1. July 12, 2008
PAGE ONE
Rescue Debate: Paulson Insists
Fannie, Freddie Holders Lose
By DEBORAH SOLOMON, JAMES R. HAGERTY and SERENA NG
July 12, 2008; Page A1
As the crisis worsens for mortgage giants Fannie Mae and Freddie Mac,
Treasury Secretary Henry Paulson is insisting that any potential government
rescue plan not benefit the companies' shareholders, according to people
familiar with the matter.
The two stockholder-owned, government-sponsored
companies, whose operations are vital to the functioning
of the U.S. housing market, faced a severe crisis of
confidence after a week in which their stocks each lost
nearly half their value. On Friday, Freddie Mac finished
the day at $7.75 a share, and Fannie Mae at $10.25.
The discussions at Treasury highlight the dilemma created
by the financial crisis gripping the U.S: Some institutions
are considered too big to fail, but propping them up could
erode the market's incentive to properly judge risk by
offering investors a false sense of security.
After a week of near panic among shareholders of the two
companies -- and a stomach-churning day on Wall Street
Friday -- the next big test will come Monday when
Freddie Mac is due to sell $3 billion of short-term debt.
An unsuccessful sale could be a major blow to investor
confidence. If the administration were to intervene, it
could do so before markets opened that day, according to
a person familiar with the deliberations.
The companies' weakened state is a new and unwelcome
headache for Wall Street's top banks and securities firms, already
battered by a year's worth of debt-related losses. The financial
firms hold mortgage securities guaranteed by Fannie Mae and
Freddie Mac as well as debt issued by the companies to fund
their operations. Some also earn fees from underwriting those
securities.
How any rescue might be orchestrated remains unclear. The
administration doesn't expect the firms to fail and it is "not
talking about nationalizing" the struggling mortgage giants,
according to a person familiar with its thinking. Mr. Paulson
issued a written statement Friday saying that the administration's "primary focus is supporting Fannie Mae
and Freddie Mac in their current form."
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WSJ's David Wessel tells Paul Lin why Washington and the
Federal Reserve want to shore up confidence in mortgage
buyers Fannie Mae and Freddie Mac by providing financial
support.
RELATED READING
• Heard on the Street: Better Debt Than Stock?1
• How the Week's Wild Selldown Went Down2
• Fannie, Freddie Critic Sadly Says 'Told You'3
• Fed: No Talks on Discount-Window Access for
GSEs4
• Text of Paulson's July 11 statement5
• Insurance Dilemma Hits Fannie, Freddie6
• Q&A: The Role of Fannie, Freddie7
• Overhaul of Financial Regulation Gains
Momentum8
Page 1 of 5Rescue Debate: Paulson Insists Fannie, Freddie Holders Lose - WSJ.com
7/20/2008http://online.wsj.com/article_print/SB121577699220645703.html

2. One option would have the government buy a chunk of Fannie and Freddie's preferred stock with terms that
dilute the equity of common shareholders. The Federal Reserve could support Fannie Mae or Freddie Mac
in a short-term funding crisis through its lending operations, which were extended to investment banks in
March with the downfall of Bear Stearns Cos. A spokeswoman said Friday the Fed hasn't discussed that
possibility with either company.
High Anxiety
Monday's auction comes at a time of huge anxiety. Fannie and
Freddie sell tens of billions of dollars of short- and long-term
debt each month and use the proceeds to finance their purchases
of mortgages from banks. If they were unable to replace
maturing debt for an extended period, they would have to stop
buying mortgages and eventually sell home loans and securities
they hold in their portfolios. That would be likely to send
consumer mortgage interest rates soaring.
"I think the auction will go reasonably well," said Ira Jersey, an
interest-rate strategist at Credit Suisse in New York. Several
investment banks contacted Friday said they will participate in
the auction.
Others were more cautious. "We've been seeing a lack of buyers for [short-term notes from Fannie and
Freddie] because of uncertainty about whether there's going to be an explicit government guarantee behind
the debt," said Benjamin Cheng, an interest rates strategist at UBS AG. "If there isn't more clarity on that by
Monday, that auction could be ugly," he added.
Longer-dated bonds of Fannie and Freddie, on the other hand, saw heavy buying on Friday. Their yields
relative to Treasury securities fell, suggesting the companies' longer-term borrowing costs should stay
relatively low as debt investors are still comfortable about the outlook.
Investors believe that both companies will have to raise large amounts of capital to cope with the losses they
face on mortgage defaults. Freddie has announced plans to raise $5.5 billion through a share offering but
finds the market for its stock extremely weak. On Friday, Freddie said it doesn't need to raise capital in the
"near term." The company said its second-quarter results, due to be released early in August, will show that
it has capital well above the minimum imposed by its regulator.
Fannie also sought to reassure the markets Friday. "We are maintaining a strong capital base, building
reserves for our credit losses, and generating solid revenues," the company said. Fannie said it sold more
than $24 billion in debt in the past week.
Shares in the two companies -- which own or guarantee about $5 trillion of
mortgages or nearly half of all U.S. home-mortgage debt outstanding -- have
plunged during a wild week. Both stocks are at their lowest closing levels in more
than 16 years. With few respites, they plummeted all week as investors grew more
and more fearful that the companies' need to raise more capital would dilute or even
wipe out the value of existing shares. Investors also reacted to gloomy talk, such as
the comment from a former Federal Reserve official that Fannie and Freddie were
"technically insolvent," a statement denied by both companies.
On Friday, major indexes were all over the place, ending a roller-coaster session in
negative territory. After spending most of the session deep in the red, an erroneous
report suggesting the Fed would allow Fannie and Freddie to borrow money from
the central bank caused a dramatic reversal. Major indexes moved into positive
territory, but the rally faded.
9
Getty Images
President George W. Bush met on energy prices with
members of his economic team in Washington, D.C.,
Friday.
Page 2 of 5Rescue Debate: Paulson Insists Fannie, Freddie Holders Lose - WSJ.com
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3. The Dow Jones Industrial Average fell 128.48 points, or 1.1%, to close at 11,100.54 after earlier falling
below 11,000 for the first time since June 2006.
Freddie Mac finished the day lower by 3.1%, and Fannie Mae lost 22%. Respectively, Fannie and Freddie
saw 405 million and 394 million shares change hands in trading Friday, compared with average daily
volume of 19.6 million and 15.3 million shares over the past 52 weeks.
Investors are worried the firms will suffer more losses as mortgage defaults rise. Stock-market investors are
also worried the companies will need to raise significant amounts of capital to cover those losses. For
investors, that means the value of their ownership stakes in the company will be cut. Bond investors
continue to lend to both companies, though they are also demanding slightly higher interest rates.
Moral Hazard
If a rescue becomes necessary, Mr. Paulson does not want to help the shareholders because of the "moral
hazard" it would create -- desensitizing investors to risk because they believe the government will bail them
out. It's a similar position he took during the government-orchestrated rescue of Bear Stearns by J.P.
Morgan Chase & Co.
Growth Fund of America from American Funds, part of Capital Research & Management Co., was recently
the mutual fund with the most Fannie Mae stock, holding more than 50 million shares. Other big holders
have included AllianceBernstein Holding LP and Fidelity Investments. Growth Fund of America has also
been the biggest fund holder of Freddie Mac, recently holding more than 25 million shares, followed by
funds like Bill Miller's Legg Mason Value Trust. The firms declined comment.
The crisis has been exacerbated by the strange hybrid nature of the two companies, which have prospered
because they are seen as having the implicit backing of the U.S. government. Chartered by Congress to
ensure a steady flow of money into housing finance, they can borrow cheaply because investors believe the
government probably would rescue them in a crisis. Yet they are owned by private shareholders who want
profit growth and dividends.
The implicit guarantee has allowed the companies to borrow at lower rates and buy more mortgages,
providing a benefit to shareholders. There's a belief among many politicians and officials that it is the
shareholders -- not taxpayers -- who should bear those risks because they benefited greatly in the past from
the implied government backing.
The government has increasingly leaned on the so-called government-sponsored enterprises to provide
stability to a housing market crippled by falling home prices and banks too nervous to lend.
"Do a little examination and ask yourself, 'What do you think the housing market in the U.S. would look like
without the GSEs now?"' Richard Syron, Freddie's chairman and chief executive, said earlier this year.
The Bush administration has long worried about the systemic risk posed by the companies. The
administration has pushed for a regulatory revamp, including a new, more powerful regulator to oversee
them. Long-awaited legislation that would do that passed the Senate on Friday.
Freddie said it is looking at options to conserve capital. The company holds about $770 billion of mortgage
loans and related securities. That produces repayments of around $10 billion a month as homeowners pay
off their loans. Normally, Freddie reinvests that money in new mortgages. But if it stops buying mortgages,
it has less need for capital. Not replacing mortgages that pay off would "free up approximately $250 million
of capital per month," Freddie said.
There's a political downside: By putting on the brakes, Freddie would be providing less support to an
already weak market.
Page 3 of 5Rescue Debate: Paulson Insists Fannie, Freddie Holders Lose - WSJ.com
7/20/2008http://online.wsj.com/article_print/SB121577699220645703.html

4. RELATED ARTICLES FROM ACROSS THE WEB
Related Articles from WSJ.com
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• Troubles Could Diminish Clout of Fannie, Freddie Jul. 17, 2008
• Teva Buys Barr, as Generics Consolidation Continues Jul. 18, 2008
• The Top Life Science & Health Deals of ‘08, So Far Jul. 14, 2008
Related Web News
• Freddie Mac Takes Step Toward Stock Sale - NYTimes.com Jul. 18, 2008 nytimes.com
Freddie also said it "could consider reducing our common stock dividend" of 25 cents a share. Eliminating
that dividend would save nearly $650 million a year.
There are signs that Fannie and Freddie may have to pay modestly higher rates for short-term borrowings.
Fannie and Freddie's previously issued three-month notes traded Friday at a yield of about 2.43%, up from
the 2.34% paid at Fannie's auction of such notes Wednesday, traders said.
Freddie has total debt outstanding of $874 billion, of which 27% is short-term. In addition, the company
owns or guarantees about $2.2 trillion of mortgages. Fannie's debt outstanding is $782 billion, of which 29%
is short-term. Fannie owns or guarantees about $3 trillion of mortgages.
Risk for Wall Street
Wall Street could be exposed. David Trone, who follows financial stocks at Fox-Pitt, Kelton, estimated that
Citigroup Inc. had $36 billion in mortgage securities backed by the companies and $15 billion in debt
issued by them, and J.P. Morgan, $65 billion and $22 billion. Both companies declined to comment.
Stock analyst Matthew Albrecht of Standard & Poor's Corp. noted that Wall Street also faces the risk of a
reduction in fees for mortgage underwriting, an area of relative strength. Fees for mortgage debt backed by
Fannie and Freddie, and their securities, which totaled $952 million in 2007, have already topped $550
million this year, according to Thomson Reuters, which tracks new issues.
On Friday, some market participants said investors were trying to unload Fannie and Freddie's short-term
discount notes, but few people were willing to purchase them at levels that sellers were asking.
--Randall Smith, Damian Paletta and Sudeep Reddy contributed to this article.
Write to Serena Ng at serena.ng@wsj.com10
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5. • Fannie Mae, Freddie Mac shares jump again Jul. 18, 2008 news.yahoo.com
• Freddie Mac takes step toward issuing stock Jul. 18, 2008 usnews.com
• Freddie Mac moves toward stock sale Jul. 18, 2008 nbc.com
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