Key figures: Henry Paulson, James B. Lockhart III, Ben Bernanke, Daniel Mudd, Richard Syron, Herbert Allison, David Moffett
Summary
On September 7, 2008, the Federal Housing Finance Agency (FHFA) placed the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) into conservatorship, seizing control of the two government-sponsored enterprises (GSEs) that stood at the center of the US housing-finance system. FHFA Director James B. Lockhart III had exercised his statutory authority the previous day, September 6, with the consent of both firms’ boards, and Treasury Secretary Henry Paulson joined him to announce the takeover before markets opened. It was the largest federal intervention of the financial crisis up to that point — coming roughly six months after the Bear Stearns rescue and one week before the collapse of Lehman Brothers — and amounted to an effective nationalization of two publicly traded companies that together owned or guaranteed roughly $5 trillion in mortgages, about half of the US market.
Fannie Mae (chartered 1938) and Freddie Mac (chartered 1970) did not lend to homebuyers directly; they purchased mortgages from lenders, held some and packaged others into guaranteed mortgage-backed securities, providing liquidity that underpinned the standard 30-year fixed-rate mortgage. Because investors treated their debt as carrying an implicit federal guarantee, the GSEs operated with very thin capital relative to their vast obligations. As house prices fell and mortgage defaults mounted through 2007 and 2008, both firms reported large losses and their share prices collapsed, raising fears that a failure would freeze the mortgage market entirely and destabilize the global investors — including foreign central banks — that held their securities.
Congress had anticipated the danger by passing the Housing and Economic Recovery Act of 2008 (HERA), which President George W. Bush signed on July 30, 2008. HERA created the FHFA as a stronger regulator for the GSEs and granted the Treasury temporary authority to invest in them. Using that authority, Treasury entered into Senior Preferred Stock Purchase Agreements under which it committed up to $100 billion of capital to each enterprise (a ceiling later raised to $200 billion each in May 2009 and to a formula-based cap in December 2009). In exchange, each GSE issued Treasury $1 billion of senior preferred stock carrying a 10 percent dividend and warrants to acquire 79.9 percent of its common stock. The government also created a new secured credit facility and a program for Treasury to purchase GSE mortgage-backed securities. The firms’ chief executives — Daniel Mudd at Fannie Mae and Richard Syron at Freddie Mac — were removed and replaced by Herbert Allison and David Moffett, respectively.
Significance
The conservatorship was a decisive escalation of government involvement in the crisis. Where the Bear Stearns rescue had backstopped a single investment bank, the Fannie and Freddie takeover placed the core of the American mortgage market directly under federal control, wiping out most of the value held by common and preferred shareholders while protecting the firms’ senior debt and mortgage-backed securities. By guaranteeing those obligations, the government aimed to keep mortgage credit flowing and to reassure the foreign governments and institutions that held hundreds of billions of dollars of GSE securities. The action underscored how deeply the housing bubble had penetrated the financial system and how much systemic risk had accumulated in institutions widely assumed to be safe.
The intervention also sharpened the debate over “too big to fail” and moral hazard that ran through the autumn of 2008. Supporters argued that a disorderly failure of the GSEs would have been catastrophic for the housing market and the wider economy; critics contended that the rescue confirmed the very implicit guarantee that had encouraged the firms’ reckless expansion, and that shielding creditors socialized losses that private investors had willingly taken on. The scale of the commitment — potentially hundreds of billions of taxpayer dollars — helped set the stage for the broader bailout debate that produced the $700 billion Troubled Asset Relief Program weeks later. Fannie Mae and Freddie Mac remained in federal conservatorship long after the crisis eased, and their future became one of the most contested unresolved questions of post-crisis financial policy, feeding directly into the regulatory overhaul embodied in the Dodd-Frank Act of 2010.
Sources
- https://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Mac — Wikipedia: Federal takeover of Fannie Mae and Freddie Mac
- https://www.fhfa.gov/conservatorship/history — Federal Housing Finance Agency: “History of Fannie Mae and Freddie Mac Conservatorships”
- https://www.congress.gov/crs-product/R44525 — Congressional Research Service: “Fannie Mae and Freddie Mac in Conservatorship: Frequently Asked Questions” (Report R44525)