Government Has Many Options Short Of Nationalization If Fannie And Freddie Get Into Trouble

(RTTNews) - Despite worries about health of government-chartered mortgage giants Fannie Mae (FNM | Quote | Chart | News | PowerRating) and Freddie Mac (FRE | Quote | Chart | News | PowerRating), most experts agree that nationalization of the firms is an unlikely last resort.

While speculation of an imminent meltdown roiled the markets on Friday, the consensus among experts is that the companies should be able to avoid a critical situation, and that even if they found themselves in some trouble, the government would have steps it could take that were less drastic than nationalization.

The shares of Freddie and Fannie suffered a rollercoaster ride on Friday. Each dropped by nearly 50% early in the day amid speculation about their financial health, before rebounding significantly by the close. Freddie ended lower by only about 3%, nearly reversing its earlier losses. Fannie still ended lower by more than 20%, but had cut its peak loss for the day by more than half.

Jaret Seiberg, a financial services analyst for the Stanford Group, a Washington research firm, explained that the size of the mortgage giants makes it impossible for the government to allow them to fail. However, he believes nationalization is unlikely.

"Over the last 12 months they've been asked to shoulder a larger and larger portion of the housing burdon and finally they've gotten so big that investors have begun to questions," Seiberg said, explaining the conditions that brought on the recent sell off.

He explained that housing recovery was likely impossible without a healthy Fannie and Freddie, adding succinctly, "The government cannot allow these two organizations to fail."

Still, Seiberg believes nationalization is unlikely.

"I don't think it's possible or very likely to nationalize either Fannie or Freddie," he stated, but added, "there are steps short of that that the government can do."

Seiberg explained that the U.S. Federal Reserve could offer to lend money to the mortgage giants, or step in to by some of the companies' debt. Not only would this help to stabilize the companies if they are indeed in trouble, the analyst explained, but it would send a message to the markets that the government was standing behind the firms.

Seiberg went on to say that if there was a liquidity crunch at Freddie and Freddie, then Congress could authorize a rescue, recapitalizing the firms.

Jed Smith, from the National Association of Realtors, agreed that a liquidity crisis at Freddie and Fannie appears unlikely.

"The portfolio would have to lose around 40 billion for them to be insolvent," Smith explained, "and I don't see of any reason that that would have happened recently."

Commenting on possible government intervention, Smith said that there is "no real advantage to nationalization" and that such a move would be "unadvantageous."

Still, Smith said that some more limited action by the government could be possible, if a critical situation arose. He explained that the companies' regulator does have the authority to step in and operate them in their current form.

"I don't really see bankruptcy as real likely," Smith stated, "however, if they were to have a problem I think the government would step in, it would be simply operating the organization under federal oversight."

Such sentiments are backed up by the official positions of the companies and the Bush administration, as Treasury Secretary Henry Paulson, President George W. Bush, and the companies themselves announced on Friday.

Calling Fannie and Freddie "very important institutions," President George W. Bush said he was assured by Paulson that both he and Federal Reserve Chairman Ben Bernanke "will be working this issue very hard."

Earlier in the day, Paulson said that the administration's "primary focus" is to keep the GSEs in their "current form as they carry out their important mission. Paulson added that the Depatment was appreciative of Congress's efforts to pass FHA reform, which he said "will help promote confidence in these companies."

The Treasury Secretary added that his department is "maintaining a dialogue with regulators and with the companies."

"OFHEO will continue to work with the companies as they take the steps necessary to allow them to continue to perform their important public mission," he said.

Fannie Mae said that with a major addition of $7.4 billion in May, its total capital increased by more than $14 billion since November 2007. The current capital position is well above the company's statutory minimum capital and the regulatory requirement. Fannie Mae said it has been maintaining a robust capital base, building reserves for credit losses and generating solid revenues. The company that issued more than $24 billion in debt this week plans to provide a full financial update while reporting second-quarter results in early August.

Fellow financier, Freddie Mac followed suit providing statistics about its capital adequacy. The company is working towards achieving significant liquidity, projected above the 20% mandatory target set by the Federal Housing Enterprise Oversight or OFHEO and much above the statutory minimum capital requirement. The company stated that the average rate of run-off on its retained portfolio is about $10 billion per month, which is sufficient to free up around $250 million of capital per month. Further, Freddie Mac is mulling a reduction in its common stock dividend.

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