U.S. Unveils Takeover of Two Mortgage Giants

At a news conference on Sunday morning, the Treasury secretary Henry M. Paulson Jr. also announced that he had dismissed the chief executives of both companies and replaced them with two long-time financial executives. Herbert M. Allison, the former chairman of TIAA-CREF, the huge pension fund for teachers, will take over Fannie Mae and succeed Daniel H. Mudd. At Freddie Mac, David M. Moffett, currently a senior adviser at the Carlyle Group, the large private equity firm, will succeed Richard F. Syron. Mr. Mudd and Mr. Syron, however, will stay on temporarily to help with the transition.

“Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe,” Mr. Paulson said. “This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. 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.”

Mr. Paulson refused to say how much capital the government might eventually have to provide, or what the ultimate cost to taxpayers might be.

The companies are likely to need tens of billions of dollars over the next year, but the ultimate cost to taxpayers will largely depend on how fast the housing and mortgage markets recover.

Fannie and Freddie have each agreed to issue $1 billion of senior preferred stock to the United States; it will pay an annual interest rate of at least 10 percent. In return, the government is committing up to $100 billion to each company to cover future losses. The government also receives warrants that would allow it to buy up to 80 percent of each company’s common stock at a nominal price, or less than $1 a share.

Beginning in 2010, the companies must also pay the Treasury a quarterly fee — the amount to be determined — for any financial support provided under the agreement.

Standard & Poor’s, the bond rating agency, said Sunday that the government’s AAA/A-1+ sovereign credit rating would not be affected by the takeover.

Mr. Paulson’s plan begins with a pledge to provide additional cash by buying a new series of preferred shares that would offer dividends and be senior to both the existing preferred shares and the common stock that investors already hold.

The two companies would be allowed to “modestly increase” the size of their existing investment portfolios until the end of 2009, which means they will be allowed to use some of their new taxpayer-supplied capital to buy and hold new mortgages in investment portfolios.

But in a strong indication of Mr. Paulson’s long-term desire to wind down the companies’ portfolios, drastically shrink the role of both Fannie and Freddie and perhaps eliminate their unique status altogether, the plan calls for the companies to start reducing their investment portfolios by 10 percent a year, beginning in 2010.

The investment portfolios now total just over $1.4 trillion, and the plan calls for that to eventually shrink to $250 billion each, or $500 billion total.

“Government support needs to be either explicit or nonexistent, and structured to resolve the conflict between public and private purposes,” Mr. Paulson said. “We will make a grave error if we don’t use this time out to permanently address the structural issues presented by the G.S.E.’s,” he added, a reference to the companies as government-sponsored enterprises.

Critics have long argued that Fannie and Freddie were taking advantage of the widespread assumption that the federal government would bail them out if they got into trouble. Administration officials as well as the Federal Reserve have argued that the two companies used those implicit guarantees to borrow money at below-market rates and lend money at above-market returns, and that they had become what amounted to gigantic hedge funds operating with only a sliver of capital to protect them from unexpected surprises.

That covenant in the agreement responds to many in the Bush administration and in the private sector who had argued for years that Fannie and Freddie posed “systemic risks” to the economy because they had acquired more than $5 trillion in assets with only the thinnest of capital cushions to shield them from losses.