Nation & World

Will the government rescue Fannie Mae and Freddie Mac?

WASHINGTON — Wall Street may be poised for a rally Monday amid indications Friday of a weekend rescue plan for troubled mortgage finance titans Fannie Mae and Freddie Mac.

For the past several weeks, the Treasury Department, the Federal Reserve and other federal agencies have quietly prepared a plan to backstop Fannie and Freddie, which operate as quasi-private entities that buy top-quality mortgages and package them as bonds sold to investors.

A backstop to prevent the entities' failure is important to all Americans because mortgage lending happens in great measure thanks to Fannie and Freddie, which own or back more than $5 trillion in mortgage debt. Their problems have contributed to the nation's housing problems, which have brought the U.S. economy to the brink of recession.

A government move to shore up the two financial entities could result in lower mortgage rates for consumers and spark new mortgage lending that could bring to an end a deep two-year slump in home sales and home prices.

"We are making progress on our work with Morgan Stanley, FHFA (Federal Housing Finance Agency) and the Federal Reserve," said Jennifer Zuccarelli, a Treasury spokeswoman, stopping short of confirming a report late Friday by The Wall Street Journal that an announcement could come this weekend. "As we've been saying for weeks, we're not going to comment on every market rumor."

Although Treasury Secretary Henry Paulson has said he'd do whatever it takes to keep Fannie and Freddie solvent, he'd also said he expected them to remain in their current form. That's roiled investors, who argue that the mortgage finance giants lack adequate capital should their loan portfolios sour and losses mount.

On Thursday, the founder of California-based Pacific Investment Management Co., or PIMCO, warned on the company's Web site that the world's largest bond fund was effectively going on a buyer's strike. The federal government needs to step in to bolster financial markets by removing uncertainty surrounding Fannie and Freddie, suggested Bill Gross, or risk "turning a campfire into a wildfire."

The PIMCO executive's comment came weeks ahead of when Fannie and Freddie are scheduled to roll over $225 billion in short-term debt, and it suggested the two would have trouble finding buyers. The comment also came on a day that the Dow Jones Industrial Average fell more than 344 points.

Although stocks rebounded slightly on Friday, Gross appeared on the CNBC cable channel after the market closed and commented on rumors that federal intervention was imminent.

"Hopefully we all don't have Monday morning egg on our face," Gross said. "To the extent that it does happen, I think it is a needed step, it's not just a 24-hour thing ... to the extent that the rumor is true it may be a positive step in the right direction."

There is precedent for big announcements over a weekend following a volatile week. The Federal Reserve announced the shocking March 16 fire sale of investment bank Bear Stearns on a Sunday night, averting what many financial experts days earlier feared could be the beginning of a global financial meltdown.

Months later, the Fed and the Treasury Department announced a July 13 rescue plan for Fannie and Freddie that made explicit what had always been implicit — that the U.S. government wouldn't let the two entities fail. Paulson expanded government lending to Fannie and Freddie and Congress later authorized Treasury to buy the stock from the two to bolster share prices.

In August, Treasury tapped investment giant Morgan Stanley to advise it on ways to bolster the standing of the two financiers. One option believed under consideration is putting the two temporarily under third-party control, which would leave current shareholders holding stock worth little if anything absent a bailout from taxpayers.

Treasury will have to strike a delicate balance that finds a way to convince future investors to buy shares of Fannie and Freddie without completely bailing out current investors, many of them foreign banks that thought they bought safe bets.

"It's a very delicate problem here," Gross told CNBC.

Shares of Fannie and Freddie both lost more than 25 percent of their value in after-hours trading Friday after the reports of a weekend announcement of a backstop plan and changes in senior management.

To ask a question about this story or any economic question, go to McClatchy's economy Q&A