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According to the Wall Street Journal, as of Sunday morning, the existence of the mortgage finance companies: Fannie Mae (FNM) and Freddie Mac (FRE), which own and guarantee $5.4 trillion in outstanding home mortgage debt was now in the hands of the U.S. Government after it seized control of both mortgage giants.

What prompted the U.S. federal regulators to launch what could be Washington’s biggest federal bailout ever:

1.      Was it the effects of a softening economy that keeps facilitating the deterioration of an already weak housing sector?

2.      Was it the mounting losses at both GSEs of nearly $14 billion in the last four quarters?

3.      Was it both of these combined with a weak credit environment continuously working its way through the property sector?

In a statement made yesterday, by Secretary Henry M. Paulson, the two companies - based on a four-step plan devised with the collaboration of Federal Housing Finance Agency [FHFA], the U.S. Treasury, and the Federal Reserve, will be placed under a conservatorship and will be overseen by the FHFA. However, the conservatorship will not eliminate the outstanding preferred stock. Both companies stocks will keep trading - but the move will place preferred shareholders second, after the common shareholders, in absorbing losses. In addition, as part of the takeover, dividends on Fannie and Freddie’s common and preferred stock will be eliminated in an effort to conserve about $2 billion annually.

The second step taken by the Treasury Dept. (since both Freddie & Fannie are chartered by the U.S. government to keep money flowing to the housing market), was the establishment of a new secured lending credit facility. This facility will serve as an ultimate liquidity backstop, and will be available to both GSEs, and the Federal Home Loan Banks, through December 31, 2009. According to Treasury - the loans would be offered in exchange for collateral in the form of Mortgage-Backed Securities [MBS] issued by Fannie and Freddie and they would be short term — less than a month but no shorter than one week.

In addition to further support, the availability of mortgage financing for a proper functioning of the markets, Treasury will initiate a temporary program to purchase GSE Mortgage-Backed Security. The U.S. Treasury will immediately take a $1 billion equity stake in each company in the form of senior preferred stock with the option of injecting up to $100 billion into each firm. As result of the government’s equity stake, it would now be ranked above both preferred and common shares while carrying warrants and the government will obtain an ownership stake of nearly 80% in each firm.

Mr. Paulson said:

Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe.

However, he admitted that the move came at an unknown cost to America taxpayers, saying:

In the end, the ultimate cost to the taxpayer will depend on the business results of the GSEs going forward.

Freddie Mac chief executive Richard Syron, and Fannie Mae’s CEO, Daniel Mudd were removed from their positions. David Moffett, a former top official at U.S. Bancorp who has more than 30 years of strategic finance and operational experience in banking and payment processing, and Mr. Herb Allison, who was formerly with Merrill Lynch where he served as President and Chief Operating Officer until 1999, replaced them. Mr. Allison assumed the role of chairman, president and CEO of pension fund TIAA-CREF in November 2000, and held that position until 2008.

By giving the mortgage giants time to restore their balances, and by stabilizing them so they can better perform their mission, Sunday’s action should accelerate stabilization in the housing market, help improve the economy and the GSEs’ business outlook

Source: Freddie and Fannie Bailout: Why Now?