Government Takes Custody of Fannie Mae & Freddie Mac

In a historic, yet widely anticipated, move yesterday Secretary Henry Paulson announced plans to put Fannie Mae and Freddie Mac under government custody. The unprecedented move by the Treasury includes replacing both company's CEOs, ending all stock dividends, and creating a new preferred stock that will be senior to all other outstanding shares.

The authority for such a move was granted to the U.S. Treasury in the recently passed Housing and Economic Recovery Act and was included in the bill to help protect the $5.4 trillion in outstanding mortgages the companies currently hold. Both Government Sponsored Entities (GSEs) have been under severe pressure over the last year. Their stock shares have fallen over 90% and the markets have had severe doubts about the companies' financial capitalization.

Paulson believes the move will calm fears about the companies' creditworthiness and help convince foreign central banks (big buyers of GSE bonds) that their investments are safe and sound. In his remarks yesterday Paulson said, "By stabilizing the GSEs so they can better perform their mission, today's action should accelerate stabilization in the housing market." In addition, the hope is it will also cause mortgage interest rates to fall because Fannie and Freddie's borrowing costs will fall and that, in turn, could help the housing market with its continuing decline in home prices.

Obviously, investors will be the ones to decide the impact of the government's intervention. So far this morning, stocks initially climbed over 200 points on the news, but the 10-Year Treasury note has risen in yield from Friday's close. However, mortgage rates have not followed suit with the treasuries and are actually much better today - 30 Year conventional fixed rate loan down 0.25 from Friday to 5.75%.

Now, one day's trading does not make a market and bond traders are known to be a skittish group to say the least. It's also obvious a lot of investors have jumped out of the safety of bonds to participate in this morning's stock rally. So, it will take a few days to truly see what the markets think of this move. It will also take a while for the true costs (to taxpayers) to come to light. Only then, will we know whether it was good move or not.