What Uncle Sam's Fannie and Freddie Plan Means for You

How the government's dramatic show of support will impact investors and mortgage rates.

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It's official! After a week in which Fannie Mae and Freddie Mac saw their stock prices slashed by nearly half, investors received confirmation of what they've always suspected: Uncle Sam will in fact step in if the congressionally chartered entities get in a serious jam. Looking to head off growing concerns that the mortgage finance giants might not have enough capital to weather the painful housing downturn, Treasury Secretary Henry Paulson on Sunday said he would take steps to temporarily increase Fannie and Freddie's credit lines with the department and even seek the authority to buy equity in either company should they need it. At the same time, the Fed voted to, in effect, provide Fannie and Freddie with access to its discount window.

The dramatic moves represent a sweeping effort to restore the market's confidence in Fannie and Freddie, which have become increasingly critical to the mortgage markets amid the ongoing housing crisis. Mike Larson, a real estate analyst at Weiss Research, says the government had little choice but to take such drastic action. "Fannie and Freddie have become sort of the last lifelines of liquidity for the mortgage market, and you can't have these huge gigantic institutions go under," Larson says. "Of the bad options out there, what [the federal government] is doing is probably the least bad of those options." So what does this all mean for investors and mortgage rates? U.S. News spoke with various industry professionals to find out.


The good news: Treasury is asking Congress to let it buy stock in the government-sponsored enterprises (GSEs) and raise the amount it can lend. Predictably, shares of Fannie and Freddie jumped between 20 and 30 percent in early trading. Unfortunately, the rally didn't last. The government's welcome show of support may stave off the worst-case scenario where the stocks go to zero, but both Fannie and Freddie were solidly in the red by midday.

That's because government support doesn't necessarily mean help for shareholders.

Paulson has reportedly made it clear he is willing to let shareholders take a bath rather than bail them out in order to avoid creating a "moral hazard." As the WSJ points out, bank bailouts during this crisis haven't exactly favored long-suffering equity investors. (Anybody own Bear Stearns shares?) Right now, the various scenarios for the future of Fannie and Freddie look like a choice between bad and worse for their stocks. First, the Fed's ability to buy up chunks of equity in the lenders could prove dilutive for shareholders. That's actually the good news. The opposite position—nationalization of the lenders—leaves investors in a scenario where shares basically become worthless. That is still a possibility.

Global Insight's Brian Bethune notes shares won't have much help until the Treasury telegraphs just how big an investment it's willing to make. He suggests the capital boost needs to be "very significant," possibly $20 billion or higher for both, in order to halt the sell-off.

Until that happens there is little for investors to do but watch and wait, a proposition that should grate on some nerves after watching shares plummet at least 75 percent this year in the wake of last week's massive drop.

Debt Holders

If the GSEs' stockholders are sweating their shrinking portfolios, everyone should be worried about Fannie's and Freddie's debt.

The primary goal of the government's plan is to reinforce faith in the pair and stamp out the sort of crisis of confidence that results in failures like that of IndyMac over the weekend.

There are early signs the drastic weekend measures are working.

This morning, Freddie Mac started the week with a generally successful $3 billion auction of short-term debt. Positive demand for the offering, reportedly pushed over the weekend by Treasury officials in calls to investment banks, seems to have succeeded as modestly better-than-expected. Fannie Mae's treasurer told Reuters borrowing was "business as usual."

That's a ray of sunshine for debt holders. If investors back away from buying new debt, there's little the government or the GSEs can to do restore confidence in either company as a going concern. After the offering, prices for agency debt and mortgage-backed securities rose relative to treasuries.