Shares of Fannie Mae and Freddie Mac hit 17-year lows today as investors’ fears about the companies’ ability to raise additional capital fueled speculation of the possibility of a government bailout.
The government-chartered companies — which purchase mortgages and securitize and sell pools of loans to investors with guarantees on their performance — are adequately capitalized, federal officials insist.
But some investors are worried that their shares in the publicly traded companies will be diluted if losses at Fannie and Freddie force the companies to issue more common stock to raise additional capital. Investors could face even more substantial losses if the companies are unable to raise capital and the government steps in to provide assistance.
On Monday, a Lehman Brothers report stoked fears that Fannie and Freddie would be forced to raise about $75 billion in additional capital because of proposed changes to an accounting rule by the Financial Accounting Standards Board.
James Lockhart, head of the Office of Federal Housing Enterprise Oversight (OFHEO) — the regulator charged with overseeing the safety and soundness of both companies — tried to quell those fears Tuesday, saying Fannie and Freddie are adequately capitalized and the rule changes wouldn’t require them to raise more money than currently envisioned.
In an interview with CNBC, Lockhart said Fannie has already raised $15 billion, and OFHEO expects Freddie will have $5.5 billion it’s agreed to raise in the bank by the end of the summer. The capital already raised should "allow them to ride out the problems of the past years and underwrite this year what should be a very profitable book of business," Lockhart said.
Although Lockhart’s statement initially calmed investors’ fears, reports in the Wall Street Journal and Bloomberg have renewed talk of government intervention.
Former St. Louis Federal Reserve President William Poole told Bloomberg Wednesday that because the value of their assets is falling, Fannie and Freddie are already "insolvent." Congress should recognize "that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer," Poole, a longtime critic of Fannie and Freddie, said.
Fannie and Freddie own or guarantee about $5.2 trillion in mortgages, nearly half of the $12 trillion in outstanding U.S. home loans, and have raised about $20 billion to offset $11 billion in losses since the credit crunch hit last year, Bloomberg reported.
Howard Shapiro, an analyst at Fox-Pit Kelton, estimates that Fannie and Freddie can withstand losses of $85 billion and $141 billion in the next three to five years and remain solvent, Reuters reported.
In a front page story today, the Wall Street Journal reported that while the government does not expect Fannie and Freddie to fail and "no rescue plan is imminent," Treasury Department officials are "nonetheless talking about what the government could — or should — do if Fannie and Freddie become so pressed that they are unable to borrow money and continue operating."
The Wall Street Journal reported that so far, Fannie and Freddie have been able to borrow money "at relatively low cost, despite jitters over their financial condition." Fannie Mae issued $3 billion in two-year bonds this week at a yield of 3.272 percent. But the yield on the bonds was 0.74 percent more than comparable Treasury bonds — more than twice the spread a year ago, the Journal said.
If investors stopped buying the companies’ debt, they might be forced to sell assets including mortgage-backed securities, which would raise interest rates on mortgages, the Journalreported.
In his prepared remarks to the House Financial Services committee today, Treasury Secretary Henry Paulson said Fannie and Freddie are "working through this challenging period" and that OFHEO has "made clear that they are adequately capitalized."
The worries about Fannie and Freddie come at a time when Congress is asking them to do more to help pull the nation out of the housing slump. Congress and the Bush administration are allowing the companies to purchase and guarantee loans of up to $729,750 in high-cost markets, far above the previous conforming loan limit of $417,000.
That action was taken in the hopes of bringing down interest rates on jumbo mortgages, which skyrocketed after Wall Street investors stopped buying mortgage-backed securities not guaranteed by Fannie and Freddie last August.
In addition, OFHEO has lifted growth limits on Fannie and Freddie’s loan portfolios and relaxed stricter capital requirements put in place in 2004 in the wake of accounting and management scandals.
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