In the aftermath of the third-largest bank failure in U.S. history on Friday and on the eve of a "crucial debt issue" by mortgage finance giant Freddie Mac, the U.S. Treasury, "desperate" to "bolster confidence in the mortgage finance giants and head off a potential meltdown in financial markets," announced Sunday "it would temporarily boost its line of credit, as well as purchase equity in [both Freddie Mac and Fannie Mae], a step never taken before, if needed," Reuters reported on Sunday.[1]  --  The two "mortgage finance giants" are presently teetering on the brink of collapse.  --  The move was announced by U.S. Treasury Secretary Henry Paulson himself on the steps of the Treasury building, Glenn Somerville and Alister Bull reported.  --  At present the Treasury lacks the legal authority for such moves, but "[a] senior Treasury official . . . expressed confidence that could be secured this week."  --  At stake are about $5 trillion in outstanding mortgage debt.  --  "[A]nalysts remain skeptical," Somerville and Bull said, and "critics fumed.  'It's outrageous.  It's offensive.  Welcome to the socialist state.  In capitalism, winners are supposed to reap rewards and losers are supposed to take losses for bad risk management.  These are private companies,' said Josh Rosner, managing director at Graham Fisher in New York."  --  The Financial Times of London called the announcement "a dramatic effort to quell the crisis."[2]  --  James Politi, Krishna Guha, and Francesco Guerrera said it "came after a weekend of crisis talks involving Mr. Paulson, Fed chairman Ben Bernanke, and New York Fed chief Tim Geithner" and went "further than many market participants expected.  In effect the government is seeking full discretion to inject both debt and equity into Fannie and Freddie, and take them over if necessary."  --  The announcement came on Sunday so that it would be heard "before the start of trading in Asia — where central banks are among the biggest holders of Fannie and Freddie debt."  --  "A senior Treasury official said Mr. Paulson had spoken to all key figures in Congress and was confident that the authorizing legislation would be inserted into the housing bill making its way through Congress and swiftly approved," the Financial Times reported.  --  In a blog entry, Financial Times columnist Clive Crook explained that the import of the announcement is that the ordinary American taxpayer is going to be made to pay for the consequences of the financial greed of fabulously wealthy financial interests:  "Covering the agencies’ losses on their loans and guarantees is going to require an actual outlay, which will fall on taxpayers."[3]  --  "A plan to take the enterprises over exists," Crook wrote.  "Rather than nationalizing them — which would be un-American and could be mistaken for socialism — they would be placed in 'conservatorship.'  It is the same thing, except that it could allow the government to pretend the GSEs’ liabilities were even then not its own.  A finding from the enterprises’ regulator that they are 'critically undercapitalized' would be needed, it seems, to start the process.  Up to now, the Office of Federal Housing Enterprise Oversight has been concerned to send the opposite message.  It will be interesting to see how quickly 'adequately capitalized' will turn to 'critically undercapitalized' if the authorities decide to nationalize — I mean, put the enterprises into conservatorship."  --  COMMENT:  This episode recalls a remark by Spengler about epochs of civilization in which "the money-spirit" becomes a predominant social force:  "Though forms subsist, the great political parties nevertheless cease to be more than reputed centres of decision.  The decisions in fact lie elsewhere.  A small number of superior heads, whose names are very likely not the best-known, settle everything, while below them are the great mass of second-rate politicians — rhetors, tribunes, deputies, journalists — selected through a provincially-conceived franchise to keep alive the illusion of popular self-determination" (The Decline of the West, vol. 1, translated by Charles Francis Atkinson [New York: Alfred A. Knopf, 1926], p. 35; originally published 1918)....

1.

U.S. MOVES TO SHORE UP FANNIE, FREDDIE
By Glenn Somerville and Alister Bull

Reuters
July 13, 2008

http://www.reuters.com/article/topNews/idUSN1332789320080714?feedType=RSS&feedName=topNews

WASHINGTON -- The United States on Sunday offered massive aid to Fannie Mae and Freddie Mac to bolster confidence in the mortgage finance giants and head off a potential meltdown in financial markets.

The dollar jumped and stock futures rallied on the powerful message of support from the U.S. Treasury and the Federal Reserve, which also drew criticism for being a potential bailout that could cost U.S. taxpayers dearly.

Unveiling the latest emergency measures to calm markets roiled by the country's prolonged housing crisis, the Fed said Fannie and Freddie could have access to its emergency cash if necessary, effectively opening its discount window in a move echoing recent action to save investment bank Bear Stearns.

The Treasury separately said it would temporarily boost its line of credit to the two mortgage financiers, as well as purchase equity in them, a step never taken before, if needed.

Both companies, which are shareholder-owned but also government-sponsored, said they are adequately capitalized, but welcomed the measures and said they would help confidence.

NERVES ON EDGE

Officials are desperate to calm nerves ahead of a crucial debt issue by Freddie Mac on Monday and after U.S. bank regulators on Friday seized mortgage lender IndyMac Bancorp in the third-largest bank failure in U.S. history.

"(Their) continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore, we must take steps to address the current situation as we move to a stronger regulatory structure," U.S. Treasury Secretary Henry Paulson said in a statement that he read on the steps of the Treasury building.

A senior Treasury official said all the actions it proposed need congressional approval, but expressed confidence that could be secured this week.

A spokesman for Speaker of the House of Representatives Democrat Nancy Pelosi said she would work with the Republican administration of President George W. Bush on this matter.

Shares in the two mortgage giants, which own or guarantee just under half of the country's $12 trillion in outstanding mortgage debt, have been hammered by concerns that they might run out of capital amid mounting home-loan losses.

On Sunday the Securities and Exchange Commission stepped in to warn against rumor-mongering of any kind against any firm.

The SEC said it will conduct investigations to make sure that no false information was being spread, although it did not name any companies it felt might be victimized.

WEIGHT ON ECONOMY

Housing woes have forced the Fed to slash benchmark interest rates since September and open its discount window to investment banks for the first time since the Great Depression some 80 years ago.

Fannie and Freddie buy mortgages from lenders and package them into guaranteed securities, providing more funds to keep mortgage markets lubricated.

They also borrow regularly on capital markets to fund their operations and one investor predicted Freddie's planned auction of $3 billion in 3- and 6-month notes on Monday would go well.

Dan Fuss, vice chairman of Boston-based Loomis Sayles, which oversees more than $100 billion in fixed-income securities, also said he had been buying Fannie and Freddie paper in recent days because it was "outstanding value."

Freddie and Fannie debt rallied sharply on Friday as investors bet they would get closer government backing and analysts said that this was in fact happening.

"Fannie Mae and Freddie Mac have never been more related to the U.S. government," said Margaret Kerins, U.S. agency strategist at RBS Greenwich Capital in Chicago.

"Now that Paulson has reiterated their relationship to the government, they should be able to fund themselves probably even better than they had before this crisis," she said.

But Fannie and Freddie's shares have been savaged in recent days and reduced to a fraction of their value a year ago and analysts remain skeptical.

"The problems with Fannie Mae and Freddie Mac are pretty straightforward. Combined, the two GSEs have about $95 billion in capital but hold over $5 trillion in mortgages," said Mark Vitner, a senior economist for Wachovia in Charlotte.

The two companies play a vital role in U.S. housing markets, which already are experiencing their deepest downturn since the Great Depression, and Treasury and the Fed are on the spot to make sure they do not put a sorely stressed financial system in worse shape than it is already in.

Many fear that were they to fail it would unhinge already battered world financial markets and inflict a deep recession in the United States that would chill growth everywhere.

A senior Treasury official told reporters in a conference call the moves were not driven by any deterioration in market conditions since Friday. He said policymakers had consulted closely over the weekend and it "makes sense" to take the actions announced.

Treasury said its temporary increase in the line of credit that the GSEs now have with Treasury, would be up to an amount to be determined by Paulson. The current credit line for each lender is $2.25 billion.

In addition, "to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed," Paulson said. Critics fumed.

"It's outrageous. It's offensive. Welcome to the socialist state. In capitalism, winners are supposed to reap rewards and losers are supposed to take losses for bad risk management. These are private companies," said Josh Rosner, managing director at Graham Fisher in New York.

(Additional reporting by Patrick Rucker, Rachelle Younglai, and Mark Felsenthal in Washington, Eric Burroughs in Tokyo, and Lynn Adler, Jennifer Ablan and Al Yoon in New York; Editing by James Dalgleish)

2.

In depth

Credit squeeze

RESCUE PLAN FOR U.S. MORTGAGE GIANTS
By James Politi and Krishna Guha (Washington) and Francesco Guerrera (New York)

Financial Times (London)
July 13, 2008 (as updated Jul. 14)

http://www.ft.com/cms/s/0/5773a770-5106-11dd-b751-000077b07658.html

In a dramatic effort to quell the crisis surrounding Fannie Mae and Freddie Mac, the U.S. government on Sunday night announced that it will seek unlimited authority from Congress to lend money to the troubled mortgage groups and invest in their equity.

The Federal Reserve meanwhile said it would give Fannie and Freddie access to emergency funds on the same terms as banks, “should such lending prove necessary.”

The rescue plan, announced by Treasury secretary Hank Paulson, came after a weekend of crisis talks involving Mr. Paulson, Fed chairman Ben Bernanke, and New York Fed chief Tim Geithner.

It goes further than many market participants expected. In effect the government is seeking full discretion to inject both debt and equity into Fannie and Freddie, and take them over if necessary.

The Fed will act as a bridge by providing a backstop source of emergency finance in the interim while Congress passes the required legislation.

The extent of the move reflects Washington’s fears that failure to bolster Fannie and Freddie could deepen financial turmoil, undermining domestic and foreign investors’ fragile confidence in U.S. capital markets and the dollar. “We need to stabilize the current situation,” a senior Treasury official said on Sunday night.

In a statement released on Sunday before the start of trading in Asia -- where central banks are among the biggest holders of Fannie and Freddie debt.

Mr Paulson said the two enterprises, which own or guarantee more than $5,300bn in U.S. mortgages, “play a central role in our housing finance system and must continue to do so in their current form.”

Mr. Paulson outlined a three-pronged strategy to resolve the crisis at Fannie and Freddie, whose shares have collapsed over concerns about their potential losses on mortgage holdings.

Under the plan, the Treasury will be authorized to increase its existing $2.25bn lines of credit to Fannie and Freddie. In addition, the Treasury will have temporary authority to purchase equity in either of the two entities if needed. Support will be at the discretion of the Treasury secretary. “Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer,” Mr Paulson said.

The third part of the plan allows Fannie and Freddie to borrow from the Fed’s “discount window” through which it extends emergency finance in return for collateral. The Fed will also be granted a consultative role in shaping the future regulatory framework for Fannie and Freddie.

A senior Treasury official said Mr. Paulson had spoken to all key figures in Congress and was confident that the authorizing legislation would be inserted into the housing bill making its way through Congress and swiftly approved.

The market will get the chance to express its views on Paulson plan today when Freddie begins marketing $3bn in short-term debt. Wall Street bankers said Treasury officials had been in touch with big investment and commercial banks to ensure they were still considering placing bids for the bond sale.

3.

Columnists

GUARANTEES FOR AMERICA'S GUARANTORS
By Clive Crook

Financial Times (London)
July 13, 2008

http://www.ft.com/cms/s/0/d4794e4e-50fe-11dd-b751-000077b07658.html

U.S. taxpayers are about to find out what their long-standing and (strictly speaking) non-existent guarantee of Fannie Mae and Freddie Mac will cost them. One way to think of it is this: take the U.S. national debt of roughly $9,000bn and add $5,000bn. Not bad for an obligation still officially denied.

In the end, that astounding prospect might be the outcome. Partial or outright nationalization of the housing lenders -- colossal pseudo-private entities that own and underwrite U.S. housing loans -- would add some or all of their $5,000bn (€3,144bn, £2,513bn) in liabilities to the government’s balance sheet. While it is true that the agencies (unlike the government) own housing-related assets that roughly match those liabilities, the still-collapsing housing market makes this a lot less reassuring than one could wish.

Covering the agencies’ losses on their loans and guarantees is going to require an actual outlay, which will fall on taxpayers. You could plausibly call the rest -- namely, bringing these “government-sponsored enterprises” explicitly inside the public sector -- just a bookkeeping entry. But what an entry! It would surely shake financial markets, raise the government’s cost of funding, and put heavy downward pressure on the dollar. Meanwhile, the turmoil impedes or paralyzes the GSEs in their crucial life-support role for the housing market.

A small irony deserves to be noted. Fannie’s and Freddie’s shares have been falling for months, but it was an analyst’s report from Lehman Brothers -- a struggling securities firm judged by many to be next in line for the fate of Bear Stearns -- that provoked new alarm last week. Then on Wednesday Bill Poole, a respected former chief of the St. Louis Federal Reserve, said that Fannie and Freddie were insolvent in the first quarter on a mark-to-market basis. This should have come as no surprise and has no bearing on their solvency in what the U.S. Treasury calls “the regulatory sense.” Strangely, being reminded of something they already know often throws financial markets into a spin.

Here is a greater irony: Fannie and Freddie were the inventors of the mortgage-backed security, a principal cause of the housing bubble and its subsequent deflation. They won plaudits for it: for years, the unbundling and reselling of mortgages was deemed a good thing, the secret of the U.S. housing market’s success. Alan Greenspan, former Federal Reserve chairman, praised it ceaselessly as a breakthrough that did much to widen home ownership. But it weakened mortgage originators’ oversight of loan quality -- without securitization and the backing of Fannie and Freddie, could there ever have been “ninja” mortgages (no income, no job or assets)? When securitized loans go bad, they are much harder to restructure. Fannie and Freddie have been scrambling to contain the damage their innovation helped set in train -- and now seem likely to fall victim themselves.

Truly, the tale of Fannie and Freddie is an old one. Their doom has been foretold countless times over the years -- and yet, at the same time, has been regarded as unthinkable. In one sense, so it is. They are the limiting case of “too big to fail.” Lately, their operations have more than accounted for the entire mortgage market (since other lenders have been scaling back). Until recently, discussion in official circles has revolved around the need to get Fannie and Freddie doing even more. Legislation partly to that effect advanced in the Senate last week. Now the question is, will they even survive?

One way or another, the answer is assured. The consequences of letting the GSEs go under are unthinkable. But just as the Bear Stearns “rescue” eviscerated the firm’s shareholders, the GSEs’ owners are at risk and unfortunately they are not alone.

A plan to take the enterprises over exists. Rather than nationalizing them -- which would be un-American and could be mistaken for socialism -- they would be placed in “conservatorship.” It is the same thing, except that it could allow the government to pretend the GSEs’ liabilities were even then not its own. A finding from the enterprises’ regulator that they are “critically undercapitalized” would be needed, it seems, to start the process. Up to now, the Office of Federal Housing Enterprise Oversight has been concerned to send the opposite message. It will be interesting to see how quickly “adequately capitalized” will turn to “critically undercapitalized” if the authorities decide to nationalize -- I mean, put the enterprises into conservatorship.

The sooner the need for this is acknowledged and acted upon, the better. However, hybrid solutions are also possible, with superior opportunities for evasion of responsibility, and thus greater political appeal.

On Sunday the Treasury indicated that its main focus was still on supporting Fannie and Freddie in their current form. Some mixture of expressions of support, a line of credit, and a possible injection of capital will have to do for the moment. In short, the aim is to muddle through.

What will force the issue is the ability of the GSEs to raise new capital and credit from private sources. They must do both to keep playing the pivotal role they have been assigned in sorting out the housing-finance mess. New private stakes in the enterprises are an unenticing prospect; and private lenders will be concerned about where they stand if more drastic remedies are tried. Until the situation is resolved, the upshot is likely to be a new reduction in the supply, and increase in the cost, of mortgage finance -- further lessening the chances of an early recovery in the housing market and the wider economy. Look on your works, Fannie and Freddie, and despair.