Mortgage giants face US takeover

Bailout of Fannie Mae and Freddie Mac could cost taxpayers tens of billions

WASHINGTON - Senior officials from the Bush administration and the Federal Reserve yesterday informed top executives of Fannie Mae and Freddie Mac, the mortgage finance giants, that the government was preparing to seize the two companies and place them in a conservatorship, officials and company executives briefed on the discussions said.

The plan, effectively a government bailout, was outlined in separate meetings that the chief executives were summoned to attend yesterday at the office of the companies' new regulator. The executives were told that, under the plan, they and their boards would be replaced and shareholders would be virtually wiped out but that the companies would be able to continue functioning with the government generally standing behind their debt, people briefed on the discussions said.

It is not possible to calculate the cost of any government bailout, but the huge potential liabilities of the companies could cost taxpayers tens of billions of dollars and make any rescue among the largest in the nation's history.

The drastic effort follows the bailout this year of Bear Stearns, the investment bank, as government officials continue to grapple with how to stem the credit crisis and housing crisis that have hobbled the economy. With Bear Stearns, the government provided guarantees and the bulk of its assets were transferred to JPMorgan Chase, leaving shareholders with a nominal amount.

Under a conservatorship, the remaining common and preferred shares of Fannie and Freddie would be worth little, and any losses on mortgages they own or guarantee could be paid by taxpayers. A conservatorship would operate much like a prepackaged bankruptcy, similar to what smaller companies use to clean up their books and then emerge with stronger balance sheets.

The executives were told that the government had been planning to announce the decision as early as tomorrow, before the Asian markets reopen, the officials said. For months, administration officials have grappled with the steady erosion of the books of the two mortgage finance giants. A fierce debate behind the scenes among policymakers has considered whether to seize the companies or let them work out their problems.

But the declining housing and financial markets have apparently now forced the administration's hand. With foreign governments growing increasingly skittish about holding billions of dollars in securities issued by the companies, no sign that their losses will abate any time soon and the inability of the companies to raise new capital, the administration apparently decided it would be better to act now rather than closer to the presidential election in two months.

Just five weeks ago, President Bush signed a law to give the administration the authority to inject billions of dollars into the companies through investments or loans. In proposing the legislation, Treasury Secretary Henry M. Paulson Jr. said that he had no plan to provide loans or investments and that merely giving the government the authority to backstop the companies would provide a strong shot of confidence to the markets. But the thin capital reserves that have kept the two companies afloat have continued to erode as the housing market has steadily declined and the number of foreclosures has soared.

As their problems have deepened - and the marketplace has come to expect some sort of government rescue - both companies have found it difficult to raise new capital to absorb future losses. In recent weeks, Paulson has been reaching out to foreign governments that hold billions of dollars of Fannie and Freddie securities to reassure them that the United States stands behind the companies. In issuing their quarterly financial statements last month, the two companies reported huge losses and predicted that home prices would fall more than previously projected.

The debt securities the companies issue to finance their operations are widely owned by mutual funds, pension funds, foreign governments, and big companies.

Officials said the participants at the meetings included Paulson, Ben S. Bernanke, the chairman of the Fed, and James Lockhart, the head of both the old and new agency that regulates the companies. The companies were represented by Daniel H. Mudd, the chief executive of Fannie Mae, and Richard F. Syron, chief executive of Freddie Mac. Also participating was H. Rodgin Cohen, the chairman of the law firm, Sullivan & Cromwell, who was representing Fannie. Officials and executives briefed on the meetings said Mudd and Syron were told that they would have to leave the companies. Spokesmen at the two companies did not return telephone calls seeking comment.

The meetings reflected the reality that senior administration officials did not believe they could wait for some kind of financial tipping point, as happened with Bear Stearns, which was saved from insolvency in March by government intervention after its stock plummeted and lenders withheld their capital. Instead, Paulson has struggled to navigate through potentially conflicting goals - stabilizing the financial markets, making mortgages more widely available in a tightening credit environment, and protecting taxpayers from possibly enormous losses.

Publicly, administration officials have tried to bolster the companies because the nation's mortgage system relies on their continued ability to purchase mortgages from commercial lenders and pull the housing markets out of their slump.

But privately, senior officials have been critical of top executives at the companies, particularly Freddie Mac. They have raised concerns about major risks to taxpayers of a bailout of companies whose executives have received huge compensation packages. Syron, for instance, collected more than $38 million in compensation since he joined the company in 2003.

Syron was slated to step down from the chief executive position last year, but that was delayed when his appointed successor, Eugene McQuade, chose to leave the company.