'Too big to Fail': Fannie Mae and Freddie Mac, Part I

The US government has exercised a four-part plan to place Fannie Mae and Freddie Mac -- government sponsored entities (GSEs) that together control about half of the country's outstanding mortgages -- under its control.

Here is the September 7 statement by Treasury Secretary Henry M. Paulson, Jr. and Jim Lockhart, Director of the new independent regulator, the Federal Housing Finance Agency (FHFA).

The four parts of the plan are:

First part: 'Conservatorship,' meaning that the Federal Housing Finance Agency (FHFA) has been appointed as official overseer of the two companies.

From the Treasury website:

Q: What is a conservatorship?

A: A conservatorship is the legal process in which a person or entity is appointed to establish control and oversight of a Company to put it in a sound and solvent condition. In a conservatorship, the powers of the Company’s directors, officers, and shareholders are transferred to the designated Conservator.

Q: What is a Conservator?

A: A Conservator is the person or entity appointed to oversee the affairs of a Company for the purpose of bringing the Company back to financial health. In this instance, the Federal Housing Finance Agency ("FHFA") has been appointed by its Director to be the Conservator of the Company in accordance with the Federal Housing Finance Regulatory Reform Act of 2008 (Public Law 110-289) and the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4501, et seq., as amended) to keep the Company in a safe and solvent financial condition.

Second part: Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities. Jim Lockhart, director of the FHFA, says:

"Under these agreements, Treasury will ensure that each company maintains a positive net worth. These agreements support market stability by providing additional security and clarity to GSE debt holders – senior and subordinated – and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities."

Third part: The establishment of a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Mr. Lockhart says:

"This facility is intended to serve as an ultimate liquidity backstop, in essence, implementing the temporary liquidity backstop authority granted by Congress in July, and will be available until those authorities expire in December 2009."

Fourth part: a temporary program to purchase GSE MBS [mortgage-backed securities]. From the Treasury website:

• Congress granted Treasury authority to purchase MBS in the Housing and Economic Recovery Act of 2008. The authority expires on December 31, 2009.

• Treasury will begin later this month by investing in new GSE MBS, which are credit-guaranteed by the GSEs. Additional purchases will be made as deemed appropriate.

• Treasury can hold this portfolio of MBS to maturity and, based on mortgage market conditions, Treasury may make adjustments to the portfolio.