Fannie and Freddie: What Would Happen If They Fail

Freddie Mac (FRE) and Fannie Mae (FNM), both government sponsored enterprises – fell to the lowest levels in more than 12 years during the course of this week’s trading. The PPS – dump, on both tickers, came amid concerns that the two largest U.S. mortgage-finance companies may need to raise more capital. According to a Lehman Brother analyst ; Fannie Mae would need to add $46 billion of capital while Freddie Mac would need approximately $29 billion.

On Wednesday Fortune ran an article titled: The Fannie and Freddie doomsday scenario. The article alludes to the premise of what would happened if both govt. sponsored enterprises failed. Article also offers (thankfully, since that’s the last thing all major averages would need right now) a bailout scenario.

[Via: Fortune]

Here’s a scary, and relevant, question to ponder as the housing market continues to slide: What would it take for the government to step in and help Fannie Mae and Freddie Mac, and how would a rescue affect you, the taxpayer?
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“If Fannie or Freddie failed, it would be far worse than the fall of [investment bank] Bear Stearns,” says Sean Egan, head of credit ratings firm Egan Jones. “It could throw the economy into depression or something close to it.”

Since both companies play not only a critical and essential role in the market, but also a stabilizing one for the sector in particular and the economy in general, I don’t see how the Treasury or the FED can realistically afford to show negligence around such a dire situation. (if it were to get to that level that is). The doomsday scenario, notes article – could cost taxpayers more than $1 trillion.

More likely, the Treasury Department or the Federal Reserve would come in and provide a liquidity backstop, in the form of a loan or guarantee to bondholders that they will be paid. Fannie and Freddie could even do a preferred stock deal with the government, much like the deal forged by Citigroup with the Abu Dhabi Investment Authority, says Egan.

“In an April report, Standard & Poor’s said an Armageddon scenario whereby Fannie and Freddie are insolvent is unlikely, but that the mere possibility of failure at either is a greater threat to the economy than the actual collapse of any investment bank.”

Investors remain understandably skeptical and confused. On Tuesday, James Lockhart, [Via: CNBC] director of the Office of Federal Housing Enterprise, which regulates the two enterprises – said “Fannie Mae and Freddie Mac are adequately capitalized and continue to be active in the mortgage market”.

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