Fannie, Freddie to shrink after seizure

WASHINGTON - The Bush administration seized control of the two largest mortgage finance companies yesterday, seeking to shrink dramatically their outsize influence on Wall Street and on Capitol Hill while at the same time counting on them to pull the nation out of its worst housing crisis in decades.

The bailout puts Fannie Mae and Freddie Mac in a conservatorship and replaces their management.

It could become one of the most expensive financial bailouts in US history, though it will not involve any immediate taxpayer loans or investments. Treasury Secretary Henry M. Paulson Jr. would not say how much capital the government might eventually have to provide, or what the ultimate cost to taxpayers might be. Two months ago, the Congressional Budget Office gave a rough estimate of $25 billion. One senior official, speaking on the condition of anonymity, signaled yesterday that even that figure was optimistic.

Paulson said a failure of either company would cause turmoil in US and world financial markets: "This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans, and other consumer credit and business finance."

The chief executives of both companies were replaced. Herbert M. Allison, former chairman of TIAA-CREF, will take over Fannie Mae and succeed Daniel H. Mudd. At Freddie Mac, David M. Moffett, senior adviser at the Carlyle Group, succeeds Richard F. Syron.

The plan commits the government to provide as much as $100 billion to each company to backstop any shortfalls in capital. It enables the Treasury to ultimately buy the companies outright at little cost. It bans them from lobbying the government, putting an end to their ability to use their vaunted political machine.

It also eliminates dividend payments to current shareholders while protecting the principal and interest payments on the debt, now held by foreign central banks, financial institutions, pension funds, and others.

The Treasury will force both companies to shrink their portfolios in the near term - they now hold or guarantee about half of the country's mortgages - by having the government buy as much as $5 billion of their mortgage-backed securities on the open market. This step, never before undertaken by the government, could begin to restore some confidence in the credit markets and lead to lower interest rates for mortgages.

The plan represents a temporary cease-fire in a decades-long battle over the companies. Free-market conservatives see them as extensions of "big government"; Democrats have protected them as the main vehicle to promote affordable housing.

Alan Greenspan, former Federal Reserve chairman, and many others have long said the companies were too powerful and that their huge portfolios posed enormous risks to the financial system. Moreover, critics have complained, the companies used their ability to borrow at low interest rates to dominate the market.

Free-market adherents have warned of impending disaster as Fannie and Freddie used an implicit government backing to borrow at will, with only a sliver of capital to protect them from nasty surprises like the fall in housing prices and rise in foreclosures.

Holders of the companies' common stock will not fare well. The plan suspends their dividend payments and holds the potential to make their shares virtually worthless if the government exercises its right to buy the common stock. Their shares will continue to trade and could fall further.

Hoping to limit taxpayer losses and gain any financial windfall if the companies are restored to profitability, the administration will get purchase rights for up to 80 percent of the common shares at less than $1 a share. The companies provide the government with $1 billion of new preferred senior stock, which will pay the Treasury a dividend of at least 10 percent a year, as well as an unspecified quarterly payment. The companies can "modestly increase" the size of their portfolios until the end of 2009.

But in a strong indication of Paulson's long-term wish to wind down the companies' portfolios, drastically shrink their role, and perhaps eliminate their unique status, the plan calls for the companies to start reducing their investment portfolios 10 percent a year, beginning in 2010.