Fannie, Freddie rescue plans leave many anxious

August 22, 2008 6:40:34 AM PDT
A government rescue of Fannie Mae and Freddie Mac could be costly for scores of investment, banking and insurance companies that hold billions in preferred shares of the mortgage finance giants as assets. Speculation has been building on Wall Street that a government investment to rescue Fannie and Freddie would come in the form of a cash infusion through the acquisition of preferred shares in the companies.

Those shares, which pay a bond-like yield, get preference over common shares in the event a company is liquidated.

While existing common stockholders would likely see the value of their stakes reduced to zero, the outcome is less certain for preferred shareholders.

"That depends on how big Fannie and Freddie blow up," said Michael Shedlock, an investment adviser for SitkaPacific Capital Management who writes the financial blog "Mish's Global Economic Trend Analysis."

With Fannie and Freddie's existing preferred shares currently paying yields of around 17 percent to 19 percent, compared with original yields of about 6 percent, credit markets are indicating that "some hit is going to come from existing preferred shareholders," Shedlock said.

Investors generally believe that stakes in Fannie and Freddie's debt would be protected under any government rescue plan. But congressional analysts estimate a government rescue of the mortgage giants could cost taxpayers $25 billion, with the exact amount based on how far the housing market falls and how severe their financial situation turns out to be in the long run.

Tony Plath, an associate professor of finance at the University of North Carolina at Charlotte, said the entire financial industry is trying to figure out what will happen to Fannie and Freddie because investment in their equity and debt is so widespread.

"There's not protection for shareholders of common or preferred shares," he said.

The U.S. insurance industry has $4 billion in exposure to Fannie and Freddie's preferred stock, according to A.M. Best Co. Inc. But that represents less than 1 percent of the surplus the industry holds against losses.

"While some companies will probably have some writedowns, I don't think there's a widespread effect on the whole industry," said Edward Keane, senior financial analyst with A.M. Best Co.

Fannie and Freddie are the largest source of funding for home mortgages in the U.S. But they have struggled with soaring losses from mortgage defaults. Washington-based Fannie and McLean, Va.-based Freddie, have lost a combined $3.1 billion between April and June, and investors fear the losses will continue to grow.

The Bush administration last month unveiled a plan to provide unlimited government loans to the two mortgage giants and to purchase stock in the two companies if needed for a period covering the next 18 months.

Many observers say Treasury Secretary Henry Paulson is not interested in protecting common shareholders, only in Fannie and Freddie's ability to support the battered mortgage market.

That means a government rescue might not occur until there is evidence the mortgage companies' are unable to sell short-term debt - an indication they would no longer be able to operate normally.

Shares of the two companies - which together hold or guarantee half the U.S. mortgage debt - have lost more than half their value this week on fears that a government bailout would wipe out common stockholders.

Fannie Mae shares rose 35 cents, or 8 percent, to $4.75 in afternoon trading, while Freddie Mac fell 13 cents, or 4 percent, to $3.12.

Freddie in particular has investors and analysts fearful. The company earlier this year promised to raise $5.5 billion to shore up its finances but has not yet done so and its sinking share price makes raising that money far less feasible.

Fannie Mae's chief executive has sought to reassure investors that no bailout is imminent, and that the company's financial position remains solid.

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AP Business Writer Ieva M. Augstums in Charlotte, N.C. contributed to this report.

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