Default Guide Blog

The anxiety over Fannie Mae and Freddie Mac, crucial to a recovery of the battered housing market and the economy as a whole, took stocks on a wild ride Friday. An early selloff was fanned by speculation of looming bailout. The stocks recovered on assurances by a leading senator that no rescue is needed. Immediately after the markets opened, shares of Fannie (FNM, Fortune 500) and Freddie (FRE, Fortune 500) fell more than 47% from their already battered closing price the day before. They soon rebounded later in the morning but Fannie shares were still down about 24% and Freddie shares were off 22% in early afternoon trading. The shares of both companies recovered most of their losses shortly after 2 p.m. when Sen. Christopher Dodd, D-Conn., the chairman of the Senate Banking Committee, defended the strength of both firms. Dodd said that his discussions with Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson, the regulators who oversee the firms and the two companies’ CEOs convinced him they have more than adequate capital and that there was no need to even discuss failure or a bailout. He also vowed quick passage of a long-debated housing bill to give greater oversight of the two companies, saying he expected it to passed and ready to be signed into law sometime next week. “There is a sort of a panic going on,” he said. “The facts don’t warrant that reaction in my view. Fannie Mae and Freddie Mac were never bottom feeders in the residential mortgage markets. People ought to feel confident about them.” While shares of Fannie were still off 10% after his remarks, Freddie shares were off only 3% when he concluded his comments. Still, the problems for Freddie and Fannie weighed on broader markets, causing a sell-off in U.S. stocks, especially hitting major banks, Wall Street firms and home builders.

Fannie and Freddie hold or back $5 trillion between them, or about half the mortgage debt in the country. They play a central role in the U.S. housing market, providing a crucial source of funding for banks and other home lenders, especially since a credit market crisis last summer left them the only major players in packaging pools of mortgage loans into securities for sale to investors. If they were unable to do so, it would significantly raise the cost and restrict the availability of mortgage loans, causing significantly more problems for already battered housing prices and sales. That in turn would be another significant problem for the overall U.S. economy, as well as global credit markets.

The New York Times reported Friday that senior Bush administration officials are considering a plan to have the government take over one or both of the companies if their problems worsen. The shares started to erase early losses when word came that Treasury Secretary Henry Paulson was set to speak. He said that the government’s primary focus is making sure that mortgage giants Fannie Mae and Freddie Mac remain as presently constituted to carry out their mission. Even before the latest report on a possible rescue plan, speculation about the future of the firms this week sparked a run by investors away from their shares. That in turn raised questions about how difficult and expensive it will be for them to raise needed capital in the future, which fed into the stock plunge in a vicious cycle. In the first four trading days of the week, the shares of Fannie have lost 30% of their value, while Freddie shares have tumbled 45%. For the year, Fannie is down 67% and Freddie 77%. “Fannie Mae and Freddie Mac have lost investor confidence evidenced by the rapid brutal sell-off in their stocks, which could dramatically hinder their ability to raise any additional capital going forward,” wrote Richard Hofmann of research firm CreditSights in a note Friday. He added that the firms’ ability to function normally “remain at the core of government efforts to stabilize the mortgage markets.” A number of scenarios were being discussed by bankers and analysts about what the government may do to deal with investors’ current crisis of confidence in the firms. Jaret Seiberg, a financial services analyst for the Stanford Group, a Washington research firm, said Thursday options that among the options are: The Federal Reserve could purchase some of the Freddie and Fannie debt or mortgage-backed securities; the Treasury Department could make billions of dollars in loans to the companies or even buy stock in the companies. “Government officials are always planning for worst-case scenarios and our note is intended to highlight some options that may be available to policymakers,” he wrote. “We suspect hybrid versions of these plans also are possible.”

Under current law, the Office of Federal Housing Enterprise Oversight (OFHEO), the regulator of Fannie and Freddie, could take control of the firms if their capital falls too far below required levels. It is unclear how the firms would operate in that situation, known as a conservatorship. OFHEO Director James Lockhart issued a statement late Thursday saying that his agency was closely monitoring the firms’ credit and capital positions. But he pointed out that they had already raised $20 billion in capital and that they adequately capitalized, holding funds well in excess of his agency’s requirements.

Still investors were worried that continued problems in the housing market would cause more than the $12.7 billion losses the two firms have lost between them since last July. The decline in their stock value makes raising additional capital to cover those future losses that much more expensive and difficult. “Our primary concern about Freddie and Fannie is that credit losses are likely to be worse than the management’s current judgment, which will further pressure the capital base, and we remain cautious until we are better able to quantify these risks,” wrote UBS analyst Eric Wasserstrom in a note Thursday. Those concerns prompted him to raise his estimated loss for Freddie and to cut his price target for the stock, although, he retained his neutral rating on both firms, rather than urging clients to sell their holdings.  Part of the problem for the stock Friday is it is unclear if current shareholders would see their holdings wiped out under some of these government rescue options.

A Fannie spokesman said Friday morning that the company had no comment, while a spokeswoman for Freddie was not available for immediate comment. Both firms issued statements on Thursday saying they had the necessary capital to continue operating, adding they would not comment on the decline in their stock value.