US financial regulators will allow ailing Fannie Mae and Freddie Mac to borrow directly from the Federal Reserve. The dramatic move to help stabilise the two mortgage giants also includes a proposal to give the Treasury Department the authority to take an equity stake in the companies.
In separate announcements, the Treasury and Fed made clear that the federal government sees it necessary to help the firms, which have seen their shares plummet over the last week amid fears about their solvency. Treasury Secretary Henry Paulson noted in a statement the debt of the two government-sponsored enterprises is held by investors around the world.
"Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets," Mr Paulson said. "Therefore we must take steps to address the current situation as we move to a stronger regulatory structure."
To underscore the gravity of the announcement, the White House issued a statement saying the proposals "will help add stability" to the housing finance system.
"Fannie Mae and Freddie Mac play an important role in our housing finance system, and they should continue to play this role in their current forms as shareholder-owned companies," the White House press secretary said in a statement.
"President Bush directed Secretary Paulson to immediately work with Congress to act on this plan," the White House statement said, referring to Mr Paulson.
The Fed's board of governors "has granted the Federal Reserve Bank of New York the authority to lend to Fannie Mae and Freddie Mac should such lending prove necessary," the Fed said in a statement. The board voted 5-0 in favour of the decision.
"Any lending would be at the primary credit rate," the Fed added. The primary credit rate, also known as the discount rate, is 2.25 per cent.
The decision to give the firm's access to the discount window comes just two days after the Fed denied reports it was discussing with the firms such a move. Fed spokeswoman Michelle Smith said on Friday that Fed officials were following the situation, "but there have been no discussions with the GSEs about access to the discount window."
"This authorisation is intended to supplement the Treasury's existing lending authority and to help ensure the ability of Fannie Mae and Freddie Mac to promote the availability of home mortgage credit during a period of stress in financial markets," the Fed said.
The Treasury proposal, which would require approval by Congress, calls for a temporary increase in the $US2.25 billion ($2.4 billion) line of credit each of the two GSEs can draw on from the federal government.
A senior Treasury official declined to say how large the new line of credit would be, saying only that it would be temporary - probably 18 months - and that the size, terms and conditions would be at the discretion of the Treasury secretary.
The 12 Federal Home Loan Banks would also have temporary access to expanded lines of credit, which would be determined by Treasury, according to an official.
The proposal would also give the Treasury the discretion to purchase an equity stake in either firm if it's deemed necessary.
The senior treasury official said the details of such a purchase, if necessary, would be determined at that time in consultation with the two firms. He declined to say the potential form of such a purchase, whether it be preferred stock or some other form of equity, or whether it would have the potential to dilute the holdings of current company stockholders.
"Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer," Mr Paulson said in his statement.
The action marks the second time in four months that the Fed has broadened use of the discount window to avert financial contagion.
In March, the Fed granted primary dealers access to the discount window - a privilege once restricted to tightly regulated commercial banks - in the wake of the failure of Bear Stearns.
That program, the primary dealer credit facility, is due to expire in September, though Fed chairman Ben Bernanke has said it may be extended.
The Fed statement did not include an end-date for Fannie and Freddie's access to the discount window, though the language of the statement suggests the access isn't permanent.
One difference between the GSE program and the access for primary dealers is that the range of securities Fannie and Freddie can use for collateral is much narrower than that for primary dealers.
The senior Treasury official said that nothing has occurred since Friday to act as a catalyst for the extraordinary moves. Rather, policymakers deemed it necessary given the precipitous declines in the companies' share prices last week and their potential to roil financial markets worldwide.
Asian central banks and financial institutions are major holders of US debt and are believed to own substantial portions of debt for Fannie Mae and Freddie Mac.
According to the US Treasury Department's latest data, foreigners owned 21.4 per cent, or $US1.3 trillion, of the total outstanding long-term debt issued by US government agencies as of June 2007.
China and Japan were by far the largest investors in such securities, holding $US376 billion and $US229 billion, respectively. It isn't clear how much debt either country owns from Fannie and Freddie specifically.
The ability of the Fed announcements to calm skittish markets will be tested quickly. Freddie Mac is scheduled to sell $US3 billion of short-term debt on Monday, and an unsuccessful sale could signal that the steps by regulators may not be enough to instill confidence.
Longer term, the Treasury plan calls for the Federal Reserve to be given a consultative role in determining the firms' capital requirements and other standards.
The three-part Treasury plan is expected to be inserted into a broad package of housing legislation currently moving through Congress. The senior Treasury official said the hope is that the changes can be made and the legislation passed by the House and Senate and sent to President George W. Bush this week.
A spokesman for House Financial Services chairman Barney Frank said that Mr Frank had multiple conversations with Mr Paulson about the Treasury plan and has called committee staff together to begin ironing out the details of the proposal.
Spokesman Steve Adamske said Mr Frank is "generally supportive" of the steps and believes lawmakers can put the plan in place quickly.
Both Fannie Mae and Freddie Mac, in separate statements, praised the moves by Treasury and the Fed. Freddie Mac chairman and CEO Richard Syron said his firm is in the process of finalising its second quarter results and that the firm estimates it will have a "substantial capital cushion above the 20 per cent mandatory target" established by the firms' regulator, the Office of Federal Housing Enterprise Oversight.
"We expect the results will also show that we have a much greater surplus above the statutory minimum capital requirement," Mr Syron's statement said.
Fannie Mae CEO Daniel Mudd took a similar tone in his comments.
"We continue to hold more than adequate capital reserves and maintain access to liquidity from the capital markets," Mr Mudd said. "Given the market turmoil, having options to access provisional sources of liquidity if needed will help to strengthen overall confidence in the market."
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