matter is, Freddie and Fannie are still continuing to do their business every single day, regardless of the price of their stock.
Government prepares for crisis
JEFFREY BROWN: All right, now let me come back to you two at the table with -- the larger question here is the risk of this spreading to the financial system in a bigger way.
Yesterday, Secretary Paulson and Chairman Bernanke were asked about this specifically at a congressional hearing. They didn't want to speculate, and one can understand why.
But let me ask you -- I'll start with you, Tom Gallagher -- what are the risks of this spreading?
TOM GALLAGHER: Well, there's the specific risk to the housing market that I just mentioned: Mortgages get harder to get, and they get more expensive.
There's a broader risk to the financial system, if the debt -- if Fannie or Freddie default on their bonds. A lot of banks own these securities. They thought that they're as good as treasuries.
If banks take further hits to their earnings, to their balance sheets, they're going to be more reluctant to lend, so the rest of the economy really, really suffers there.
Plus, a lot of foreign central banks, a lot of foreign investors have purchased these securities again thinking they're as good as treasuries, so you could have international implications of this, as well.
JEFFREY BROWN: Foreign implications, as well? This is a global issue, right, Karen?
KAREN SHAW PETROU: Oh, absolutely. Fannie Mae and Freddie Mac, debt and the mortgage-backed securities they issue are held around the world because they were deemed agency paper.
JEFFREY BROWN: What does that mean?
KAREN SHAW PETROU: As good as a U.S. government obligation, because, as Charles said, the markets always viewed them as backed by the federal government, even though legally there's no obligation for the federal government to support them.
And the Federal Reserve owns a lot of Fannie Mae, Freddie Mac paper. Central banks, your bank, everyone's banks sits on a lot of this paper.
JEFFREY BROWN: And the government is clearly -- our government is clearly aware of that to its citizens and citizens around the world?
KAREN SHAW PETROU: Oh, absolutely.
JEFFREY BROWN: Do you see them, that kind of urgency, therefore, because of that? I mean, is that why we're seeing all this activity today? And what happens over the weekend? I mean, is this a...
TOM GALLAGHER: I think the reason for the urgency is that people's portfolios are shrinking. And that creates a sense of panic that they hope policymakers share. And that's not the case.
So I think that you're going to see a more deliberate kind of a process, but, again, everybody who's talked about this, even some of the critics of Fannie and Freddie, have said that the government will be there to back them up.
So I think we're not that close to a crisis situation, but the government is clearly preparing for one, should it develop.
JEFFREY BROWN: Charles Duhigg, what does your reporting tell you about concern out there about how much or how quickly this could spread?
CHARLES DUHIGG: I think that there's a lot of concern. As Karen pointed out, everyone owns this paper, and so there's a lot of concern about sort of the ramifications of this.
We're seeing it echo through essentially every part of Wall Street. And it's certainly having a lot of impact on the financial industry.
That being said, as everyone's pointed out, I don't think that there's a lot of uncertainty over whether the government will eventually step in, if they have to. The uncertainty is over how that would happen, who would end up winning and who would end up losing.
And so as a result, although there is panic, it's not the type of panic that is so contagious that we have to be worried about the worldwide economy right now.
JEFFREY BROWN: So, Karen, it's Friday afternoon. We have the weekend. We hope that things calm down. What do you look for on Monday to tell you whether things have really calmed down?
CHARLES DUHIGG: We look for the Asian markets and the European markets over the weekend, statements throughout the weekend.
I completely agree with Charles and Tom that these are sound firms. They're sitting on a lot of capital. They should have more, but they've still got lots, and they've got access to the markets. A deep breath is really what's needed here.
JEFFREY BROWN: Tom Gallagher, final word?
TOM GALLAGHER: I agree. I'm not sure that they'll take that deep breath over the weekend.
JEFFREY BROWN: It's a nice summer weekend, but who knows, right?
TOM GALLAGHER: Exactly. But I think it's really indicative of the broader problems that many financial firms have. These are just unique because they're so big and they're government-sponsored enterprises, but lots of financial firms are having trouble raising capital, as well.
JEFFREY BROWN: All right. Tom Gallagher, Karen Shaw Petrou, and Charles Duhigg in New York, thanks very much.