U.S. Moves to Rescue Fannie, Freddie

Updated from 8:52 p.m. EDT

The Treasury Department and the Federal Reserve Sunday said they would take steps to restore confidence in troubled mortgage finance giants Fannie Mae(FNM Quote) and Freddie Mac(FRE Quote).

The Treasury's plan, outlined in a statement from Treasury Secretary Henry Paulson, will temporarily increase the department's lines of credit for the two government-sponsored companies.

It also will give the Treasury temporary authority to purchase equity in the two companies as needed, to ensure they have adequate capital to fulfill their missions.

"Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies," Paulson said in the statement. "Their support for the housing market is particularly important as we work through the current housing correction."

The plan would also modify regulatory reform legislation already moving through Congress to give the Federal Reserve a consultative role in setting capital requirements and "other prudential standards" for the two companies.

Paulson said he would work with leaders of Congress to enact the three-part plan quickly.

Also Sunday, the Fed said in a news release that it had given its New York branch the authority to lend to Fannie and Freddie, "should such lending prove necessary." This will effectively open the Fed's discount window -- traditionally the lender of last resort for banks -- to the two mortgage finance companies.

"This authorization 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's release said.

Fannie and Freddie are crucial engines for the U.S. housing market. Because of their implicit government guarantees, they are able to borrow money at low rates and use the funds to purchase and guarantee mortgages made by banks and other lenders. This allows lenders to go out and make more loans, furthering the government's long-standing goal of widespread home ownership.

Fallout from the subprime mortgage crisis, widespread home foreclosures and slumping home prices have damaged the two companies' balance sheets. Their shares plummeted this week, amid mounting concerns the government would have to place them in conservatorship. Such a scenario would wipe out the value of their stocks and put taxpayers on the hook for mortgage losses.

In Sunday's statement, Paulson said, "Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer."

Freddie shares closed Friday down 3.1% to $7.75 and Fannie shares finished 22.4% to $10.25. Earlier in the session, the stocks had lost more than 40% of their value.