WHAT NOW?

Fannie and Freddie: A wild rideBy Chris Isidore, CNNMoney.com senior writer
NEW YORK (CNNMoney.com) -- The anxiety over Fannie Mae and Freddie Mac, crucial to a recovery of the battered housing market and the economy as a whole, took stocks on a wild ride Friday.
An early selloff was fanned by speculation of a looming government bailout. The stocks recovered on assurances by a leading senator that no rescue is needed and a report that said the Federal Reserve is opening up its discount window to Fannie and Freddie.
Immediately after the markets opened, shares of Fannie and Freddie fell more than 47% from their already battered closing price the day before.
But with about a half hour left in the day, shares of Fannie were down 24% and Freddie's stock was down about 10%.
Shares of both companies started their recovery shortly after 2 p.m. when Sen. Christopher Dodd, D-Conn., the chairman of the Senate Banking Committee, defended the strength of both firms.
Dodd said his discussions with Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson, the regulators who oversee the firms and the two companies' CEOs convinced him they have more than adequate capital and that there was no need to even discuss failure or a bailout.
He also vowed quick passage of a long-debated housing bill to give greater oversight of the two companies, saying he expected it to passed and ready to be signed into law sometime next week.
"There is a sort of a panic going on," he said. "The facts don't warrant that reaction in my view. Fannie Mae and Freddie Mac were never bottom feeders in the residential mortgage markets. People ought to feel confident about them."
Shares of Freddie even moved briefly higher Friday afternoon following a report from wire service Reuters that said Bernanke had told Freddie Mac CEO Richard Syron that Freddie and Fannie would be eligible to borrow money directly from the central bank through what is known as the discount window.
The discount window is a source of funds that traditionally was only available to commercial banks. But after the Fed engineered the purchase of Wall Street firm Bear Stearns in March, it opened the window to investment banks as well.
The Fed was not immediately available for comment about the Reuters report. Freddie issued a statement that did not address the report but the company reiterated it had adequate capital.
"Freddie Mac has held a substantial stabilizing presence in ...the housing market and will continue to support the market and the nation's homebuyers during this time of turbulence," said the statement. "The fact is that it was circumstances such as those we are seeing today for which Congress created Freddie Mac and Fannie Mae."
A Fannie spokesman said Friday morning that the company had no comment about recent reports. But it issued a statement Thursday saying that it had the necessary capital to continue operating
The problems for Freddie and Fannie weighed on broader markets, causing a sell-off in U.S. stocks, especially hitting major banks, Wall Street firms and home builders.
Crucial to home market
Fannie and Freddie hold or back $5 trillion between them, or about half the mortgage debt in the country.
They play a central role in the U.S. housing market, providing a crucial source of funding for banks and other home lenders, especially since a credit market crisis last summer left them the only major players in packaging pools of mortgage loans into securities for sale to investors.
If they were unable to do so, it would significantly raise the cost and restrict the availability of mortgage loans, causing significantly more problems for already battered housing prices and sales. That in turn would be another significant problem for the overall U.S. economy, as well as global credit markets.
The New York Times reported Friday that senior Bush administration officials are considering a plan to have the government take over one or both of the companies if their problems worsen.
The shares started to erase early losses when word came that Treasury Secretary Henry Paulson was set to speak. He said that the government's primary focus is making sure that mortgage giants Fannie Mae and Freddie Mac remain as presently constituted to carry out their mission.
Even before the latest report on a possible rescue plan, speculation about the future of the firms this week sparked a run by investors away from their shares. That in turn raised questions about how difficult and expensive it will be for them to raise needed capital in the future, which fed into the stock plunge in a vicious cycle.
In the first four trading days of the week, the shares of Fannie have lost 30% of their value, while Freddie shares have tumbled 45%. For the year, Fannie is down 67% and Freddie 77%.
"Fannie Mae and Freddie Mac have lost investor confidence evidenced by the rapid brutal sell-off in their stocks, which could dramatically hinder their ability to raise any additional capital going forward," wrote Richard Hofmann of research firm CreditSights in a note Friday. He added that the firms' ability to function normally "remain at the core of government efforts to stabilize the mortgage markets."
A number of scenarios were being discussed by bankers and analysts about what the government may do to deal with investors' current crisis of confidence in the firms.
Jaret Seiberg, a financial services analyst for the Stanford Group, a Washington research firm, said Thursday options that among the options are: The Federal Reserve could purchase some of the Freddie and Fannie debt or mortgage-backed securities; the Treasury Department could make billions of dollars in loans to the companies or even buy stock in the companies.
"Government officials are always planning for worst-case scenarios and our note is intended to highlight some options that may be available to policymakers," he wrote. "We suspect hybrid versions of these plans also are possible."
Under current law, the Office of Federal Housing Enterprise Oversight (OFHEO), the regulator of Fannie and Freddie, could take control of the firms if their capital falls too far below required levels. It is unclear how the firms would operate in that situation, known as a conservatorship.
OFHEO Director James Lockhart issued a statement late Thursday saying that his agency was closely monitoring the firms' credit and capital positions. But he pointed out that they had already raised $20 billion in capital and that they adequately capitalized, holding funds well in excess of his agency's requirements.
Investor panic
Still investors were worried that continued problems in the housing market would cause more than the $12.7 billion losses the two firms have lost between them since last July. The decline in their stock value makes raising additional capital to cover those future losses that much more expensive and difficult.
"Our primary concern about Freddie and Fannie is that credit losses are likely to be worse than the management's current judgment, which will further pressure the capital base, and we remain cautious until we are better able to quantify these risks," wrote UBS analyst Eric Wasserstrom in a note Thursday.
Those concerns prompted him to raise his estimated loss for Freddie and to cut his price target for the stock, although, he retained his neutral rating on both firms, rather than urging clients to sell their holdings.
But the biggest concern Fannie and Freddie shareholders faced Friday was what would happen if the government did have to step into rescue them. Certainly, the big selloff earlier in the day reflected some investor fears that shares of Fannie and Freddie could become worthless in a bailout scenario.