Washington Hurricane Hank swept through nation's capital Sunday with gale force regulatory winds and a tidal surge of federal cash, upending two of Washington's biggest enterprises and permanently changing the landscape of housing finance in America.
In wresting control of Fannie Mae and Freddie Mac, and in authorizing the Treasury to begin purchases of mortgage-backed securities, Secretary Henry M. Paulson Jr. has taken responsibility for assuring that low-interest loans will continue to flow into the country's hard-hit housing markets. Not since the early days of the Franklin Roosevelt administration, at the depth of the Great Depression, has the government taken such a direct role in the workings of the financial system.
Although the details of Sunday's takeover are complex, the rationale is quite simple: to restore some semblance of normalcy to the housing market. Paulson and other policy-makers think that until that happens, neither financial markets nor the wider economy will be able to regain their footing.
Fannie and Freddie did not go gently into conservatorship. Although their access to badly needed equity capital had dried up and their borrowing costs had increased, they had hoped that they could muddle through by raising fees and demanding higher interest rates from borrowers. But that plan was cut short when Paulson, backed by Fed Chairman Ben Bernanke and their newly empowered regulator, James Lockhart, concluded that Fannie and Freddie could no longer reconcile their sometimes conflicting obligations to shareholders and homeowners without posing additional risks to an already shaken financial system.
Fannie and Freddie could have fought the government in court, but that wasn't much of an option for companies whose business model was based on the perception that they were backed by the government. The market would have shut them down long before the first briefs were filed.
Under the deal they could not refuse, Fannie and Freddie directors and top executives will lose their jobs. Shareholders will lose their dividends, voting rights and most of their ownership stake, while agreeing to pay dearly for the government's money and backing. Left unharmed will be holders of trillions of dollars in Fannie and Freddie debt, or securities backed by mortgages that Fannie and Freddie have insured against default, who will get all their money back, with interest.
Until this weekend, Fannie and Freddie have been unique entities - for-profit, shareholder-owned companies that were required by government charters to provide low-cost capital to secondary mortgage markets in good times and bad.
But in the mid-1990s, things began to change. Rather than being satisfied with modest growth, Fannie and then Freddie began promising Wall Street double-digit earnings growth, which required them to grow their balance sheets well beyond what was necessary to assure liquidity in the mortgage market. Instead of just buying mortgages, insuring them and selling them in packages to investors, they bought more of them for their own portfolios, using ever-increasing amounts of borrowed money. Buying their own securities was profitable, but it left them highly exposed if anything went really wrong with the housing market, which is exactly what has happened.