By JESSICA HOLZER
September 6, 2008 7:26 p.m.
WASHINGTON -- Homebuyers and holders of Fannie Mae and Freddie Mac debt are the likely beneficiaries of a U.S. Treasury plan to takeover the beleaguered mortgage giants, but it is less clear how shareholders will fare.
A capital infusion by the Treasury could harm investors in the firms' common and preferred stock in the near term, but may ultimately prove a boon to shareholders if the companies rebound, analysts said.
"If the companies are stabilized and the crisis passes, the stock will be worth a lot," Peter Wallison, former general counsel to the Treasury and a frequent critic of the firms, argued.
Treasury is finalizing a plan to backstop Fannie and Freddie that will likely involve an injection of capital into the firms and a shake up of their top management, The Wall Street Journal reported on Friday.
The intervention, which could be announced this weekend, is expected to put the companies into the conservatorship of their regulator, the Federal Housing Finance Agency. The companies' boards met on Saturday to discuss the plan.
In a statement on Saturday, House Financial Services Chairman Barney Frank (D., Mass.), said he knew from Treasury Secretary Henry Paulson only that the intervention was intended "to ensure the continued and stable functioning" of the firms.
Fannie and Freddie have provided financing for 70% of mortgages originated in recent months, as purely private investors have fled the market.
Worries about the firms' ability to weather the housing crisis has pushed up their capital costs in recent weeks, causing mortgage rates to rise.
An intervention to stabilize the firms would help to keep mortgage rates down, helping potential homebuyers, argued Brian Gardner, an analyst at Keefe, Bruyette & Woods.
The Treasury is widely expected to make whole investors in the firms' debt, which his held by central banks around the world. Treasury officials in recent conversations with such foreign investors assured them of the safety of their holdings.
Less certain is how the Treasury plan would affect the firms' stockholders. Under a conservator, as opposed to a receiver, shareholders are typically not wiped out, analysts said.
However, if Treasury does not inject capital, the conservatorship might be a precursor to receivership, argued Mr. Wallison. In that case, the government might purchase the outstanding shares at a fraction of their market value, or the shareholders could receive nothing at all.
Alternatively, the Treasury could recapitalize the firms via a new class of shares with priority over the existing shareholders. Then, it might shut off dividend payments to common and preferred shareholders in order to preserve capital in the firms.
Such an approach could help to limit taxpayer losses and moral hazard -- or the risk that a federal bailout would spur more risky behavior.
Yet it would send the firms' share prices plunging to near-zero values for at least the time being, said Gerald Hanweck, a banking professor at George Mason University.
He predicted it would be at least a couple of years before the firms would stabilize if they were allowed to remain in their current form.
Many suspect the Treasury will attempt to limit the damage to the preferred shares, which are widely held by banks, insurance companies and retail investors. Fannie and Freddie together have nearly $36 billion in preferred shares outstanding.
Banks, already grappling with soaring mortgage defaults, have lobbied the Treasury in recent weeks to protect their holdings of preferred shares in a potential bailout of the firms.
"Between banks, insurance companies and retail investors, I'm sure the Treasury is walking very gingerly," Mr. Gardner said.
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