Treasury, FHFA Outline Fannie, Freddie Rescue - TheStreet

Updated from Sunday, Sept. 7

The U.S. Treasury and Federal Housing Finance Agency announced Sunday a plan to temporarily take control of faltering mortgage giants

Fannie Mae

(FNM)

and

Freddie Mac

(FRE)

, an intervention that could result in the largest federal bailout in U.S. history.

Treasury Secretary Henry Paulson and FHFA Director James Lockhart, in a press conference in Washington, outlined the federal government's plan to fund and control the public-private firms under a conservatorship agreement.

"We examined all options available, and determined that this comprehensive and complementary set of actions best meets our three objectives of market stability, mortgage availability and taxpayer protection," said Paulson, who further noted that "conservatorship was the only form in which I would commit taxpayer money to the GSEs."

Cramer: The Bailout's Biggest Winners

var config = new Array(); config<BRACKET>"videoId"</BRACKET> = 1782378488; config<BRACKET>"playerTag"</BRACKET> = "TSCM Embedded Video Player"; config<BRACKET>"autoStart"</BRACKET> = false; config<BRACKET>"preloadBackColor"</BRACKET> = "#FFFFFF"; config<BRACKET>"useOverlayMenu"</BRACKET> = "false"; config<BRACKET>"width"</BRACKET> = 265; config<BRACKET>"height"</BRACKET> = 255; config<BRACKET>"playerId"</BRACKET> = 1243645856; createExperience(config, 8);

Business at Fannie and Freddie will open as usual Monday, said Lockhart, "only with stronger backing for the holders of MBS, senior debt and subordinated debt." The firms will be allowed to modestly increase their mortgage-backed securities portfolios through the end of 2009 in an effort to help stabilize the secondary mortgage market and lower the cost of funding.

The New York Stock Exchange said Monday premarket trading in the common and related preferred stock of Fannie Mae and Freddie Mac will be halted, but regular trading of the shares is expected to open at 9:30 a.m. ET.

But under the plan, approved by both firms' boards Saturday, the FHFA will take control of management and the boards. The current CEOs of the two firms will depart after a brief transition. At Fannie Mae, CEO Daniel Mudd will be replaced by Herb Allison, former vice chairman of

Merrill Lynch

(MER)

and former chairman of TIAA-Cref. At Freddie Mac, CEO Richard Syron will be replaced by David Moffett, former vice chairman and CFO of

US Bancorp

(USB) - Get Report

. Allison and Moffett's "compensation will be significantly lower than the outgoing CEOs," said Lockhart.

"Conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses," said Paulson. In a further effort to save capital, the common and preferred stock dividends will be eliminated, but the common and all preferred stocks will continue to remain outstanding. All lobbying activities will be halted.

The Treasury and FHFA have established so-called preferred stock purchase agreements, contractual agreements between the Treasury and the firms to ensure they maintain positive net worths. Paulson said this commitment will eliminate any "mandatory triggering of receivership" and will ensure that Fannie and Freddie have the ability to fulfill their financial obligations.

"It is more efficient than a one-time equity injection, because it will be used only as needed and on terms that Treasury has set. With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers," said Paulson. Common and preferred shareholders bear losses ahead of the new government senior preferred shares. "In the end," said Paulson, "the ultimate cost to the taxpayer will depend on the business results of the GSEs going forward."

The Treasury also has agreed to temporarily purchase GSE mortgage-backed securities MBS. "As the GSEs have grappled with their difficulties, we've seen mortgage rate spreads to Treasuries widen, making mortgages less affordable for homebuyers, said Paulson. "While the GSEs are expected to moderately increase the size of their portfolios over the next 15 months through prudent mortgage purchases, complementary government efforts can aid mortgage affordability." To that end, the Treasury will begin to invest in new GSE MBS later this month.

Paulson said that because the Treasury can hold these securities to maturity, the spreads between Treasury issuances and GSE MBS indicate there's no reason to expect taxpayer losses from this program, and, in fact, it could produce gains. This program will also expire with the Treasury's temporary authorities in December 2009.

Paulson characterized the plan as a "time out" under which policymakers should determine the future role and structure of both firms. "Because the GSEs are Congressionally-chartered, only Congress can address the inherent conflict of attempting to serve both shareholders and a public mission."

Fannie and Freddie, created by Congress in 1938 and 1970 to support the housing market, currently hold $5.4 trillion of the roughly $12 trillion U.S. mortgage market. Over the past four quarters, Fannie and Freddie have posted losses totaling roughly $14 billion, as mortgage foreclosure rates continue to climb in the U.S.

Shares of the two government-sponsored mortgage giants have been volatile in trading over the past few months, as traders reacted to rumors and speculation over whether a government bailout was imminent. While both stocks posted positive closes Friday, they took a severe beating in after-hours trading following

The Wall Street Journal's

post-market report of the impending bailout this weekend. Fannie Mae shares fell 21.9% to $5.50, and Freddie Mac sank 20.8% to $4.04.

Image placeholder title

For more details, check out Paulson's full statement as well as Lockhart's prepared remarks at the Treasury and FHFA Web sites.

This article was written by a staff member of TheStreet.com.