With mortgage defaults rocketing, the companies' size has become a huge liability.
Nationwide, the portion of home loans at some stage in the foreclosure process was 2.75 percent at the end of June, up from 2.47 percent in the first quarter and 1.4 percent in the second quarter of 2007. The latest figure is the highest since the Mortgage Bankers Association began keeping track 29 years ago.
Fannie Mae and Freddie Mac have suffered about $14 billion in loan losses during the past year and could face a rising tide of red ink as the housing crisis wears on. Yet they have become more critical to the mortgage market as the U.S. credit crunch has worsened, and many lenders have been unwilling to make any home loans unless they can sell them to Fannie Mae or Freddie Mac.
As the companies' financial outlooks worsened in July, Congress gave the Treasury the authority to put taxpayer money into the companies to keep them solvent. The Federal Housing Finance Agency was also created this summer to regulate Fannie and Freddie; that agency will run the conservatorship.
"Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe," Paulson said. "... A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today."
As expected, Paulson said the current chief executives of the companies would step down.
Fannie Chief Executive Daniel Mudd will be replaced by Herbert Allison, former chief of teachers pension fund TIAA-CREF; Freddie Chief Executive Richard Syron will be replaced by David Moffett, a former top executive of Minneapolis-based US Bancorp who now is an executive of the Carlyle Group, a Washington-based investment firm.
By placing the companies into conservatorship - which allows their shareholders to retain a slim hope of getting some of their money back - Paulson's plan is "a half-measure between doing nothing and a full nationalization," said Christopher Whalen, a partner at Hawthorne, Calif.-based research firm Institutional Risk Analytics.
Still, he said, the government's now-explicit backstopping of the companies' massive debts should allow Fannie Mae and Freddie Mac to pay lower rates to borrow, which in turn could allow them to reduce the rates they require on mortgages they buy from lenders.
