Historic U.S. government takeover of Fannie and Freddie

Treasury Secretary Henry Paulson and James Lockhart, director of the Federal Housing Finance Agency on Sunday unveiled an extraordinary takeover of twin mortgage buyers, Fannie Mae and Freddie Mac, putting the government in charge of the twin mortgage giants and the $5 trillion in home loans they back. The sweeping plan places the two companies into a "conservatorship" to be overseen by the Federal Housing Finance Agency. Under the plan, the FHFA will assume the power of the board, and the two firms' cheif executives will resign after a transitional period.

Fannie and Freddie, which were created by the U.S. government, have been badly hurt in the last year by the sharp decline in home prices as well as rising mortgage delinquencies and foreclosures.

The move marks Washington's most dramatic attempt yet to shore up the nation's housing market, which is suffering from record foreclosures and falling prices. Paulson said that the cost to taxpayers would largely depend on the future financial performance of Fannie and Freddie.

For more than a decade Fannie Mae and Freddie Mac have attracted overseas investors with a simple pitch: the securities they issue are just as good as the United States government’s, and they usually pay better. The trillions in securities issued by Fannie and Freddie and backed by American mortgages were never explicitly guaranteed by the U.S government, but foreign and domestic investors alike have always believed that the guarantee would be backed up if it were tested.

About one-fifth of securities issued by Fannie, Freddie and a handful of much smaller quasi-governmental agencies, some $1.5 trillion worth, were held by foreign investors at the end of March. One out of 10 American mortgages is, in effect, in the hands of institutions and governments outside the United States. Asian institutions and investors hold some $800 billion in securities issued by Fannie and Freddie, the bulk of that in China and Japan. China held $376 billion and Japan $228 billion as of June 2007, the most recent country-specific Treasury figures.

The bulk of investments related to Fannie and Freddie are in the form of mortgage-backed securities, often called agency securities or agency paper. This agency paper is considered of much higher quality than securities backed by sub-prime loans because Fannie and Freddie generally lend to borrowers with good credit histories and require higher down payments.