Possible Weekend Bailout for Freddie Mac and Fannie Mae

By Jennifer Yousfi
Managing Editor

Speculation that the U.S. government would have to step in to bail out struggling mortgage-giants Freddie Mac (FRE) and Fannie Mae (FNM) escalated as the markets set to close for the weekend.

Shares recovered slightly after Reuters reported U.S. Federal Reserve Chairman Ben S. Bernanke granted Freddie Mac and Fannie Mae emergency access to the Fed's discount window.

Freddie Mac shares pared earlier losses to shed just $0.25 Friday, a 3% decline, to close at $7.75. Earlier in the day, the stock had traded as low as $4.01. Freddie Mac is down over 77% year-to-date as of Friday's close. The stock has traded between $3.89 and $67.20 over the past 52 weeks.

Fannie Mae stock had a similar fate, shedding $2.95, a 22% to decline to close at $10.25, after climbing from $7.25 in early hours trading. Fannie Mae shares are down 45% in the past week and 74% year-to-date. Shares have traded between $6.68 and $70.57 over the last 12 months.

Rumors of a government-sponsored bailout swirled, with The New York Times reporting that President Bush & Co. were mulling over options. But Citigroup Corp. (C) issued a bold research note supporting the two government-sponsored entities (GSEs) in their current incarnations.

"We believe that no one in Washington desires for a nationalization of the GSEs, which would bring the burden of providing mortgage access and liquidity on to the shoulders of taxpayers," Citigroup Global Markets analysts Bradley Ball and Arren Cyganovich wrote in a research note Friday concerning Freddie Mac and Fannie Mae.

"We believe the market needs to be reminded that the GSEs were structured as shareholder-owned institutions for a reason - to provide non-federal capital support for the U.S. housing and mortgage markets, and that the GSE structure has worked in the past (such as during 1998) and continues to work today," the analysts continued, MarketWatch reported.

And while it's true that the government might be hesitant to step in after what many considered a taxpayer-sponsored bailout of The Bear Stearns Cos. Inc. (BSC), it's also true that the government can't afford to let Freddie Mac and Fannie Mae fail. Together, the two lenders guarantee about half of the $12 trillion U.S. home mortgage market.

"The impact of a failure of Fannie and Freddie, though technically insolvent, is beyond imagining, far greater than the bankruptcy of a Bear Stearns," said Barron's Randall W. Forsyth on Friday. "For that reason alone, such an eventuality is unthinkable."

Foreclosures Hit Fannie Mae and Freddie Mac in the Bottom Line

Rocketing foreclosure rates are only serving to exacerbate the problems of the largest U.S. lenders as one in every 501 households was at some stage of the foreclosure process in June, industry watchdog RealtyTrak announced Thursday.

"The foreclosure problem is getting worse and will stay with us well into the next decade," Mark Zandi, chief economist for Moody's Economy.com (MCO) said in an interview with Bloomberg News. "The job market is eroding and homeowners have less equity. Lenders are much less willing to work with you if you've got negative equity, and you're more likely to give up your house if you're deeply underwater."

U.S. Treasury Secretary Henry Paulson tried to reassure investors about Freddie Mac and Fannie Mae, saying both firms remain "adequately capitalized," The New York Times reported.

"Fannie Mae and Freddie Mac are also working through this challenging period," Paulson said in testimony before the House Financial Services Committee earlier this week. "They play an important role in our housing markets today and need to continue to play an important role in the future."
But former St. Louis Federal Reserve President William Poole questioned the solvency of Freddie Mac and Fannie Mae, saying the government might need to step in to rescue the struggling lenders.

"Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer," Poole, who left the Fed in March, said in the interview Wednesday, Bloomberg reported.

Poole has long been a critic of Freddie Mac and Fannie Mae, saying as early as 2003 that the companies would not be able to weather a serious market destabilization.

While the two firms are considered government-sponsored enterprises, neither Freddie Mac nor Fannie Mae receives funding from the U.S. government. Likewise, the government does not guarantee any debt-issued by the firms.

"At some point we're going to reach that inflection, where the government is going to have to either guarantee explicitly or Fannie and Freddie are going to have be left to fend for themselves," Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York, said in an interview with Bloomberg Television. "We're getting to that point where a decision has to be made by Washington."

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