In These New Times

Report suggests that the administration doubts mortgage giant firms will be able to raise needed capital, making a government takeover inevitable

NEW YORK (CNNMoney.com) — Shares of Fannie Mae and Freddie Mac tumbled Monday on a report suggesting that a government takeover of the troubled mortgage finance giants is inevitable.

Shares of Fannie (FNM, Fortune 500) and Freddie (FRE, Fortune 500) fell 22% and 25% respectively. Both companies have seen their shares plunge more than 80% since the start of the year.

In addition, the price of credit default swaps, financial instruments used to protect bondholders against default, jumped 11% at Fannie and 8% for Fannie, in trading Monday, according to tracking service CMA Datavision. That rise indicates that traders are pricing in an increased chance of a default on the firms’ subordinated debt in the next five years. A wire service report on the change in those credit default swaps pricing fed into the sell-off of Fannie and Freddie shares just before noon.

The financial newsweekly Barron’s quoted an unnamed Bush administration official as saying that government officials don’t expect the two firms to be able to raise needed capital from private sector investors to cover future losses from rising defaults and foreclosures.

The article said that inability to raise capital will leave the government no choice but to have the federal government loan them money or buy their equity. Congress recently granted the Treasury Department the power to loan Fannie and Freddie an unlimited amount of money or to buy up their shares if necessary. The article suggested that such an infusion of capital will wipe out the holdings of current shareholders.

Fannie spokesman Jason Lobo declined to comment. Freddie spokeswoman Sharon McHale denied that the company is in trouble.

“It significantly overstates our financial situation,” she said. “We continue to be adequately capitalized and we are committed to raising additional capital. We’re financially sound and have strong liquidity.”

Officials from Freddie have pledged to regulators it will raise $5.5 billion in additional capital, but even without that the firm is meeting current capital requirements. Executives have not given a time frame for when they will raise that additional financial cushion.

“Any capital that we do raise will depend on a variety of factors, including prevailing market conditions,” McHale said.

Executives at Fannie and Freddie, as well as Treasury Secretary Henry Paulson, have repeatedly said they do not expect the firms to need to turn to the government for loans or an equity infusion. Both recently reported steep quarterly losses that were much larger than expected. But even with those losses, executives said they have capital in excess of minimum requirements.