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Fannie and Freddie Test Their 25-Year Lows

The government-sponsored mortgage giants were reeling after Freddie sold debt at unusually unfavorable terms.

Updated from 1:12 p.m. EDT.

Fannie Mae



Freddie Mac


shares slipped to their lowest levels in more than 25 years on Wednesday, as fear of an imminent government bailout continued to hammer the stocks.

Freddie was recently trading down 21.6%, at $3.27, up from an all-time low of $2.84 hit earlier in the day. Fannie was down 25.6%, at $4.47, but earlier traded at $4.74, the second-lowest level on record, since hitting $4.70 in October 1981.

The government-backed mortgage giants have been struggling through the housing downturn, posting billions of dollars in losses as real-estate prices dropped and investors shied away from the perceived risk of mortgage debt. Those still purchasing Freddie and Fannie bonds may be demanding higher interest payments, if Freddie's offering Tuesday is any indication.

The company managed to sell $3 billion worth of five-year notes in the auction, which was oversubscribed -- perhaps because of the tantalizing yields. The notes were priced 1.13 percentage points above Treasury notes, with a yield of 4.172%, the widest spread Freddie has ever posted on such an offering.

However, spreads on other Fannie and Freddie debt performed an about-face on Tuesday and Wednesday, narrowing sharply as the market shifted into investments that would be better protected than stock if a government bailout does occur. The cumulative decline for both days' offerings was 10.8 basis points for Fannie and 11.1 basis points for Freddie.

"Today's narrowing might reflect the sense that additional government involvement is imminent, involvement that would primarily protect debt holders, not equity holders, most feel," Miller Tabak & Co. analyst Tony Crescenzi, a contributor to

, says in a note Wednesday.

Still, worries about higher borrowing costs surely added pressure to Freddie and Fannie shares. If those costs translate into higher mortgage rates, it could also add more pressure on consumer demand for new homes, further hurting the companies, the housing market and the broader economy.

Freddie spokeswoman Sharon McHale notes that widening spreads are common right now in the risk-averse debt market. Much of the panic is overstated, McHale says, since Freddie's primary guarantee business is "stronger than it has been in a long time."

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McHale says Freddie is reiterating the message that it has sufficient capital and liquidity to make it through the tough cycle. Freddie has not accessed funds from the

Federal Reserve's

discount window -- which was opened up to Fannie and Freddie last month on a temporary basis -- and doesn't plan to in the future.

"I think we're just showing the world that despite the panic out there, we're well capitalized, our liquidity position is strong, our guarantee business is doing extremely well," says McHale. "We are doing business as we always have."

Regulators have teamed u p with

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to assess the best strategy for handling the Fannie-Freddie crisis. The Treasury Department gained approval from Congress to purchase an equity stake in the firms or loan them unlimited funds to shore up capital levels. While Treasury Secretary Henry Paulson and executives from both companies have maintained that Fannie and Freddie will remain in their current structure -- as shareholder-owned companies that have implicit government backing -- investors are concerned about their stakes being devalued if a government bailout becomes necessary.

Fannie and Freddie shares have been tumbling all week, down more than 40% since Friday.

Fannie spokesman Brian Faith noted in a statement that the company has raised more than $7 billion in capital during the second quarter and is "bolstering our loss mitigation efforts." He did not provide any insight on discussions with regulators, except to say that Fannie "will continue working closely with the

Federal Housing Financing Agency, the

Federal Reserve

, the Department of Treasury, Congress and our partners so that we continue to provide a critical, reliable source of mortgage funding and liquidity in the years to come."

Freddie did not immediately respond to a request for comment.

The lack of confidence is not necessarily supported by the companies' business outlook, according to Fox-Pitt analyst Howard Shapiro.

In an analysis of the companies' book of mortgage holdings, Shapiro notes that their exposure to Alt-A loans, which require little or no proof of income, will hurt results, but that it would still take more than $50 billion worth of losses over the next year and a half for Fannie or Freddie to fall below their minimum capital requirements.

"It is not just the size of the exposure but the type, or quality, of the exposure that is important," Shapiro emphasized. "Put another way, in assessing capital needs, it is not just the absolute size of the exposure but the likelihood of loss that must be assessed. We doubt that even critics would find much cause for concern in the companies' exposure to seasoned 30- and 15-year fixed rate mortgages."

McHale says that smaller competitors' exit from the market has put Freddie in a good position, and that the company was purchasing mortgages "at very high volumes" on Wednesday.

"That's very high-revenue business that's coming in the door today," says McHale, adding that "while spreads have widened for us -- as they have for everyone -- we are still significantly outperforming other issuers."