WASHINGTON — The government's takeover of Fannie Mae and Freddie Mac raised critical questions about how it came together, why it was necessary, and what effect it will have on the financial services market.
The House and the Senate will hold oversight hearings that are expected to start next week. Here's a look at the questions policymakers are likely to field, along with some possible answers.
Did the Treasury Department mislead Congress about its intentions?
This could be an overarching theme of the hearings. When Treasury Secretary Henry Paulson appeared before the Senate Banking Committee in July, he forcefully argued that Congress should give him power to purchase debt and equity in Fannie and Freddie and let the government-sponsored enterprises draw from a virtually uncapped credit line with the government. He said merely having the authority would negate the need to use it.
Obviously, things did not work out that way, and some lawmakers are wondering if Mr. Paulson had intended to use his newfound powers all along.
Senate Banking Committee Chairman Chris Dodd raised the possibility that lawmakers had been duped.
"All he wanted was the bazooka, he didn't want to use it," the Connecticut Democrat told reporters in a conference call Monday. "We accepted him at his word that this was all that was going to be necessary. He's used that authority very aggressively. … Fool me once, your fault. Fool my twice, my fault."
Sen. Jim Bunning, R-Ky., went even further in a press release.
"Secretary Paulson knew more than he was telling us during his appearance before the Banking Committee," he said. "He knew that Fannie and Freddie were in an irreversible state of damage. He knew all along he was going to have to use this authority despite what he was telling Congress and the American people at the time."
But that feeling was by no means uniform, with some Democrats defending Mr. Paulson.
"It comes as a surprise to all of us but I don't feel like I've been duped or the secretary has played the Congress," Rep. Mel Watt, D-N.C., said in an interview Tuesday. "He has done things he thought would work and they haven't worked as well as he anticipated."
Is the Federal Housing Finance Agency a credible operator of Fannie and Freddie?
James Lockhart, the agency's director, is suffering from a black eye in some circles. Before putting them into conservatorship Sunday, he spent months arguing that Fannie and Freddie were fundamentally sound and well capitalized.
"The enterprises' $95 billion in total capital, their substantial cash and liquidity portfolios, and their experienced management serve as strong supports for the enterprises' continued operation," he said July 13.
Some observers say such statements undercut Mr. Lockhart's credibility.
"In my mind, there is some significant uncertainty about the ability to actually run these organizations in the conservatorship," said L. Richard Fischer, a partner with Morrison & Foerster LLP. "It is the same individual and the same organization that's been overseeing the GSEs for some time now. I don't think his organization alone is going to be able to do this."
What exactly has changed?
On the operational side, not much. New chief executives have been installed — Herb Allison at Fannie and David Moffett at Freddie — but how much power they have is unclear. Mr. Lockhart appears to be running the show as conservator.
Of course, Fannie and Freddie also have new sources of capital and liquidity. The government will take a senior preferred equity stake in them, purchase $5 billion of mortgage-backed securities, and provide them with up to $100 billion of liquidity each.
So why now? What changed in the last month that required the Sept. 7 takeover?
That is perhaps one of the most perplexing questions, and one lawmakers say they want to examine.
"It is important for them to tell us why they felt they had to move," said Rep. Maxine Waters, D-Calif.
Mr. Lockhart has not answered directly, but in an interview Monday with PBS' "Nightly Business Report," he said examinations found "significant deteriorations over the last three months."
Speculation has grown that Mr. Paulson pulled the trigger after learning of growing fear among foreign investors and central banks. During an interview Monday on CNBC, he hinted that was a concern. "Overseas buyers had reduced the level of buying, and some had stopped buying," Mr. Paulson said. "There was just grave concern throughout this country and outside of this country."
Will the takeover cause bank failures?
This is the overriding concern of many lawmakers this week. At issue are companies that had significant concentrations of GSE preferred stock, whose value has plummeted. Regulators have said they plan to help institutions with capital restoration plans, but it remains unclear how many banks and thrifts are affected.
House Financial Services Committee Chairman Barney Frank said he does not think any bank will be allowed to fail as a result of the takeover.
"I do think there are conversations with the regulator to deal with that, and you will see some regulatory forbearance if necessary," he said. "I would be very badly surprised if anything failed because of this. The secretary is going to take every effort to make sure that doesn't happen."
What does the conservatorship mean for the affordable housing fund?
The housing law enacted in July requires Fannie and Freddie to contribute to a fund that finances a government program for distressed homeowners. But now that they are in conservatorship, some worry Mr. Lockhart, never a fan of the fund, could suspend payments to it. That would anger Democratic lawmakers.
However, Rep. Frank said he has been assured that the fund will remain viable. Mr. Paulson "told me on Friday that he intends to stand by his commitment, and Mr. Lockhart was with him when he told me that," the Massachusetts Democrat said Tuesday.
Every time the government has acted in the current housing crisis, a bigger and broader plan has always been needed shortly thereafter. That has left some lawmakers wondering what the Treasury may already be planning.
"Is this action going to produce the desired results, or are there other actions that are being thought about that we aren't being told about?" Sen. Dodd asked.
One possibility — raised by several observers — is that Fannie and Freddie will be put into a receivership and effectively unwound. The Treasury and the Finance Agency did not do so this weekend, but everything remains in flux.
Former Rep. Jim Leach said such a move could be made after the presidential election. "My guess is … [receivership] is the next philosophical step, and my guess is the executive branch wants to put off having to make that decision," he said. "I don't rule out further pre-Christmas decision-makings … or post-election decision-makings."
Others agreed that receivership is a possibility. "One could argue if there were more issues to be dealt with, it would really be in the best interest of everyone to just do it," Mr. Fischer said.