Government Preparing for Possible Fannie Mae or Freddie Mac Collapse

CNBC reports:

Alarmed by the growing financial stress at the nation’s two largest mortgage finance companies, senior Bush administration officials are considering a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, people briefed about the plan said on Thursday.

The companies, Fannie Mae and Freddie Mac, have been hit hard by the mortgage foreclosure crisis. Their shares are plummeting and their borrowing costs are rising as investors worry that the companies will suffer losses far larger than the $11 billion they have already lost in recent months. Now, as housing prices decline further and foreclosures grow, the markets are worried that Fannie and Freddie themselves may default on their debt.

Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers. ...

Officials have also been concerned that the difficulties of the two companies, if not fixed, could damage economies worldwide. ...

Under a 1992 law, Fannie or Freddie could be put into conservatorship if their top regulator found that either one is “critically undercapitalized.” A conservator would have sweeping powers to overhaul them, but would not have the authority to close them. ...

The companies are by far the biggest providers of financing for domestic home loans. If they are unable to borrow, they will not be able to buy mortgages from commercial lenders. In turn, that would make it more expensive and difficult, if not impossible, for home buyers to obtain credit, freezing the United States housing market. ...

Together the two companies touch more than half of the nation’s $12 trillion in mortgages by either owning them or backing them. ...

In recent weeks, the companies have spiraled downward, undermined by declining confidence in their future and shaken by sharp declines in their assets as the housing markets have continued to slide and foreclosures have risen. In the last week alone, Freddie has lost 45 percent of its value, and Fannie is off 30 percent.

For anyone who invests in government bond funds or money market funds, let me point out that quite often "federal" bond funds invest in U.S. Treasury bonds as well as bonds of government sponsored entities (GSEs) like Fannie Mae and Freddie Mac. By contrast, "treasury" bond funds only invest in U.S. Treasury bonds, not GSE bonds. Check your prospectus.