Shares in markets around the world jumped yesterday as investors welcomed a US
Government plan to inject up to $200 billion (£114 billion) into Freddie Mac
and Fannie Mae, which was disclosed to the chief executives of the two
mortgage giants, and as a fait accompli, only on Friday.
Investors were reacting to a Treasury announcement on Sunday that the
Government was seizing control of Freddie and Fannie, the mortgage groups
that underpin the entire American housing market, and was prepared to inject
up to $100 billion into each.
Furthermore, the Government has offered to lend each institution billions of
dollars on preferential terms and said that it would help to boost liquidity
in the home loan market by buying mortgage-backed securities.
Although the Government's decision to take such drastic action was months in
the making and was not finalised until late last week, the die was probably
cast three weeks ago, when Freddie failed to raise muchneeded capital to
repair its battered balance sheet.
In a last-ditch attempt to raise about $5 billion in a new share issue to
offset billions of dollars of mortgage losses, Richard Syron, Freddie's
chief executive, travelled to New York to meet potential investors at
Goldman Sachs's head office, just off Wall Street, on 85 Broad Street. Over
the next two days, Mr Syron and senior colleagues made their pitch, but were
rebuffed every step of the way. A disappointed Mr Syron had no option but to
bite the bullet. He cancelled his plans to join his family at their holiday
home in Cape Cod and returned to Washington to face Henry Paulson, the US
Treasury Secretary.
During that meeting, the consensus emerged that, if a hugely damaging housing
meltdown was to be avoided, the US Government had no choice but to use the
power granted by Congress in July to inject billions of dollars into Freddie
and, by extension, Fannie, which was suffering from similar problems.
Mr Syron's admission set in motion a two-week period in which Mr Paulson and
his Treasury team worked frantically, often for 18 hours a day, to hammer
out a solution.
They began just before Democrats gathered for their party convention in
Denver, Colorado, two weeks ago and continued through the Republican
convention in St Paul. Minnesota, the following week.
The period also took in the Labor Day holiday weekend at the start of
September, during which Mr Paulson held meetings with Ben Bernanke, Chairman
of the Federal Reserve, Kevin Walsh, a Federal Reserve board member, and
James Lockhart, director of the Federal Housing Finance Agency, which
regulates Fannie and Freddie.
Because his preparations were so market-sensitive, Mr Paulson conducted them
almost in secret. On August 26, for example, he spoke to President Bush at
his ranch in Crawford, Texas, from a bunker under the West Wing of the White
House using a secure video teleconference link.
By Friday, September 5, the plan was in place. Mr Paulson and other top
officials summoned senior executives of Freddie and Fannie and told them
that if they did not agree to be taken over by the Government, it would be
imposed upon them anyway.
“We have grounds to do this on an involuntary basis, and we will go the course
if needed,” The Wall Street Journal reported Mr Paulson as telling the
assembled executives. The executives were said to have been surprised by the
Government's decision to take them over but had little choice but,
reluctantly, to agree.
In all, the plan involved dozens of lawyers, bankers, regulators and Treasury
staff, including 40 people from Morgan Stanley alone, who Mr Paulson had
hired to help him and who provided him with regular updates most days
between the hours of 7am and 11pm.
The Government's plan was well-received by analysts and by holders of debt and
equity worldwide.
Kevin Logan, a senior economist at Dresdner Kleinwort, said: “The US
Government has rescued the US economy from a death spiral. Its action has
eliminated the risk that could have caused chaos in the capital markets and
the economy as a whole.
“Every company has better prospects going forward. It doesn't matter whether
you are selling toothpaste, cars, aircraft or medical devices.”
Ethan Harris, chief US economist at Lehman Brothers, said: “This is very
aggressive action from the Government and removes one of the major recession
risks in the US economy.”
The financial services groups Citigroup, Wachovia and Bank of America all
added more than 4 per cent in early afternoon trading. KB Home, the
housebuilder, rose by 10 per cent.
In the US, the Standard & Poor's 500 index gained 13.18 points, or 1.1 per
cent, to hit 1,255.49 in afternoon New York trading, while the Dow Jones,
added 181 points, or 1.6 per cent, to stand at 11,401.96.
Investors in Fannie and Freddie fared less well, amid fears that a government
cash injection, in return for newly issued shares, would significantly
dilute their holdings. Freddie fell by 82 per cent and Fannie by 87 per cent.
Fannie and Freddie are crucial to the capital markets because they own or
guarantee about $5,400 billion of mortgage-backed securities, which
represent almost half of the $12,000billion of outstanding American home
loans.
By agreeing to backstop Fannie and Freddie, the Government has averted the
possibility that they could have become insolvent, a development that would
have left them unable to honour the guarantees on the bonds that they insure
or to repay their corporate debts. Without reliable guarantees, a
significant portion of about $5,400 billion of debt connected to Fannie and
Freddie could have been wiped out, as rising foreclosures fed through into
defaults on mortgage bonds.
The Government's action has also averted the possibility of a full-scale
meltdown of the housing market, which would have hit consumers harder,
reducing their spending power and pulling the economy down farther.
Furthermore, avoiding billions of dollars in further writedowns on
investments in mortgage bonds will boost liquidity across the board, leaving
banks with more money to lend and making investors less nervous about buying
assets backed by debt.
However, analysts said that the stock market could well have further to fall.
They argued that although the Government may have averted a catastrophe, the
housing market would remain weak as people struggle to repay their mortgages
and defaults continue to rise. Unemployment in the US is likely to continue
to rise in the coming months, they added.
The Treasury's plan also included the immediate removal of Daniel Mudd and
Richard Syron, the chief executives of Fannie and Freddie, respectively. Mr
Mudd is expected to receive $9.3 million in pay and retirement benefits
under the terms of his contract, while Mr Syron could walk away with $14.1
million.
Herb Allison, a former vice-chairman of Merrill Lynch and now chairman of
TIAA-Cref, one of America's biggest pension fund mangers, has become chief
executive of Fannie. David Moffit, from US Bancorp, has moved to Freddie.
