In September 2008, the Federal Housing Finance Agency (FHFA) announced that it would take over the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Both government-sponsored enterprises, which finance home mortgages in the United States by issuing bonds, had become illiquid as the market for those bonds collapsed in the subprime mortgage crisis. The FHFA established conservatorships in which each enterprise's management works under the FHFA's direction to reduce losses and to develop a new operating structure that will allow a return to self-management.
As of 2024, Fannie Mae and Freddie Mac remain under conservatorship, and after more than repaying their Treasury loans are building capital reserves for an expected eventual exit.
Background and financial market crisis
The combined GSE losses of US$14.9 billion and market concerns about their ability to raise capital and debt threatened to disrupt the U.S. housing financial market. The Treasury committed to investing as much as US$200 billion in preferred stock and extend credit through 2009 to keep the GSEs solvent and operating. The two GSEs had outstanding more than US$5 trillion in mortgage-backed securities (MBS) and debt; the debt portion alone was $1.6 trillion.
The conservatorship action has been described as "one of the most sweeping government interventions in private financial markets in decades" and one that "could turn into the biggest and costliest government bailout ever of private companies".
With a growing sense of crisis in U.S. financial markets, the conservatorship action and commitment by the U.S. government to backstop the two GSEs with up to US$200 billion in additional capital turned out to be the first significant event in a tumultuous month among U.S.-based investment banking, financial institutions, and federal regulatory bodies. By September 15, 2008, the 158-year-old Lehman Brothers holding company filed for bankruptcy with the intent to liquidate its assets, leaving its financially sound subsidiaries operational and outside of the bankruptcy filing. The collapse was the largest investment bank failure since Drexel Burnham Lambert in 1990.
The 94-year-old Merrill Lynch accepted a purchase offer by Bank of America for approximately US$50 billion, a big drop from a year-earlier market valuation of about US$100 billion. A credit rating downgrade of the large insurer American International Group (AIG) led to a September 16, 2008 rescue agreement with the Federal Reserve Bank for a US$85 billion secured loan facility, in exchange for warrants for 79.9% of the equity of AIG.
Previous attempts at GSE reform
In 2003, the Bush Administration sought to create a new agency, replacing the Office of Federal Housing Enterprise Oversight, to oversee Fannie Mae and Freddie Mac. In 1992, in the wake of the savings and loan crisis, and over concern that similar lending problems would develop, the Office of Federal Housing Enterprise Oversight was created as part of the Department of Housing and Urban Development. While Senate and House leaders voiced their intention to bring about the needed legislation, no reform bills materialized. A Senate reform bill introduced by Senator Jon Corzine (D-NJ) (S.1656) never made it out of the 21-member (10 D, 11 R) Senate Banking, Housing, and Urban Affairs Committee. At the time, some members of the 108th Congress expressed faith in the solvency of Fannie Mae and Freddie Mac. Congressman Barney Frank (D-MA), for example, described them as "not facing any kind of financial crisis".
In 2005, the Federal Housing Enterprise Regulatory Reform Act, sponsored by Senator Chuck Hagel (R-NE) and co-sponsored by Senators Elizabeth Dole (R-NC), John McCain (R-AZ) and John Sununu (R-NH), would have increased government oversight of loans given by Fannie Mae and Freddie Mac. Like the 2003 bill, it also died in the Senate Banking, Housing, and Urban Affairs Committee, this time in the 109th Congress. A full and accurate record of the congressional attempts to regulate the housing GSEs is given in the Congressional Record prepared in 2005.
Federal Housing Finance Agency and Treasury authority
The Housing and Economic Recovery Act of 2008—passed by the United States Congress on July 24, 2008, with bipartisan support and signed into law by President George W. Bush on July 30, 2008—enabled expanded regulatory authority over Fannie Mae and Freddie Mac by the newly established FHFA, and gave the U.S. Treasury the authority to advance funds for the purpose of stabilizing Fannie Mae, or Freddie Mac, limited only by the amount of debt that the entire federal government is permitted by law to commit to. The law raised the Treasury's debt ceiling by US$800 billion, to a total of US$10.7 trillion, in anticipation of the potential need for the Treasury to have the flexibility to support Fannie Mae, Freddie Mac, or the Federal Home Loan Banks.
The September 7 conservatorship was termed by The Economist as the "second" bailout of the GSEs. Prior to the enactment of the Housing and Economic Recovery Act of 2008, on July 13, 2008, Treasury Secretary Henry Paulson announced an effort to backstop the GSEs based on prior statutory authority, in coordination with the Federal Reserve Bank. That announcement occurred after a week in which the market values of shares of Fannie Mae and Freddie Mac fell almost by half (from a previously diminished value of approximately half of year-earlier market highs).
That plan contained three measures: an increase in the line of credit available to the GSEs from the Treasury to provide liquidity; the right for the Treasury to purchase equity in the GSEs, to provide capital; and a consultative role for the Federal Reserve in a reformed GSE regulatory system.
On the same day, the Federal Reserve announced that the Federal Reserve Bank of New York would have the right to lend to the GSEs as necessary.
Capital infusion by the Treasury
The agreement the Treasury made with both GSEs specifies that in exchange for future support and capital investments of up to US$100 billion in each GSE, at the inception of the conservatorship, each GSE shall issue to the Treasury US$1 billion of senior preferred stock, with a 10% coupon, without cost to the Treasury.
Also, each GSE contracted to issue common stock warrants representing an ownership stake of 79.9%, at an exercise price of one-thousandth of a U.S. cent ($0.00001) per share, and with a warrant duration of twenty years.