USA, FANNY MAE..., LA HORA DE LA VERDAD (1),NYT

By STEPHEN LABATON

Published: July 12, 2008

WASHINGTON — A day that began with a stomach-churning drop in stock prices for the two largest mortgage finance companies ended with a measure of relief, after government officials and lawmakers managed to calm investors worried about the health of the two companies.

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Making Sense of Problems at Fannie and Freddie

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Times Topics: Freddie Mac

Times Topics: Federal National Mortgage Association (Fannie Mae)

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Bush administration officials had worked into the early morning hours on Friday drawing up contingency plans to rescue the companies, Fannie Mae and Freddie Mac, should their financial plight worsen. And when both companies’ stocks fell 50 percent initially, some investors feared the worst.

But by the end of the day, the shares rebounded after both were able to easily continue the regular borrowing of money they need to finance their day-to-day operations and keep the nation’s mortgage machinery humming.

If Fannie and Freddie had been cut off from borrowing by other financial institutions, the government might have been forced to step in and support them.

Still, the modest relief on Friday was tempered by concerns over what might unfold in coming weeks, should the housing market’s woes continue and further weaken the finances of Fannie and Freddie.

Uncertainty about the financial stability of the companies, which lie at the heart of the nation’s housing market, underscored their size and complexity.

Both companies, which already have suffered $11 billion in losses in the last nine months, could report new quarterly losses in August if foreclosures continue.

The financial markets continue to show signs of stress, underscored by the decline in the Dow Jones industrial average, which fell below 11,000 on Friday for the first time in two years before closing at 11,100.54, down 1.1 percent.

Shares of Freddie Mac closed at $7.75, down more than 45 percent for the week. Fannie Mae settled at $10.25, a 30 percent slide for the week. And a fresh sign of industry problems emerged on Friday when the Federal Deposit Insurance Corporation seized IndyMac Bank, making it the largest bank to fail since the 1990s.

The company, an offshoot of Countrywide Financial and once one of the nation’s largest independent mortgage lenders, was a major issuer of subprime loans.

After meeting with his economic policy team on Friday morning, President Bush said that he had been briefed about the problems confronting Fannie and Freddie by the Treasury secretary, Henry M. Paulson Jr.

“Freddie Mac and Fannie Mae are very important institutions,” the president said. “He assured me that he and Ben Bernanke will be working this issue very hard,” referring the chairman of the Federal Reserve.

Earlier in the day, Mr. Paulson sought to calm investors concerned that the stock of Fannie and Freddie could be wiped out if the government took over one or both of the companies and placed them under the control of a conservator, as the law permits. The administration has prepared such a plan if the companies continue to decline, people briefed on the plan have said.

“Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission,” Mr. Paulson said. Officials said Mr. Paulson wanted to convey the message that even under a conservatorship, the companies would not be nationalized. Instead, a conservator would have to prepare a plan to restore the company to financial health, much like a company in Chapter 11 bankruptcy proceedings.

Federal Reserve officials took pains to dismiss rumors swirling through the markets and in Washington that the central bank was considering a new program to lend money directly to the companies through its so-called discount window. The Fed began two such programs to lend money to the nation’s largest investment banks last March.

“Fed officials are following the situation closely,” said Michelle A. Smith, the Fed’s chief spokeswoman. “We’ve had no discussions with the companies about the discount window. We don’t discuss the range of options we are considering.”

After a flurry of phone calls with administration and Fed officials, senior Democrats in Congress also said they were persuaded that the steep declines in the stock of the two companies did not reflect new underlying financial problems, and that the companies had the financial wherewithal to get through the turmoil. Their comments went far beyond the cautiously worded assurances by senior officials earlier in the week that had done little to calm the markets.

“There is a sort of a panic going on and that’s not what ought to be,” said Senator Christopher J. Dodd, the Connecticut Democrat who heads the Senate banking committee. “The facts don’t warrant that reaction, in my view.”

Mr. Dodd said that he was persuaded by conversations with Mr. Paulson and Mr. Bernanke that the two companies “are fundamentally sound and strong.”

He said that housing legislation the Senate approved on Friday evening, part of which would overhaul the regulation of Fannie and Freddie, could be completed by Congress and signed into law by President Bush by next week. The measure, sponsored by Mr. Dodd, must go back to the House to be reconciled with its version adopted in May.

Investors, left dizzy by the rapid-fire turns in Freddie and Fannie’s shares, suffered through one of the most volatile days in the market since the Bear Stearns debacle in March.

The day began darkly with investors confronting figures that once seemed unthinkable: Freddie Mac’s stock was down a whopping 50 percent, with Fannie Mae not far behind. As rumors of a government bailout made their way across trading desks, Mr. Paulson’s statement — suggesting that no government takeover of Fannie and Freddie was imminent — seemed to only increase the uncertainty.

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Making Sense of Problems at Fannie and Freddie

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“Paulson jumped in earlier today and tried to be reassuring, but in many ways it backfired,” Edward Yardeni, an investment strategist, said. “He really didn’t say anything that he hadn’t before.”

But some investors saw the depressed shares as a buying opportunity. At the close, Freddie finished down just 3 percent, a relief to investors who had feared the worst. Fannie, however, sold off 22 percent of its value.

As they watched the markets, senior officials at the Treasury and the Federal Reserve were described on Friday as being less fixated on the stock prices of Fannie and Freddie and more interested in the companies’ ability to raise money to continue to fund their daily operations and buy new mortgages from banks and other lenders.

The two companies already own or guarantee more than $5 trillion in mortgages. They need to borrow money constantly so they can buy mortgages from lenders, repackage them as securities and sell them to investors.

Fannie and Freddie hold some of the mortgages they buy in their own investment portfolios; the rest are sold to pension funds, mutual funds and other investors, with Fannie and Freddie guaranteeing each mortgage against default by the homeowner. Officials noted that the companies’ ability to raise money had improved in recent months, including on Friday, allowing the companies to borrow at rates close to those of the United States Treasury.

One interpretation of this is that the debt markets believe that the federal government will take steps to bail out the companies should they become insolvent. Moreover, the insurance premiums that are paid by the buyers of the debt securities issued by the companies declined significantly on Friday, a sign that the markets do not believe the companies are on the brink of failure.

“In these volatile markets, share price is not the most reliable measure for judging Fannie and Freddie and will not dictate the responses by the regulators,” said Senator Charles E. Schumer, Democrat of New York, who has held discussions all week with senior administration officials. “Rather, the regulators are closely watching the performance of the companies’ bonds, and how their yields compare to U.S. Treasuries. Right now, Freddie and Fannie bonds are trading closer to Treasuries than they were in March after the Bear Stearns collapse, a reassuring signal.”

It was a crushing liquidity problem — as lenders called in existing loans and refused to lend any more — that ultimately prompted the government to rescue Bear Stearns last March from possible bankruptcy.

Normally, when a company’s stock price plunges to dangerously low levels, the company also has significant problems raising money in the debt markets because borrowers fear that they may not be repaid. But in a perverse cycle, the news this week that the government was considering putting them into a conservatorship has had the effect of making the debt of those companies more attractive.

Fannie Mae, founded in 1938, was originally called the Federal National Mortgage Association, but adopted its nickname as a formal title in the 1990s. Its younger and smaller sibling, Freddie Mac, was begun in 1970.

Michael M. Grynbaum contributed reporting from New York.