U.S. Takes Over Ailing Mortgage Lenders

The Bush administration, acting to avert the potential for major financial turmoil, says the federal government was taking control of mortgage giants Fannie Mae and Freddie Mac.

Officials announced that the executives of both institutions had been replaced.

Herb Allison, a former vice chairman of Merrill Lynch, was selected to head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp, was picked to head Freddie Mac.

Treasury Secretary Henry Paulson says the actions were being taken because "Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe."

The huge potential liabilities facing each company, as a result of soaring mortgage defaults, could cost taxpayers tens of billions of dollars, but Paulson stressed that the financial impacts if the two companies had been allowed to fail would be far more serious.

"A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance," Paulson said.

Both companies were placed into a government conservatorship that will be run by the Federal Housing Finance Agency, the new agency created by Congress this summer to regulate Fannie and Freddie.

The Federal Reserve and other federal banking regulators said in a joint statement Sunday that "a limited number of smaller institutions" have significant holdings of common or preferred stock shares in Fannie and Freddie, and that regulators were "prepared to work with these institutions to develop capital-restoration plans."

The two companies had nearly $36 billion in preferred shares outstanding as of June 30, according to filings with the Securities and Exchange Commission.

The takeover follows a report Friday by the Mortgage Bankers Association that more than 4 million American homeowners with a mortgage, a record 9 percent, were either behind on their payments or in foreclosure at the end of June.

Sen. Joe Biden said the government's rescue of the big mortgage companies Freddie Mac and Fannie Mae should not mean bailing out shareholders at the expense of taxpayers.

The Democratic nominee for vice president says it is important to help homeowners and make sure the two companies still are in a position to keep making loans.

That confirmed what investors saw in Fannie and Freddie's recent financial results: trouble in the mortgage market has shifted to homeowners who had solid credit but took out exotic loans with little or no proof of their income and assets.

For decades, Fannie and Freddie fulfilled the American dream, reports CBS News correspondent Tony Guida. Consumers took out loans from banks, which in turn sell those loans to Fannie or Freddie. Then the mortgage giants repackaged those loans and sold them to investors, guaranteeing the mortgages would be repaid.

As home ownership grew universal, Fannie and Freddie prospered. Their CEOs, Daniel Mudd and Roger Syron together earned around $30 million dollars in 2007, reports Guida.

But as they fat, critics say they got greedy, underwriting too many home loans that never should have been made.

Fannie Mae and Freddie Mac lost a combined $3.1 billion between April and June. Half of their credit losses came from these types of risky loans with ballooning monthly payments.

While both companies said they had enough resources to withstand the losses, many investors believe their financial cushions could wither away as defaults and foreclosures mount.

Frank said the companies' financial picture was better than Wall Street investors assumed, but "it just plainly became clear that elements of the market wouldn't' accept that."

The epic decision highlights the size of the threats facing the housing market and the economy. On Friday, Nevada regulators shut down Silver State Bank, the 11th failure this year of a federally insured bank. And earlier this year, the government orchestrated the takeover of investment bank Bear Stearns by JP Morgan Chase.

"Any government action must help to strengthen our economy, which is suffering a crisis brought on by the administration's failure to stop predatory lending," said Sen. Chris Dodd, D-Conn., who chairs the Senate Committee on Banking, Housing, and Urban Affairs. "Any intervention also must minimize the cost to American taxpayers, and should not put other financial institutions at risk."

The crisis surrounding Fannie and Freddie promises to be a major challenge for the next president.

The role the two companies play in the U.S. mortgage market has grown dramatically over the past year as other lenders collapsed under the weight of bad subprime loans. The companies guaranteed about three-quarters of all new mortgages in the second quarter of this year, up from under 40 percent in 2006, according to the trade publication Inside Mortgage Finance.

Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson and James Lockhart, the companies' chief regulator, met Friday afternoon with the top executives from the mortgage companies and informed them of the government's plan to put the companies into a conservatorship as early as this weekend.

In July, Congress passed a plan to provide unlimited government loans to Fannie and Freddie and to purchase stock in the companies if needed. Critics say the open-ended nature of the rescue package could expose taxpayers to billions of dollars of potential losses.

Fannie Mae was created by the government in 1938, and was turned into a public company 30 years later. Freddie Mac was established in 1970 to provide competition for Fannie.