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Life in Fannie and Freddie's New Home
Posted On: 11/12/2008In quieter, happier times, the government takeover of Fannie Mae and Freddie Mac would have been the financial story of the decade.
U.S. Treasury Secretary Henry Paulson announced Sept. 5 that Washington was seizing the reins of the teetering mortgage giants and effectively guaranteeing their debt. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corp. (Freddie Mac) back or own outright about $5 trillion worth of mortgages. That's about half of all mortgages in the country, including a literally untold number of toxic subprime mortgages that were pulling the firms to the brink of insolvency.
By getting rid of Fannie and Freddie's upper management, agreeing to infuse about $100 billion into each of the companies and taking over, Washington hopes to not only save the two firms, known as government-sponsored enterprises, but the entire U.S. financial system: Fannie and Freddie had grown so vast that their failures might have caused the credit market to furterh seize up and crater the American economy.
Washington's intervention was such a dramatic and expensive move that it took an even more dramatic - and vastly more expensive - federal bailout of Wall Street to knock the story off the front pages. Nevertheless, the takeover of Fannie Mae and Freddie Mac has implications that will affect the average homeowner for years, possibly even decades to come.
In the long term, the action raises serious questions about the whole concept of a free-market economy. The term explicitly implies that America's financial health depends on giving companies free rein to either thrive or die. But by inserting itself into the Fannie and Freddie quagmire and assuming the companies' debt, Washington has essentially become America's largest mortgage lender.
But the more immediate effect of the takeover, most financial experts say, should be the stabilization and possibly even reduction in loan interest rates.
"By stabilizing the financial situation, (the government has) made it possible for Fannie Mae and Freddie Mac to continue to make conforming loans," says Cynthia Kroll, a senior regional economist at the University of California at Berkeley's Fisher Center Real Estate and Urban Economics. "That was the hope - that it would make loans more available and keep interest rates from climbing too much. People I know in the lending community say that, yes, it's kept the loan interest rates from climbing too much."
Put as simply as possible, the federal government hopes that by guaranteeing the Fannie and Freddie's debt, investors will be more willing to buy up more Fannie and Freddie bonds. This should allow Fannie and Freddie to buy more mortgages from banks, which should allow the banks to lend more. At the same time, the U.S. Treasury's promise to buy more mortgage-backed securities from the GSEs should raise demand for the securities and thereby cause interest on the investments - and, hopefully, mortgage interest rates - to go down. Lower interest rates would make it easier for people to buy homes, which would reduce the available inventory of houses - the real culprit behind America's housing bust.
"Interest rates for buying mortgages is going to go down," says Radhakrishnan Gopalan, assistant professor of finance at Washington University in St. Louis. "With the removal of management and the government's other actions, the interest rates at which the GSEs are willing to buy mortgages has gone down because the cost of borrowing has gone down."
All of which to say: "If you are a homebuyer who's able to put down 20 percent, and your credit's good enough to satisfy requirements, then you're in a very good position right now," Gopalan adds. "I read somewhere that interest rates dropped significantly as soon as news of the bailout came out."
This should translate to good news for home sellers, who might actually find buyers for their properties, and homeowners in general, who have seen their property values plummet over the past few years. Driving the devaluation of American homes has been the dismal reality that are simply more houses available than people willing or able to buy them. Since 2005, sellers have been cutting prices in order to attract buyers, which only led to further property devaluations, and on and in a downward spiral that ultimately spilled over to Wall Street and the greatest financial crisis since the Great Depression.
The great hope is that a reconstituted, economically viable Fannie Mae and Freddie Mac will begin to reverse this trend.
"Making mortgage financing easier is one way to increase the number of transactions happening in the real-estate market, which will in turn help home prices to stabilize," Gopalan says.
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