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Fannie Mae, Freddie Mac Takeover: Cause and Effect

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Fannie Mae, Freddie Mac Takeover: Cause and Effect

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In a historic bailout, the U.S. Treasury Department took over mortgage giants Fannie Mae and Freddie Mac. The companies, designed to make housing more affordable to the average person, own or guarantee over $5 trillion worth of mortgages—nearly half of the home loans in America.

The move by the federal government had immediate effects upon international trading markets and investors are hopeful it will help turn the latest recession in the world markets around.

The two companies, which were guaranteed by government funding to supply home loans, undertook risky lending practices, lending extensively to those with poor credit histories.

Fannie Mae and Freddie Mac lost billions of dollars in the latest housing crunch to strike the U.S. economy. With figures showing nearly 9% of U.S. mortgage holders behind on their payments, both companies were in serious financial distress. Due to the nature of the two lenders, and the amount of the mortgage market they own, a collapse for either company was a nonissue since it signified such a great danger to the world’s economy. Treasury Secretary Henry Paulson said, “Fannie Mae and Freddie Mac are so large and interwoven in our financial system that a failure of either of them would create great turmoil in financial markets here and around the globe” (BBC).

The Treasury Department took control of the companies, starting a series of moves designed to prevent further damage to the economy. The bailout placed them into a government conservatorship, similar to a bankruptcy organization. The conservatorship dismissed both directors of Fannie Mae and Freddie Mac from their positions; however, they will be kept aboard as advisors to assist in the transition of both companies’ newly-appointed management. The government is also prepared to invest close to $100 million to keep both companies afloat with fresh capital to continue operations and allow them to remain functioning until they can sell enough of their assets to stabilize the economy.

To minimize dangers to the U.S. taxpayers, the Treasury Department will suspend paying dividends to all stockholders of Freddie and Fannie, and is coercing the companies to shrink their investment portfolios to be sold at a later time. “We structured this facility to protect the taxpayer,” Mr. Paulson stated. “The government will be repaid…before the shareholders of these companies get a penny” (International Herald Tribune).

The plan will also deny access to lobbying on Capitol Hill, ending the companies’ ability to influence any and all government actions regarding them.

Given that foreign investors own approximately $2.5 trillion worth of both Fannie and Freddie’s debt, following news of the takeover, trading hubs reacted positively around the world. With foreign market trading moving upward as much as 5.5%, the bailout signaled at least a small reprieve from the uncertainty caused by the two lenders’ dire fiscal shape. Japanese Finance Minister Bunmei Ibuki stated, “This will remove one factor causing instability in the U.S. economy and have a good effect on the world economy” (Reuters).

The Treasury Department hopes that the bailout, will boost international trading and confidence, slow the traumatic drop in real estate value, and allow world markets to begin a recovery. They hope that the stabilization of real estate’s value will reinvigorate the economy enough to restart growth.

While Mr. Paulson was optimistic about the effects of these measures, he admitted they were only stopgap solutions; the largest decisions about Fannie Mae and Freddie Mac will be left to the next administration and Congress.

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