Fannie, Freddie aftershocks: More bank problems

If Fannie Mae and Freddie Mac would be taken over it will surely cause big problems for many community banks nationwide and will lead to a new round of bank failures.

This is because many smaller banks have funds in the shares of Fannie and Freddie, depending on the value of the shares. Now the dividends have been scrapped and the share values are in question.

"For many banks it was a safe and steady income stream," said Brian Gardner, senior vice president and chief political analyst for Keefe, Bruyette & Woods, an investment bank that specializes in financial firms. "It's cutting off an important source of income for the banks at time when income is not easy to come by."

Taking over of Fannie and Freddie

ON Sunday, the government took over Fannie and Freddie and they are keeping the common and preferred shares in place. But without the dividends, the already battered value of the shares could fall further, leaving banks that hold them without capital levels.

Even before Sunday's action, the FDIC's watch list of problem banks and thrifts had jumped 30% from the end of March to the end of June, leaving 117 at-risk institutions. A year earlier, the list had just 61. This past Friday, the 11th bank of the year failed.

"Investors might be relieved that all they did was lose their dividend," said William Isaac, a former chairman of Federal Deposit Insurance Corp. "A lot of people were worried the preferred would be wiped out."

Sunday’s action could further hit shares that have already lost half of their value in the recent months.

Reason for taking control by the government

On Sunday, Treasury Secretary Henry Paulson indicated that the reason the government took control of Fannie and Freddie was "based on what we have learned about these institutions over the past four weeks - including what we learned about their capital requirements.”

Paulson also said "there is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form."

Gardner said that means at the least there will be a lot of uncertainty about the future of the two firms, which generally is bad for share prices.

"We've all known about problems for quite some time, but until there was a crisis there was no need to resolve it," said Gardner. "Well, crisis don't get much bigger than this."