Treasury Department Releases Plan for Takeover of Fannie Mae and Freddie Mac
Treasury Announces Takeover of Fannie Mae and Freddie Mac
On September 7, 2008, Secretary Paulson of the U.S. Department of the Treasury (the “Treasury”) announced a comprehensive plan to take over the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), and to provide them with needed capital and liquidity.1 The plan is designed to provide stability to the financial markets, and support the continued availability of mortgage financing for the housing market, but accomplish these goals while minimizing risk to U.S. taxpayers. The Treasury’s plan involves four key components: (1) placing Fannie Mae and Freddie Mac under the authority of a conservator (the Federal Housing Finance Agency (“FHFA”); (2) establishing a preferred stock purchase plan by the Treasury to capitalize Fannie Mae and Freddie Mac; (3) allowing the Treasury to purchase mortgage- backed securities (“MBS”) issued by Fannie Mae and Freddie Mac; and (4) establishing a secured credit facility where Treasury will make loans available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.
Fannie Mae and Freddie Mac are government- sponsored corporations owned by private stockholders. They were created by Congress for the purpose of increasing the availability of mortgage credit for residential housing. Fannie Mae and Freddie Mac purchase residential mortgages from mortgage originators such as mortgage bankers, commercial banks, savings and loan associations, and credit unions, and in turn issue MBS certificates, the interest and principal on which they guarantee, but which are not backed by the full faith and credit of the U.S. Government. Notwithstanding the lack of an explicit U.S. government guarantee, the companies’ unique and somewhat ambiguous status as government sponsored enterprises (“GSEs”), coupled with the huge role they play in the nation’s mortgage market, has caused the financial markets to treat their mortgage- backed securities as subject to an implicit government guarantee, and to assume that the U.S. government would step in to prevent Fannie Mae and Freddie Mac from failing.
Because of the recent difficulties faced by the U.S. housing and mortgage markets and the related concerns regarding Fannie Mae’s and Freddie Mac’s capital levels, on July 30, 2008, Congress passed the Housing and Economic Recovery Act of 2008 (“2008 Housing Act”).2 That legislation approved the Treasury’s plan to authorize the government to buy stock of Fannie Mae and Freddie Mac, and to increase temporarily their credit lines from the Treasury to meet short-term capital needs. In addition, the Federal Reserve voted to allow the Federal Reserve Bank of New York to lend emergency capital to Fannie Mae and Freddie Mac, if needed. On September 7, 2008, the Treasury, the Federal Reserve, and the FHFA announced that they are taking a number of steps under this legislation to protect the stability and liquidity of Fannie Mae and Freddie Mac.
Executive Summary of Takeover Plan
As previously noted, the Treasury has outlined a four- part plan to place Fannie Mae and Freddie Mac under conservatorship of the FHFA. The Treasury’s proposal is intended to ameliorate the current disruptions in the housing and financial markets at minimal taxpayer expense.
As a condition to contributing taxpayer money to support Fannie Mae and Freddie Mac, the Director of the FHFA placed both companies under the conservatorship of the FHFA. Pursuant to the conservatorship plan, the FHFA will assume control and direct the operations of both Fannie Mae and Freddie Mac and exercise all powers collectively held by the shareholders, directors, or officers of the two companies. Under the conservatorship plan, current stock in Fannie Mae and Freddie Mac may continue to trade, although voting rights and dividend payments to shareholders will be suspended during the term of the conservatorship.
Preferred Stock Purchase
As a means of providing liquidity and acknowledging the U.S. government’s guarantee of issued MBS offerings, the Treasury has agreed to enter into Senior Preferred Stock Purchase Agreements (the “Purchase Agreements”) with both Fannie Mae and Freddie Mac. Under the Purchase Agreements, the Treasury will receive a newly issued class of senior preferred equity shares in exchange for certain cash investments up to $100 billion per agreement. These new preferred equity shares will have the effect of both diluting and subordinating the interests and rights of existing common and preferred shareholders. Pursuant to the specific terms of the Purchase Agreements, existing common and preferred shareholders will bear losses ahead of the newly issued senior preferred shares. In light of the expected dilution in value of existing common and preferred shares, the Treasury has encouraged any depository institutions that have significant holdings in these shares to contact federal regulators if they believe their losses on such holdings will adversely affect their capitalization requirements.
Treasury Purchase of New MBS Offerings
Part three of the Treasury’s plan is to create a temporary program to purchase new issue MBS certificates offered by Fannie Mae and Freddie Mac. This program is intended to ensure additional capital and a viable market for new MBS issuance. Moreover, because the Treasury can hold such certificates to maturity, the government does not expect to incur losses from them. The Treasury expects that this purchase program will begin by the end of September.
Available Credit Facility
As a “liquidity backstop,” the Treasury will also establish a secured credit facility that will make loans available to Fannie Mae, Freddie Mac, and Federal Home Loan Banks.
FHFA has been appointed as the “Conservator” of Fannie Mae and Freddie Mac in accordance with the 2008 Housing Act and the Federal Housing Enterprises Financial Safety and Soundness Act of 1992. As a result, FHFA will assume control and direct the operations of Fannie Mae and Freddie Mac. According to FHFA, the purpose of the conservatorship is to preserve and conserve assets and put both Fannie Mae and Freddie Mac in a sound and solvent condition.3 The goals of the conservatorship are to help restore confidence in Fannie Mae and Freddie Mac, enhance their capacity to fulfill their respective missions, and mitigate the systemic risk that has contributed to the instability of the current market.
The conservatorship empowers FHFA to (1) take over the assets of and operate Fannie Mae and Freddie Mac with all the powers of the shareholders, directors, and officers of the companies and to conduct all company business; (2) collect all obligations and money due to Fannie Mae and Freddie Mac; (3) perform all functions of Fannie Mae and Freddie Mac that are consistent with each company’s appointment; (4) preserve and conserve the assets and property of Fannie Mae and Freddie Mac; and (5) contract for assistance in fulfilling any function, activity, action, or duty of Fannie Mae and Freddie Mac. During the conservatorship, both Fannie Mae and Freddie Mac will continue to operate as usual and the Conservator will delegate to each company’s management the authority to manage the day to day operations of the companies subject to the Conservator’s oversight. To achieve that goal, the Director of FHFA announced that Herb Allison, former Chairman of TIAA-CREF , has been appointed as the CEO of Fannie Mae, and David Moffett, former Vice Chairman and CFO of US Bancorp, has been appointed as the CEO of Freddie Mac.
Other elements of the conservatorship are as follows:
- The stock of Fannie Mae and Freddie Mac will continue to trade during the conservatorship, but the powers of the shareholders (including all voting rights) are suspended until the conservatorship is terminated.
- Fannie Mae and Freddie Mac may continue to buy and sell investments and complete financial transactions during the conservatorship; however, these activities are subject to the oversight of the Conservator.
- While the current CEOs of Fannie Mae and Freddie Mac will be leaving their positions, they have been asked to stay on temporarily to help with the transition.
- In order to conserve over $2 billion in capital every year, the common stock and preferred stock dividends of Fannie Mae and Freddie Mac will be eliminated, but the common and all preferred stock will continue to remain outstanding. Subordinated debt interest and principal payments will continue to be made.
- Fannie Mae and Freddie Mac will be prohibited from lobbying and other political activities and their charitable giving is being reviewed and may be curtailed.
Conservatorship is distinguished from “receivership,” which is a statutory process for the liquidation of a regulated entity. While the FHFA has authority to place Fannie Mae and Freddie Mac into receivership, the FHFA indicated that there are no plans to liquidate either company.
Preferred Stock Purchase Plan
In connection with the actions taken by FHFA, the Treasury also announced that it entered into Purchase Agreements with both Fannie Mae and Freddie Mac. As described below, these Purchase Agreements will establish the Treasury as the holder of a new class of stock that will be issued in connection with financial contributions from the Treasury. The Purchase Agreements have a capacity of $100 billion each, an amount that the Treasury states “was chosen to demonstrate a strong commitment to the Company’s creditors and mortgage-backed security holders,” but which Treasury states is “unrelated to Treasury’s analysis of the current financial condition of Fannie Mae and Freddie Mac.”4 The Purchase Agreements are designed to protect the senior and subordinated debt and mortgage-backed securities of Fannie Mae and Freddie Mac and to ensure that the existing common stock and preferred shareholders of each company will bear any losses ahead of the government.
Other key terms of the Purchase Agreements are as follows:
- Treasury will immediately receive $1 billion of senior preferred stock from each company and warrants for the purchase of common stock of each company representing 79.9% of the common stock of Fannie Mae and Freddie Mac on a fully-diluted basis at a nominal price.
- If the FHFA determines that either Fannie Mae’s or Freddie Mac’s liabilities have exceeded their assets under Generally Accepted Accounting Principles, Treasury will contribute cash in an amount equal to the difference between liabilities and assets. An amount equal to such contribution will be added to the senior preferred stock held by Treasury which will be senior to all other capital stock held by Fannie Mae or Freddie Mac.
- There are no voting rights relating to the senior preferred stock. As noted above, during the conservatorship period the Conservator has all voting power for Fannie Mae and Freddie Mac.
- Beginning March 31, 2010, Fannie Mae and Freddie Mac will pay the Treasury on a quarterly basis a periodic commitment fee that will compensate the Treasury and the Conservator for the support provided under the Purchase Agreements. The amount paid will be determined by the Secretary of the Treasury in consultation with the Chairman of the Federal Reserve. The fee may be paid in cash or added to the senior preferred stock.
- The Purchase Agreements provide that neither Fannie Mae nor Freddie Mac may take the following actions without the consent of the Treasury:
- make any payment to purchase or redeem its capital stock, or pay any dividends (other than dividends on the senior preferred stock); issue capital stock of any kind;
- enter into or adjust any existing compensation arrangements with “named executive officers” without consulting Treasury;
- terminate “conservatorship,” except in connection with a “receivership;”
- increase its debt to more than 110% of its debt as of June 30, 2008; or acquire or consolidate with, or merge into, another entity.
Finally, the Purchase Agreements provide that both companies’ mortgage and mortgage-backed securities portfolios shall not exceed $850 billion as of December 31, 2009, and shall decline by 10% per year until each portfolio is no larger than $250 billion.
Treasury Purchase of MBS Certificates
The Treasury announced that it will purchase MBS certificates issued by Fannie Mae and Freddie Mac in the open market. Purchases would begin later in September 2008. Treasury believes that these purchases will provide additional capital for mortgage funding for current and prospective homeowners and promote market stability. Treasury can hold the MBS certificates it purchases until maturity, or based on market conditions make adjustments to the portfolio. Treasury will designate independent asset managers to purchase and manage a portfolio of MBS on behalf of the Treasury. Treasury’s authority to invest in these securities will expire in December 2009.
Investing in Fannie Mae and Freddie Mac MBS certificates exposes the Treasury, and thus taxpayers, to the risk of loss. The Treasury believes, however, that in the long run taxpayers will benefit from the program through increased availability and lower cost mortgage financing, and through the potential returns from the MBS portfolio, as well as the expectation of increased stability in the financial and housing markets.
Secured Credit Facility
The Treasury also announced the establishment of the Government Sponsored Enterprise Credit Facility. This facility is intended to serve as a liquidity backstop, and will provide secured funding on an as needed basis to Fannie Mae and Freddie Mac as well as the Federal Home Loan Banks. Funding will come directly from the Treasury, through the Federal Reserve Bank of New York. All such loans will be collateralized by MBS certificates issued by Fannie Mae and Freddie Mac, and advances made by the Federal Home Loan Banks, and will be subject to collateral margin requirements established by the Treasury.
The rate on these loans will typically be LIBOR plus 50 basis points, subject to the discretion of the Treasury Secretary. The loans are intended to be short term, typically ranging from one week to less than one month. Authority for this program will continue until December 2009.
The Treasury’s four-part plan to place Fannie Mae and Freddie Mac under conservatorship represents an extraordinary government effort to inject stability in the financial and housing markets. While the Treasury believes ensuring the continued short-term existence of Fannie Mae and Freddie Mac is crucial to securing such stability, the Secretary of Treasury has also acknowledged that in the long-term, the new Congress and next administration must decide what role these entities should play in the housing market. Indeed, Treasury Secretary Paulson noted that the takeover of Fannie Mae and Freddie Mac was necessitated in part by the “inherent conflict and flawed business model embedded in the GSE structure.”5 Although the Treasury has confirmed that their purchase of senior preferred shares will not eliminate the beneficial interests of existing common and preferred shareholders, for practical purposes the dilution and subordination of such existing shares will have a significant adverse impact on the market for such shares. While the Treasury acknowledged that the expected decline in the value of existing shares of Fannie Mae and Freddie Mac will cause losses for existing shareholders, they also emphasized that Treasury’s actions should help stabilize the financial and housing markets.
1) Statement by Secretary Henry M. Paulson on Treasury and Federal Housing Finance Agency Action to Protect Financial Markets and Taxpayers (September 7, 2008) (the “Treasury Statement”).
2) See DechertOnPoint, “President Signs Housing and Economic Recovery Act of 2008” (July 2008).
3) Statement of FHFA Director James B. Lockhart (September 7, 2008) (the “FHFA Statement”).
4) Fact Sheet: Treasury Senior Preferred Stock Purchase Agreement (September 7, 2008).
5) Treasury Statement, pg. 2.