Freddie Mac and Fannie Mae saw their shares get cut almost in half last week. Freddie Mac's stock tumbled from a close of $14.50 on July 3rd to trading as low as $3.89 last Friday before recovering to $7.75. Fannie Mae went from $18.78 on July 3rd to as low as $6.68 last Friday before closing at $10.10. The freefall was kickstarted on Monday when Lehman Brothers analysts wrote a note to clients:
The new FAS 140 rule that seeks to stop companies keeping assets in off-balance sheet entities may force Fannie Mae and Freddie Mac to bring mortgages back onto their books, requiring them to put up capital, Lehman analysts led by Bruce Harting wrote in a note to clients today. Fannie Mae would need to add $46 billion of capital and Freddie Mac would need about $29 billion, the Lehman analysts wrote. The companies will probably get an exemption from the rule because it would be ``very difficult'' for them to raise that amount of capital, the analysts said.
Fannie Mae and Freddie Mac shares rebounded on Tuesday possibly in part because the market realized that the analyst also said that the companies would probably get an exemption from the rule. James Lockhart, the director of the Office of Federal Housing Enterprise Oversight, also said on Tuesday that "Fannie and Freddie are adequately capitalized at this point."
On Wednesday Fannie Mae paid a record yield of 74 basis points over the U.S. Treasuries. This was triple what they paid in June 2006. Credit-default swaps tied to their AAA rated debt were trading at levels implying their debt should be rated A2 instead. Also on Wednesday, William Poole, former St. Louis Federal Reserve President said that:
Freddie Mac is technically insolvent under fair value accounting, which measures a company's net worth if it had to liquidate all its assets to repay liabilities. Fannie Mae may become insolvent this quarter, Poole said, increasing pressure on the government to instigate a rescue. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules. The fair value of Fannie Mae's assets tumbled 66 percent to $12.2 billion and may be negative next quarter, Poole said.
On Sunday, the U.S. Treasury announced a plan making the implicit guarantee explicit. Here is Treasury Secretary Henry Paulson's statement:
Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction. GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure. In recent days, I have consulted with the Federal Reserve, OFHEO, the SEC, Congressional leaders of both parties and with the two companies to develop a three-part plan for immediate action. The President has asked me to work with Congress to act on this plan immediately. First, as a liquidity backstop, the plan includes a temporary increase in the line of credit the GSEs have with Treasury. Treasury would determine the terms and conditions for accessing the line of credit and the amount to be drawn. Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed. Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer. Third, to protect the financial system from systemic risk going forward, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards. I look forward to working closely with the Congressional leaders to enact this legislation as soon as possible, as one complete package.
Fannie and Freddie were brought to their knees by declining home values. The decline in home prices may be half way done. If that is the case, it is hard to value how large this assistance to the GSEs will become. However, with the GSEs holding or guaranteeing $5 trillion in mortgages, the number could be staggering.
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