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Fannie and Freddie: why the takeover

Treasury said Sunday the mortgage giants will enter a conservatorship.

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In the 1980s, he says, the savings and loan industry got into trouble because regulators and Congress allowed such a pattern to play out.

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Fannie Mae and Freddie Mac have a central role in the housing market, with their odd names representing shorthand for longer titles including the words "federal" and "mortgage." The duo fuels home lending by purchasing loans from other lenders, or by providing guarantees to back the share of mortgage loans that meet their standards. The guarantees give investors confidence to buy packages of mortgage debt, known as mortgage-backed securities.

Those actions can keep loans flowing even when, as now, many traditional banks are reluctant or unable to make home loans and hold them on their own books. Currently, most mortgages in the US flow through Fannie or Freddie, and nearly half of all outstanding mortgage debt is linked to them in some way.

Their role in the housing market has long been controversial, but in the current weak economy their outright failure is unthinkable for most policymakers.

The conservatorship represents a temporary step, akin to a bankruptcy from which the GSEs will ultimately emerge. Next year, Paulson said, the next US president and Congress will have to determine the firms' longer-term structure and size. Ultimately, Paulson said, "government support needs to be either explicit or nonexistent."

For now, however, the focus is on improving the economic and credit climate.

Mr. Lockhart and Paulson detailed a multipronged plan for Fannie and Freddie in the near term:

•The firms will continue to make loans "without limits," at a time when mainstream banks have tightened lending standards or raised interest rates.

•They will stop paying shareholder dividends, conserving $2 billion a year.

•They will have access to a line of credit from the Treasury, if needed.

•The Treasury will become an investor in preferred shares and warrants of the GSEs, with a position senior to current investors. The size and timing of investments will be as needed to maintain a positive net worth for the enterprises.

•The Treasury will be a buyer of new GSE-issued mortgage-backed securities, a move designed to help keep mortgage rates low.

•The firms' chief executives, Daniel Mudd and Richard Syron, will be replaced, but will stay for a transition period. Herb Allison, a former Merrill Lynch executive, will head Fannie Mae, and former banker David Moffett will head Freddie Mac. The incoming CEOs, as public employees, will have much lower salaries.

•Political lobbying efforts, long a source of GSE clout on Capitol Hill, will cease. Charitable giving will be reviewed.

Paulson said he expects the purchase of GSE debt would come at no cost, and possibly at a profit, to taxpayers. But the overall taxpayer cost of the intervention would depend on business conditions going forward, he said Sunday.

"I have long said the housing correction poses the biggest risk to our economy," Paulson said.