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Treasury Secretary Henry Paulson announced this morning (Sept. 7) the long-expected news: the government will take over mortgage behemoths Fannie Mae and Freddie Mac, which together own or guarantee $5 trillion of U.S. home mortgages, half the total. The chief executives will leave after an interim period. There was no word whether they would be investigated; news came out late yesterday that government auditors have discovered accounting irregularities that may have led to an overstatement of capital. Fannie and Freddie have long been undercapitalized. Investors always assumed that these government-sponsored entities would be taken over by the U.S. in a crisis. Hence, risk was not a major factor: Fannie and Freddie could borrow at below-market rates and lend at above-market returns. Capital was therefore inadequate, and now it appears this thin capital may have been overstated. The takeover was timed to be announced before Asian markets open this evening. This was the same strategy in the takeover of Wall Street's Bear Stearns earlier this year. Yet government officials say with a straight face that their decisions are not based on stock market reaction. As in the move to have Bear Stearns taken over by JP Morgan, the government argues that Fannie and Freddie are too interconnected with the global financial system to be permitted to fail. Current stockholders of the companies won't see their shares canceled, but if too much goverment money is poured into the rescue, share values could be erased.
Treasury Secretary Henry Paulson announced this morning (Sept. 7) the long-expected news: the government will take over mortgage behemoths Fannie Mae and Freddie Mac, which together own or guarantee $5 trillion of U.S. home mortgages, half the total. The chief executives will leave after an interim period. There was no word whether they would be investigated; news came out late yesterday that government auditors have discovered accounting irregularities that may have led to an overstatement of capital. Fannie and Freddie have long been undercapitalized. Investors always assumed that these government-sponsored entities would be taken over by the U.S. in a crisis. Hence, risk was not a major factor: Fannie and Freddie could borrow at below-market rates and lend at above-market returns. Capital was therefore inadequate, and now it appears this thin capital may have been overstated. The takeover was timed to be announced before Asian markets open this evening. This was the same strategy in the takeover of Wall Street's Bear Stearns earlier this year. Yet government officials say with a straight face that their decisions are not based on stock market reaction. As in the move to have Bear Stearns taken over by JP Morgan, the government argues that Fannie and Freddie are too interconnected with the global financial system to be permitted to fail. Current stockholders of the companies won't see their shares canceled, but if too much goverment money is poured into the rescue, share values could be erased.