Fear could hurt Fannie and Freddie

Fears that the government will be forced to rescue Fannie Mae and Freddie Mac could well become a self-fulfilling prophecy.

Shares of the government-chartered mortgage finance giants plummeted Thursday and are trading at levels last seen in the early 1990s.

If the prices don't recover, it will be harder for the companies to raise more money through stock sales to compensate for losses from the housing bust. Investors are afraid their stakes will vanish if the government is forced to rescue the companies.

“The government has to step in and do something,” said Paul Miller, an analyst with Friedman, Billings, Ramsey & Co.

Freddie Mac shares fell $2.26 or 22 percent, to $8, after sinking as low as $6.75 earlier in the day. Shares of Fannie Mae fell $2.11, or 13.8 percent, to $13.20, after earlier falling to $11.70.

James Lockhart, director of the Office of Federal Housing Enterprise Oversight, said after the close of trading that the companies' capital levels are “well in excess” of government requirements.

Meanwhile, politicians vowed to intervene if necessary. “They cannot and will not fail,” presumptive Republican presidential nominee Sen. John McCain of Arizona told reporters.

“If they need additional support, Congress will act quickly,” Sen. Charles Schumer, D-N.Y., said in a statement.

The two companies are coping with worries that they won't be able to withstand soaring losses from foreclosures and home loan defaults.

Washington-based Fannie Mae raised $7.4 billion in May to fortify its balance sheet. McLean, Va.-based Freddie Mac plans to raise $5.5 billion, but has been waiting to initiate the offerings because its stock is not yet registered with the Securities and Exchange Commission.

Congress created Fannie in 1938 and Freddie in 1970 to keep money flowing into the home-loan market by buying up mortgages and bundling them into securities for sale to investors worldwide – thereby making home ownership affordable for low- and middle-income Americans.

Today the companies hold or guarantee around $5.3 trillion in home-loan debt, though under a 1992 law they are required to hold only a fraction of what is mandated for commercial banks as a financial cushion against risk.

While the government isn't obligated to assist Fannie or Freddie in a financial emergency, there is a widespread perception that they would be bailed out in the event of a collapse. The idea they are “too big to fail” enables the two companies to borrow relatively cheaply on global markets by issuing top-rated mortgage-backed securities.

Fannie and Freddie play a vital role in the U.S. mortgage market, one that has grown dramatically over the past year after the subprime mortgage market's collapse.

The companies issued about three-quarters of all new mortgage-backed securities in the second quarter of 2008, up from under 40 percent in 2006, according to trade publication Inside Mortgage Finance.