Government plan for Fannie, Freddie to hit shareholders

The corporate logo for Freddie Mac is seen at its headquarters building in McLean, Virginia, July 23, 2008. (REUTERS/Larry Downing)

WASHINGTON (Reuters) - The U.S. government plans to take over Fannie Mae and Freddie Mac and all shareholders of the two mortgage giants will take a hit, an influential lawmaker said on Saturday.

The move to take control of the two companies, expected to be announced on Sunday, could amount to the largest financial bailout in the nation's history, and is a bid to ward off further damage to a housing market in its deepest downturn since the Great Depression.

"I think all shareholders will be disadvantaged," Rep. Barney Frank, chairman of the U.S. House of Representatives Financial Services Committee, told Reuters.

"The government will act as the new management," implying the chief executives would be ousted, according to Frank, who spoke to U.S. Treasury Secretary Paulson on Friday about the plan to put the companies into federal conservatorship to protect the interest of all parties.

An industry source said the two government-sponsored enterprises were sent a letter by their regulator, the Federal Housing Finance Agency, detailing shortcomings at the companies and explaining why the federal government was taking control.

The source said the letter suggested the companies, which own or guarantee almost half of the country's $12 trillion in outstanding home mortgage debt, should agree to the arrangement in order to avoid the more onerous step of being placed in a receivership in the interests of debtholders.

In a separate interview with The Washington Post, Frank said the government was expected to control the companies for at least a year as it considers whether they should remain government-run, or be restructured.

Paulson, Federal Reserve Chairman Ben Bernanke, and the director of the companies' regulator, James Lockhart, met with the chief executives of the two companies on Friday to detail the plan.

Other sources said the boards of Fannie Mae and Freddie Mac were briefed in meetings or conference calls on Saturday. Fannie Mae argued it was in a stronger capital position than Freddie Mac and had fulfilled a promise to raise funds, but there was no sign that argument gained traction.

The U.S. Treasury, the Federal Reserve and Freddie Mac declined to comment. Fannie Mae did not return calls seeking comment.

The planned intervention reflects concerns among U.S. officials that financial markets had begun to lose confidence in the companies, after they suffered combined losses of nearly $14 billion in the last four quarters.

The stocks of the two companies have fallen more than 90 percent in the past year and in recent months foreign investors have pared their holdings of the companies' securities.

In an emergency move in July, the U.S. Congress gave the Treasury the authority to extend an undetermined amount of credit to the companies or take a stake in them if they ran into trouble.

ECHOES ON CAMPAIGN TRAIL

Paulson discussed the plan with Democratic presidential hopeful Sen. Barack Obama on Friday and Republican candidate Sen. John McCain on Saturday.

"I think it has to be done," McCain said in an interview with the CBS program "Face the Nation" to air on Sunday. "There's got to be restructuring, there's got to be reorganization, and there's got to be some confidence that we've stopped this downward spiral."

Obama also agreed action was needed.

"Intervention was necessary," he said in an interview on the ABC program "This Week with George Stephanopoulos" that will also air on Sunday. But at a campaign stop in Terre Haute, Indiana, he said he was withholding final judgment until he could see details.

"We have to protect taxpayers and not bail out the shareholders and management," Obama said. McCain also said it should not be a "bailout of Wall Street speculators and irresponsible executives."

FINANCIAL MARKETS SAW IT COMING

Financial markets have come to expect that an investment by the U.S. Treasury would explicitly back the companies' $1.6 trillion in debt, but leave their shares nearly valueless.

The Washington Post reported on Saturday that the value of the company's common stock would be diluted but not wiped out, while the holdings of other securities, including company debt and preferred shares, would be protected by the government.

Separately, The New York Times said the executives and their boards would be replaced and shareholder value diluted, but the companies would be able to continue functioning with the government generally standing behind their debt.

Analysts at Citigroup, Merrill Lynch, and Goldman Sachs have issued reports since mid-August saying the companies had plenty of capital to operate for the near term, and both have successfully rolled over debt in the meantime.

However, since August22, all the major credit rating agencies have cut their ratings on the companies' preferred stock on expectations that the share price declines had cut access to capital, increasing the need for emergency financial support.

While the companies never lost their access to capital markets, the biggest buyers of their debt had grown more cautious. Foreign central banks reduced their holdings of "federal agency" debt in custody at the Federal Reserve in the past week for the seventh week in a row.

With foreign demand now in question, "it sounds like they said, 'Why wait until there's a total panic? Let's go ahead and forestall it somewhat.' But there's still so much uncertainty of how investors will be treated," said James McGlynn, portfolio manager at Summit Investment Partners in Southlake, Texas.

(Additional reporting by Deborah Charles in Terre Haute, Indiana, Jeff Mason in Colorado Springs, Al Yoon in New York and Mark Felsenthal, David Lawder and Glenn Somerville in Washington; Writing by Tim Ahmann; Editing by Peter Cooney)