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Candidates briefed on seizure of Fannie Mae, Freddie Mac

WASHINGTON — The widening housing crisis took center stage on the presidential campaign trail Saturday after the Treasury Department confirmed to the candidates it was preparing a historic seizure of mortgage finance giants Fannie Mae and Freddie Mac.

Speaking in Terre Haute, Ind., Democrat Barack Obama welcomed the move by Treasury, saying the two entities had sought profits over the stability of their own companies, which are vital to U.S. mortgage lending.

"The management was not making decisions that were designed to help them meet what should have been the mission," he said. "They were boosting profits as a priority — with the management bonuses that came with those priorities."

Treasury Secretary Henry Paulson briefed Obama late Friday on plans to seize, perhaps as early as this weekend, Fannie Mae and Freddie Mac in an effort to bolster the pair and calm jittery global financial markets.

Paulson told Republican John McCain that Fannie and Freddie — which purchase mortgages from banks and package them into popular bonds sold to investors — would be seized and placed under temporary control in one of the largest government bailouts ever. The move is expected before Asian markets open Monday, which is Sunday night on the U.S. East Coast.

McCain's campaign on Saturday called for the eventual elimination of Fannie and Freddie, complaining they have become so large and poorly managed that they pose a risk to the broader financial markets.

Senator McCain will get real regulation that limits their ability to borrow, shrinks their size until they are no longer a threat to our economy, and privatizes and eliminates their links to the government," said Doug Holtz-Eakin, a senior McCain policy adviser.

Obama, too, has been critical, complaining that Fannie and Freddie should either operate as public entities without profit, or as private companies that won't be rescued if they fall into trouble.

McCain's running mate, Alaska Gov. Sarah Palin, speaking in Colorado Springs, Colo., said Fannie and Freddie had "gotten too big and too expensive to the taxpayers." The companies, however, aren't taxpayer funded but operate as private companies. The takeover may result in a taxpayer bailout during reorganization.

As explained to the campaigns, Fannie and Freddie would be placed under the control of their regulator, the new Federal Housing Finance Agency. This agency was created when President Bush signed legislation on July 30 replacing the prior regulator of Fannie and Freddie, the Office of Federal Housing Enterprise Oversight.

The new agency has greater powers and the authority to manage the two entities if they are placed under government control. Treasury hopes the action will stabilize credit markets, give banks incentive to do more mortgage lending and bring down mortgage rates by reducing the gap between mortgage rates and longer-term Treasury bonds.

"It should bring mortgage rates down, because Fannie and Freddie are now (after the takeover) like Treasury debt," said Mark Zandi, chief economist for forecaster Moody's Economy.com.

Rates on a 30-year fixed mortgage could come down to between 5.25 percent and 5.5 percent, he said, and world financial markets should respond favorably on Monday.

"Fannie and Freddie were a significant cloud over the market that presumably has been lifted," he said. "I think investors should respond positively."

The government takeover process is called conservatorship, and it works sort of like a Chapter 11 bankruptcy, where assets are preserved, not sold off, and the company is reorganized rather than closed.

The coming takeover was also confirmed Saturday by Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee. In a Saturday afternoon statement, Frank confirmed that he spoke late Friday with Paulson and was told that Treasury "intends to use the powers that Congress provided it to ensure the continued and stable functioning of Fannie Mae and Freddie Mac."

The two mortgage finance titans, once feared for their lobbying prowess in Washington, would continue to operate but the top management of each -- Richard Syron at Freddie Mac and Daniel Mudd at Fannie Mae -- would be shown the door. It appears that most outstanding shares would be diluted, thus losing their value, but the government would stand behind Fannie and Freddie's debt. Treasury is likely to open its books and lend to Fannie and Freddie, since investors have been reluctant to help the two bolster their weakening finances.

Fannie and Freddie are huge, and that's why Paulson is moving now to shore them up. Together they own or back more than half of U.S. mortgage debt -- more than $5.2 trillion worth -- and the two entities have lost almost $15 billion this year while their shares have lost more than 90 percent of their value.

The two lenders securitize home loans, which means they buy mortgages from banks and other lenders, then pool them together and sell them as bonds. These bonds have traditionally been viewed as very safe and were snapped up by big U.S. commercial banks, foreign central banks and foreign and domestic investment funds.

But the profound two-year slump in the national housing market has tarnished anything associated with home finance, and investors have clamored for more explicit backing of Fannie and Freddie on fears that continued drops in home prices will erode the underlying value of their massive mortgage holdings.

As recently as July, Paulson said he did not expect to intervene in the affairs or Fannie and Freddie.

Critics of intervention say it creates so-called moral hazard, where the government interferes in open markets and lets investors off the hook for bad investments. But Paulson and Federal Reserve Chairman Ben Bernanke are believed to favor intervention because the risk of inaction could lead to a broader global financial meltdown.

This was their logic on March 16 when Paulson and Bernanke worked together to engineer the shocking weekend sale of the venerable investment bank Bear Stearns to rival JP Morgan Chase. The two defended the unprecedented action by saying they moved to protect the global financial system.

To ask a question about this story or any economic question, go to McClatchy's economy Q&A

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