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This week has been buzzing with news of the government takeover of Fannie Mae and Freddie Mac. It is a big deal as the NY Times called it a "In Rescue to Stabilize Lending, U.S. Takes Over Mortgage Finance Titans". It is an extraordinary move for the federal government to essentially bail out two gigantic mortgage lenders with public funds. If you've heard the names Fannie Mae and Freddie Mac but aren't sure about who they are, what they do, and why all this matters, let's start with the basics. The Irish Times Newspaper has a great article "Fannie Mae Freddie Mac:Anatomy of a Crisis" that succinctly answers some of the fundamentals - What are Fannie Mae and Freddie Mac and What do They Do?
What are Fannie Mae and Freddie Mac? They are called government-sponsored enterprises because they initially were formed by the federal government. Fannie Mae is a common name for Federal National Mortgage Association. in Washington, DC. Freddie Mac is a common name for Federal Home Loan Mortgage Corp. in McLean, Virginia.
What do Fannie Mae and Freddie Mac do? Fannie Mae and Freddie Mac buy mortgages from savings and loans, banks and other lenders to generate more cash for those lenders to make more home loans. Together they hold or guarantee $5.4 trillion of mortgages, about half of the US's outstanding home loans.
So what happened? Well as home prices fell, foreclosures went up, and lenders ran into trouble, so did Fannie and Freddie. Loans they backed went bad, capital became harder to come by and it was harder for Fannie Mae and Freddie Mac to sell their loan packages. Thus, like any desperate, compromising soul, they lowered their standards and backed riskier mortgages and all this came back to bite them. Whether you are Sally-Homeowner or a big financial institution, you can't hide from sound financial principles and the truth of the matter. "So What Did Fannie Mae & Freddie Mac Do To Mortgage Rates?" That is what Quizzle asks:
Like many Americans having trouble selling their homes, ol’ Fannie and Freddie have been having trouble selling their packages of loans. The investors who typically buy from them have become much pickier about what they’ll buy - with good reason - they were worried about increased risk as mortgage defaults rose and home prices fell. Since the two companies own or insure about $5 trillion in mortgages (nearly half of the nation’s total), the world has been watching them very carefully. Especially the American government. In the opinion of the government leaders, Fannie & Freddie were headed toward failure. Since they’re so big, their failure would have dramatic (likely worldwide) consequences. So Uncle Sam worked the weekend and officially stepped in. So why are mortgage rates falling now? Think of it like this: Fannie and Freddie are kind of like big insurance companies. Before this announcement, investors worried that Fannie or Freddie might not be around to pay if mortgages they bought went sour. Worried investors = high mortgage rates for consumers. Now that Uncle Sam has stepped in, mortgage bond holders feel much safer. Happy investors = lower mortgage rates for consumers.
Wisebread has a superb post outlining the the winners and losers
in this bailout. As you might expect, guess who one of the biggest losers are?American taxpayers - This bailout is not free. Noone knows the final damage this bailout will do to the Treasury, but most believe that the losses will be in the hundreds of billions. Considering that Fannie and Freddie holds approximately $5 trillion in home loans and currently more than 9% of loans are in the process of defaulting, then simple math tells us that these two companies could potentially lose $450 billion. Additionally, taxpayers will have to pay for the upkeep and operations of these companies so the costs will keep on increasing for years to come.
Some of the winners I never really thought of were interesting, particularly:
Banks that invested in Fannie and Freddie's debt - Fannie and Freddie sold trillions of dollars in mortgaged backed securities to central banks all around the world. For example, China's People's Bank owns more than $300 billion in Fannie and Freddie's mortgage backed securities. If both of these companies defaulted on all of these securites the Chinese national bank may have gone bankrupt
So in some respects the government is busy bailing out everyone at the expense of the taxpayers who DO
