With Fannie Falling, All Eyes on Paulson

This post first appeared on Minyanville on August 8th.

You can almost hear Treasury Secretary Paulson firing up his bazooka.

This morning, Fannie Mae (FNM) joined its smaller cousin Freddie Mac (FRE) in announcing losses that exceeded Wall Street's already dour expectations.

The company lost $2.3 billion in the second quarter and plans to slash its dividend to a paltry $0.05 per share, down from $0.25, according to Bloomberg.

All eyes now turn to Paulson, who just weeks ago asked for -- and received -- a blank check from Congress to support the beleaguered government sponsored enterprises, should the need arise. He had hoped the mere existence of the backstop would calm Investors' nerves such that he wouldn't need to step in.

Reality, it appears, had other plans: Shares of the 2 companies have slid back down to where they were when markets feared they'd collapse under the weight of their massive loan portfolios.

Fannie and Freddie are hopelessly levered to the U.S. housing market, which slides deeper into disarray every day. The 2 companies collectively back over $5 trillion of American mortgages, which are going sour at a record pace.

As I wrote earlier this week, after Freddie announced equally dismal results, it's no longer a matter of if they collapse, but when.

It turns out buying mortgages with nothing but a superficial glance at the paperwork -- something Fannie and Freddie excelled at during the housing boom -- just isn't good business.

Although the 2 firms only lightly dabbled in subprime loans, originators easily duped their automated risk engines into buying fraudulent or otherwise shoddy loans.

But since banks like Citigroup (C), Bank of America (BAC) and Wachovia (WB) are saddled with troubles of their own, Fannie and Freddie have been asked to expand their role in the market. They now provide the only liquidity left for new mortgages.

The government has little choice but to bail out their wayward children. If it doesn't, Hank will need a lot more than just a bazooka to save the ship.