Federal Takeover of Fannie Mae and Freddie Mac - Background and Financial Market Crisis

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 invest as much as US$200 billion in preferred stock and extend credit through 2009 to keep the GSEs solvent and operating. The two GSEs have outstanding more than US$ 5 trillion in mortgage backed securities (MBS) and debt; the debt portion alone is $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 intent to liquidate its assets, leaving its financially sound subsidiaries operational and outside of the bankruptcy filing. The collapse is 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 dollar secured loan facility, in exchange for a warrants for 79.9% of the equity of AIG.