Winners, losers in the U.S. takeover of Fannie/Freddie

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Who wins and who loses under the Treasury’s decision to take control of mortgage titans Fannie Mae and Freddie Mac?

Here’s a quick rundown:

--- Owners of both common and preferred shares in the companies could lose it all, depending on how much capital the government winds up putting into the firms to keep them solvent. The government won’t cancel the common or preferred shares, but all dividend payments on the stocks will be halted.

The Treasury will buy a new class of senior preferred stock from the companies. The shares will pay the government a 10% annualized yield initially and will carry with them warrants representing a potential ownership stake of 79.9% in the companies.

The Treasury could invest as much as $100 billion in each company via the new preferred stock over time. The more stock the government has to buy -- to bolster the companies’ capital cushions against mortgage losses -- the more likely it will be that current common and preferred shareholders will lose everything. But that may not be known for years.

There had been some speculation that the government would preserve the current preferred shares (about $36 billion is outstanding between the two companies), because some banks and thrifts have been big investors in those securities. Those institutions now stand to suffer heavy losses if the preferred shares’ market value plunges further.

Bank regulators said today they would work with banks that are stung by losses on Fannie and Freddie preferred stock to ‘develop capital-restoration plans.’ But in the short term, a dive in the value of the companies’ preferred shares could worsen stresses in the financial system by further weakening some banks and thrifts.

--- Holders of Fannie and Freddie’s senior and subordinated debt securities will be protected. Their interest payments will continue. This should ease concerns of private and public investors worldwide who own the debt. In effect, they now own U.S.-government-guaranteed bonds.

--- The Treasury also sought to give peace of mind to owners of the companies’ mortgage-backed securities. The Treasury will begin buying some of those bonds in the open market, seeking to bolster the value of the securities by providing another source of demand.

The Treasury expects its initial purchases of mortgage-backed securities to total $5 billion. The purchases and management of the bonds will be handled by independent asset managers, under contract with the government. (There’s a win for Wall Street.)

Because the government expects to earn more on the bonds than its cost of borrowing to buy the securities, ‘There is no reason to expect taxpayer losses from this program, and it could produce gains,’ the Treasury said in a statement outlining the plan. But that will depend on the level of defaults and ultimate losses on the home loans backing the bonds that the Treasury buys.

--- The government hopes that its plan will bring down mortgage rates, which have remained elevated over the last year despite the Federal Reserve’s deep cuts in short-term interest rates. The average rate on 30-year conventional home loans now is 6.35%, up from 6.07% at the start of the year.

By removing doubts about the solvency of Fannie and Freddie, Treasury Secretary Henry M. Paulson Jr. hopes to make investors feel more confident about buying the companies’ mortgage-backed bonds. That could lower Fannie’s and Freddie’s cost of borrowing, which in turn could allow them to lower the rates they require on home loans purchased from banks and thrifts.

The Treasury said it expected its bond purchases to generate ‘increased availability and lower cost of mortgage financing.’ But of course, that will be up to the marketplace.