Bailout may be costliest in history

WASHINGTON - The Bush administration seized control of the nation's two largest mortgage finance companies Sunday, seeking to shrink dramatically their outsized influence on Wall Street and on Capitol Hill while at the same time counting on them to pull the nation out of its worst housing crisis in decades.

The bailout plan for the companies, Fannie Mae and Freddie Mac, a seismic event in a year of repeated financial crises followed by aggressive federal intervention, places the companies in a government conservatorship, much like a bankruptcy reorganization. The plan also replaces the management of the companies.

The rescue package represents an extraordinary federal intervention in private enterprise. It could become one of the most expensive financial bailouts in American history, though it will not involve any immediate taxpayer loans or investments. Treasury Secretary Henry M. Paulson Jr., who engineered the plan, would not say how much capital the government might eventually have to provide, or what the ultimate cost to taxpayers might be. Two months ago the Congressional Budget Office gave a rough estimate of $25 billion. One senior government official, speaking on the condition of anonymity, signaled Sunday that even that figure was optimistic.

Paulson said Sunday that it was important to rescue the mortgage giants because a failure of either company would cause turmoil in financial markets in the United States and around the world.

"This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement," he said. "A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation."

The plan received wide bipartisan support Sunday, from congressional lawmakers and both presidential campaigns.

As part of the plan, the chief executives of both companies were replaced.

Herbert M. Allison, the former chairman of TIAA-CREF, the huge pension fund for teachers that also offers mutual funds, will take over Fannie Mae and succeed Daniel H. Mudd; and at Freddie Mac, David M. Moffett, currently a senior adviser at the Carlyle Group private equity firm, succeeds Richard F. Syron. Mudd and Syron, however, will stay on during a transition period.

The plan also commits the government to provide as much as $100 billion to each company to backstop any shortfalls in capital. It enables the Treasury to ultimately buy the companies outright at little cost. It bans them from lobbying the government, putting an end to their ability to use their vaunted political machine on Capitol Hill.

It also eliminates dividend payments to current shareholders while protecting the principal and interest payments on the debt, now held by foreign central banks, financial institutions, pensions funds and others.

The Treasury will force both companies to shrink their portfolios in the near term -- they now hold or guarantee about half of the country's mortgages -- by having the government buy as much as $5 billion of their mortgage-backed securities on the open market starting this month. This step, never before undertaken by the government, could begin to restore some confidence in the credit markets and lead to lower interest rates for home mortgages.

For the companies, the takeover caps an ignominious downfall. Fannie was created during the depths of the Great Depression, and Freddie in 1970, to help make mortgages more affordable for homeowners.

The companies buy billions of dollars in mortgages each month from commercial lenders. Some are sold to investors as mortgage-backed securities; others are held by the companies in their own investment portfolios.

The plan represents a temporary cease-fire in a decades-long ideological battle over the proper role of the companies. Free-market conservatives see the companies as extensions of "big government," while Democrats have protected them as their main vehicle to promote affordable housing for middle- and lower-income people.

Alan Greenspan, the former Federal Reserve chairman, and Lawrence Summers, a former Treasury secretary under President Clinton, along with many other critics, have long maintained that the companies were too powerful politically and financially, and that their huge portfolios posed enormous risks to the financial system.

Moreover, these critics have complained, the companies have used their ability to borrow at low interest rates to dominate the mortgage-finance market, usurping the role of other financial institutions that do not have the same subsidy.

Free-market adherents warned of impending disaster as Fannie and Freddie used an implicit government backing to borrow at will, with only a tiny sliver of capital to protect them from nasty surprises like the recent sharp decline in housing prices and rise in foreclosures.

Paulson has sought to avoid taking sides in the debate, but in recent months came to the conclusion that the companies' conflicting missions of providing federally backed financing for affordable housing while serving shareholders were untenable.

"Market discipline is best served when shareholders bear both the risk and the reward of their investment," Paulson said Sunday.

Paulson made clear that the solution put forward Sunday would only defer the most important decisions about the mission of the companies for the next president and Congress.

At a news conference on Sunday, Paulson said: "There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form. Government support needs to be either explicit or non-existent."