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U.S. nears rescue plan for Fannie and Freddie

The government has formulated a plan to put troubled mortgage giants Fannie Mae and Freddie Mac
under federal control, dismiss their top executives and prop them up financially, federal officials
told the two companies yesterday, according to three sources familiar with the conversations.

Under the plan, which could prompt one of the most sweeping government interventions in the workings
of financial markets in U.S. history, federal officials would place the firms under a conservatorship,
a legal status giving the government the option and time to restructure and revive the companies,
the sources said. The value of the companies' common stock would be diluted but not wiped out;
while the holdings of other securities, including company debt and preferred shares might be protected
by the government.

Instead of giving each company a big capital infusion up front, the government could make quarterly
injections as the companies' losses warrant, the sources said. This would be an attempt to minimize
the initial cost of the rescue.

The timing of government action remained unclear last night, and the final details were still under
discussion. But as the pace of discussions accelerated, Treasury officials contacted senior
congressional leaders yesterday, telling them they might be briefed on the plan this weekend and
asking for telephone numbers where they could be reached.

The action would represent a major escalation of the government's role in private lending.
The government would be assuming vast obligations it has historically disavowed, potentially
using taxpayer money to make up for private business decisions gone wrong.

In an effort to contain the most profound financial crisis in generations, Treasury Secretary
Henry M. Paulson Jr., leaders of the Federal Reserve and other government officials have in
recent months upended decades of precedent. A bailout of the two mortgage finance titans would
follow a Fed rescue of investment bank Bear Stearns in March and earlier steps to provide implicit
government backing to Fannie Mae and Freddie Mac.

Fannie Mae and Freddie Mac have backed 70 percent of new mortgages in recent months, but both
have incurred vast losses on their loan portfolios as the housing market has tanked. Paulson,
the architect of the plan, and other government leaders view the mortgage firms as vital to
preventing an even broader financial crisis and economic downturn.

The chief executives of the two companies were called into afternoon meetings yesterday at
the 17th Street NW offices of the Federal Housing Finance Agency, their direct regulator,
sources familiar with the events said.

Executives of the two companies were told to show up without being told of an agenda.
Daniel H. Mudd, chief executive of Fannie Mae, was accompanied by lawyers from Sullivan and
Cromwell, the company's outside counsel. He arrived at 3 p.m. for a two-hour meeting.
Richard F. Syron, chief executive of Freddie Mac, began his meeting at around 5 p.m., accompanied
by several members of the Freddie Mac board and lawyers from the firm Covington and Burling.

Paulson, Federal chairman Ben S. Bernanke and James Lockhart, the director of the housing
finance regulator, told the executives of the plan, which would strip them of their jobs
but not include any broader management shake-up.

The plan was described by three sources, which include an official, a former official who
was told of the plans and a mortgage industry executive with direct information. They spoke
on condition of anonymity because its specifics had yet to be announced.

If the plan is enacted, it would bring under direct government control two companies that
have a long and complicated history as hybrid public and private entities. In July, with
the companies reeling for losses and as fears grew that they wouldn't eb able to raise new
cash privately, Paulson gained the power to invest government money in Fannie Mae and
Freddie Mac through loans or buying company stock if he concludes it is necessary.
In approving the authority, Congress gave Paulson power to invest an unlimited sum.

Although the companies' shares initially soared on that news, their financial positions
have worsened in recent weeks, along with their ability to raise money on the markets.

"It's clear the market wants some closure on this. Any sort of plan that would get the
market at ease would be preferred to what we have right now," said Mario De Rose,
chief fixed-income strategist at Edward Jones, the brokerage firm based in St. Louis.

In recent weeks, investors less willing to take risks on debt issued by Fannie Mae and
Freddie Mac have demanded higher payments, which has increased costs for consumers
taking out mortgage loans.

Investor uncertainty over the long-term fate of the companies has left a pall over
credit markets. It has been unclear which investors, if any, would suffer should the
government intervene to prop up the firms.

The answer, in Paulson's plan, is that holders of preferred shares and subordinated debt,
a riskier but higher-paying class of debt, might be made whole. Government leaders were
reluctant to allow holders of those assets to incur major losses becausethey are widely
held by banks, and major losses could cause a wave of bank failures.

Placing the companies in conservatorship, rather than receivership, could signal that
the government does not intend to nationalize or liquidate Fannie Mae and Freddie Mac.
Instead, under the terms of a federal law passed this summer, conservatorship is designed
to allow the government to restructure the companies and return them to private control.
Treasury officials have previously compared the process to Chapter 11 bankruptcy.

If the government plan succeeds, uncertainty in the markets around Fannie Mae and
Freddie Mac could subside, making it easier for the companies to get access to funding
at cheaper rates. That, in turn, could have a spillover effect in the overall market
for mortgages, lowering interest rates and helping the battered housing market recover.

The move may calm some Asian markets, where central banks and other financial institutions
have become among the largest investors in Fannie Mae and Freddie Mac and therefore one of
the largest sources of mortgage finance in the United States.

Uncertainty over whether and how Treasury would intervene has caused some major investors
to reduce their holdings of the agencies' debt, according to analysts. That threatened to
make it more costly for the companies to get financing, increasing mortgage rates and
delaying the housing recovery.

Victor Wang, a banking researcher at UBS Securities Asia, said that Chinese banks, the
largest foreign holder of agency debt, did not know how to read the possibility of a
Treasury intervention. "Very few have full confidence of that," he said. "It's a 'may.'
And 'may' means uncertainty. That's something banks don't like."

Staff writers Binyamin Appelbaum, Ariana Eunjung Cha, David Cho, Heather Landy and
Lori Montgomery contributed to this article.

© 2008 The Washington Post Company
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