Fannie, Freddie plunge spurs bailout talk

Continued sharp slide in shares of mortgage finance firms raises new concerns about need for new capital, threat of government takeover.

By Chris Isidore, CNNMoney.com senior writer
Last Updated: July 11, 2008: 10:21 AM EDT

NEW YORK (CNNMoney.com) -- The anxiety over Fannie Mae and Freddie Mac, which support $5 trillion in home loans, reached fever pitch on Friday as shares of the mortgage finance giants plunged in early trading.

Immediately after the markets opened, shares of Fannie (FNM, Fortune 500) and Freddie (FRE, Fortune 500) fell more than 47% from their already battered closing price the day before. They soon rebounded slightly but Fannie shares were down 36% and Freddie shares were off 43% about a half hour after opening.

In the first four trading days of the week, the shares of Fannie have lost 30% of their value, while Freddie shares have tumbled 45%. For the year, Fannie is down 67% and Freddie 77%.

The two firms play a central role in the U.S. housing market, providing a crucial source of funding for banks and other home lenders.

If they were unable to do so, it would significantly raise the cost and restrict the availability of mortgage loans, causing significantly more problems for already battered housing prices and sales. That in turn would be another significant problem for the overall U.S. economy, as well as global credit markets.

The New York Times reported Friday that senior Bush administration officials are considering a plan to have the government take over one or both of the companies if their problems worsen.

The shares seemed to rebound when word came that Treasury Secretary Henry Paulson was set to speak.

A number of scenarios were being discussed by bankers and analysts about what the government may do to deal with investors' current crisis of confidence in the firms.

Jaret Seiberg, a financial services analyst for the Stanford Group, a Washington research firm, said Thursday options that among the options are: The Federal Reserve could purchase some of the Freddie and Fannie debt or mortgage-backed securities; the Treasury Department could make billions of dollars in loans to the companies or even buy stock in the companies.

"Government officials are always planning for worst-case scenarios and our note is intended to highlight some options that may be available to policymakers," he wrote. "We suspect hybrid versions of these plans also are possible."

Under current law, the Office of Federal Housing Enterprise Oversight (OFHEO), the regulator of Fannie and Freddie, could take control of the firms if their capital falls too far below required levels. It is unclear how the firms would operate in that situation, known as a conservatorship.

OFHEO Director James Lockhart issued a statement late Thursday saying that his agency was closely monitoring the firms' credit and capital positions. But he pointed out that they had already raised $20 billion in capital and that they adequately capitalized, holding funds well in excess of his agency's requirements.

Still investors were worried that continued problems in the housing market would cause more than the $12.7 billion losses the two firms have lost between them since last July. The decline in their stock value makes raising additional capital to cover those future losses that much more expensive and difficult.

It is also unclear if current shareholders would see their holdings wiped out under some of these government rescue options - leading to the pre-market sell-off.

A Fannie spokesman said Friday morning that the company had no comment, while a spokeswoman for Freddie was not available for immediate comment. Both firms issued statements on Thursday saying they had the necessary capital to continue operating, adding they would not comment on the decline in their stock value.