NEW YORK (CNNMoney.com) -- Treasury Secretary Henry Paulson got some tough questioning from lawmakers on Tuesday when presenting his plan to prop up mortgage finance giants Fannie Mae and Freddie Mac.
Paulson told the Senate Banking Committee that the two firms have adequate capital to continue to operate. He said proposals he announced Sunday - expanding the Treasury credit line for or buying equity in Fannie and Freddie - were "backstops" to assure the markets.
"Our proposal was not prompted by any sudden deterioration in conditions at Fannie Mae or Freddie Mac," he said. "At the same time, recent developments convinced policymakers and the [firms] that steps are needed to respond to market concerns and increase confidence by providing assurances of access to liquidity and capital on a temporary basis if necessary."
The two firms, known as government sponsored enterprises, or GSEs, were set up by Congress to help provide mortgage funding, but they are owned by private sector shareholders. Their shares have plunged in recent days among concerns that they would need to raise additional funds to cover future losses or need to be taken over by its federal regulator. Either step would reduce or wipe out the value of current shareholders' stakes.
Committee Chairman Sen. Christopher Dodd, D-Conn., applauded Paulson for taking the steps to support the two firms.
"Inaction is not an option in my view," he said. "We can not just watch events unfold."
Dodd repeated comments in recent days that he believes Fannie and Freddie are both operating on a sound financial basis.
"I think it's very important that we not contribute to the unwarranted fear," he said. "This is a time for calm."
But Shelby, the committee's ranking Republican, questioned whether conditions are more dangerous than those assurances would suggest.
"If the enterprises are operating in a safe and sound manner, what are we doing here today? Well, we all know why we're here," Shelby said in his opening statement. "The GSE's, even when they're deemed safe and sound, can pose systemic risk.
"I fear we're sitting on a financial powder keg," said Shelby.
Shares of Fannie and Freddie on Tuesday continued the recent slide that has prompted the Treasury Department and Fed to step in and offer support. Shares of Fannie (FNM, Fortune 500) plunged 14%, on top of a 48% decline in the last six trading days. Freddie (FRE, Fortune 500) shares tumbled 13% on top of its 51% slide in the last six days.
Fannie and Freddie are a key source of funding for banks and other home lenders. Their ability to provide that funding is seen as a key to any recovery in housing and the economy as a whole.
The companies were set up by Congress, but they are owned by shareholders, who have fled the firms' stock recently on fears that continued problems in housing and rising mortgage defaults will force them to seek significantly more capital, a move that would dilute the value of existing shares.
Problems in the banking and home lending sectors were further highlighted by the failure of IndyMac, a California bank that was taken over by the federal government Friday evening in what could end up being the most costly bank failure in U.S. history. Stocks of many major regional banks plunged Monday on concerns over further failures.
IndyMac had been a major provider of mortgage loans that did not demand lenders to provide full or any documentation of their income. There are likely to be questions about the state of banking and the risk of more failures at Tuesday's hearings.
Sunday evening Paulson announced a proposal by Treasury to have Congress raise the $2.25 billion it is allowed to loan the two firms, and even open the door for the federal government to buy shares in the two companies if needed. The Fed announced it stood ready to loan money to the firms if they needed access to funds ahead of congressional actions.
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[Via Home Mortgage Rates and Real Estate News]
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