Sources: Gov't takeover of Fannie, Freddie expected

The Treasury Department is expected to announce a plan to take control of faltering mortgage giants Fannie Mae FNM and Freddie Mac FRE in what is shaping up as one of the most aggressive federal interventions ever in financial lending markets.

Sources with knowledge of the deliberations, including House Financial Services Chairman Barney Frank, D-Mass., confirmed the general outline of the government's plan. Government officials and representatives of the company continued meeting Saturday about implementation, according to another source familiar with deliberations. A public announcement could come Sunday, the source said. The source couldn't be named because talks are ongoing.

Treasury Secretary Henry Paulson called several lawmakers Friday to update them on the meetings. Frank says he was briefed twice on Friday.

"I think it is necessary," Frank said of Treasury's pending takeover. "It is very important to keep housing going. And Fannie and Freddie are important to that." Frank says the way Treasury is constructing the conservatorship will provide "maximum protection for the taxpayers."

The Treasury Department declined to comment directly on the the plan, but spokeswoman Jennifer Zuccarelli said the government is "making progress on our work with Morgan Stanley, the Federal Housing Finance Agency and the Federal Reserve. As we've said for weeks, we're not going to comment on rumors."

The plan under consideration could place Freddie and Fannie under federal control, and could include steps to dilute common stock while sheltering the agencies from major financial losses.

Such a move would amount to the most sweeping shakeup of mortgage agencies since Fannie Mae, the older of the two companies, was first established in the 1930s, and would also represent an unusually direct involvement by the federal government in the workings of the financial and lending markets.

Freddie and Fannie buy and package mortgage for other investors, and together hold or guarantee $5 trillion in housing debt, which is almost half the nation's total. Their financial health is critical to the housing market, whose slump has contributed to a faltering economy on the cusp of a recession.

As the housing market has declined — due in large part to massive run ups in housing prices and the failure of risky loans taken out by homeowners — both agencies have sustained major losses. Combined, they've lost $3.1 billion between April and June.

Freddie and Fannie are chartered by government but are shareholder owned. Both companies have said they have sufficient capital to meet their commitments. Unlike the intervention by the Federal Reserve with the faltering investment bank Bear Stearns, neither mortgage company appears to be in imminent danger of failure.

The potential cost to taxpayers is unknown, but early government intervention by the government is thought to be cheaper for taxpayers than waiting for a crisis to build.

This summer, Congress passed a plan to permit the Treasury Department to backstop the companies, including authority to purchase stock in and provide government loans to Fannie and Freddie and to bring them into conservatorship.

But as foreclosures soar, concerns have grown about the ability of the agencies to withstand financial losses and issue debt to sustain operations. But government intervention is also raising concerns that common stock holders could suffer losses and could cost taxpayers billions of dollars.

Government options include:

Federal control. The government could bring the quasi-private agencies under its control, giving it the option to restructure Fannie and Freddie. This step, which would put the agencies into a conservatorship, would make the government a major player in private lending.

Leadership changes. In exchange for federal intervention, it is top leaders at the agencies — Richard Syron and Fannie's chief executive Daniel Mudd — are expected to lose their jobs.

Federal action could help the housing market by easing fears about the solvency of Freddie and Fannie. They could then find it easier to get funding, which could lead to lower interest rates on mortgages and provide a jolt to the housing market.

"It's a bold move and it certainly has big plusses. Mortgage rates would lower and more credit would be available," says Mark Zandi, chief economist and co-founder of Moody's Economy.com. "Stepping in like this will be a big shot in the arm to the stock and bond market. It's a very positive step."

The risks that remain: how the government would privatize Fannie and Freddie again after taking control, and the potential risk to taxpayers. If the government takes over, it's the Treasury now on the line if mortgage loans go into default.

Paulson, Federal Reserve Chairman Ben Bernanke and James Lockhart, the companies' chief regulator, have been in meeting with top Freddie and Fannie executives about the plan.

The Treasury recently signed a contract with Morgan Stanley to investigate the financial position of Fannie and Freddie, with help from the Federal Housing Finance Agency, the new regulatory body created by Congress to oversee the mortgage giants.