September 18, 2008
It’s natural to want to ignore shrill Wall Street news about vaguely familiar-sounding mega firms – that’s the kind of thing that only big investors and stock market junkies care about, right? Well, almost. You can tune out as long as you don’t pay taxes, have a 401(k) or pension, hope to ever get a loan… You get the idea. It turns out that the government takeover affects just about everyone.
Who Are Fannie Mae and Freddie Mac?
Fannie Mae, or the Federal National Mortgage Association, was created by the New Deal in order to encourage home ownership. Freddie Mac was created in 1970 to provide competition. They both are government-sponsored enterprises (GSEs), which means that private shareholders own and run them for profit, but the federal government backs their debt. (more about their history and creation at http://hnn.us/articles/1849.html)
Why are they important?
Together, Fannie Mae and Freddie Mac provide financing for about two-thirds of all U.S. mortgages. They buy mortgages from lending institutions and then either resell them as mortgage-backed securities or keep them as part of an investment portfolio. While Fannie and Freddie have long played an important role in the housing market, the recent mortgage crisis has made them even more critical; as investors lost confidence in large investment banks they turned to Fannie and Freddie, whose government backing made them seem like a safer bet.
What went wrong?
Well, a lot of things. The This American Life segment, “Giant Pool of Money,” ( http://www.thisamericanlife.org/Radio_Episode.aspx?episode=355 )does a great job of explaining it. The gist is that starting somewhere around the early 2000s, lending practices began to shift toward less accountability, until finally many people taking out a mortgage no longer had to show any proof that they had the assets or salary to be able to pay their mortgages. Fannie and Freddie were the biggest buyers of these bundles of questionable mortgages. As long as the housing market continued to improve, Fannie and Freddie were OK – people were finding ways to pay their mortgages, through low initial rates in creative loan packages, or by taking out equity loans backed up by their homes’ rising value. When the housing bubble burst, the whole edifice began to crumble. The change was felt first by the individual homeowners whose monthly payment adjusted beyond their ability to pay, or whose equity evaporated as their home lost value. Soon Fannie, Freddie, and the investment banks that also bought these mortgages began to see the missed payments in their bottom line. As it became clear that many mortgages would never be paid in full and that the securities they backed had lost much of their value, investors panicked. This is where the government stepped in.
How does a government takeover work?
The purpose of the takeover was to ensure the continued availability of credit for mortgages and to quell investors’ fears that the companies lacked the capital to handle continued defaults on debt. The takeover involved ousting both companies’ CEOs and boards of directors, a massive infusion of cash, and a stipulation that the Treasury Department (read: taxpayers) will be the first to recoup its investment when the companies recover. It is unclear exactly how much money this will cost, but estimates run as high as $100 billion.
How does all this affect you and I?
One of the most direct effects people will feel is that many of us, whether we know it or not, are invested in Fannie and Freddie. Many mutual funds hold some form of mortgage-backed security, affecting investment portfolios, 401(k)s and pensions.
At some point, taxpayers are likely to feel the burden of paying for the rescue, though it is unclear how much that will cost. So far, the government has left this expenditure off the books.
In the time since the Fannie and Freddie takeover, it has become clear that the mortgage crisis is turning into a broader credit crisis. This means that the period relatively free access to credit that the world has enjoyed in the past decade or so may be coming to a close as investors who got burned in the mortgage crisis look for only very safe bets to invest in.
The upside is that mortgage rates have dropped since the takeover, as the housing market has weakened. Economist Mark Zandi with Moody’s predicts that 30-year mortgage rates could go as low as 5.5%. It is a buyer’s market, especially a first time buyer. But if this crisis has taught us anything, it is that buying a home is a major investment. It is essential to educate yourself on the potential pitfalls of buying a house. Pre-purchase counseling is available free of charge, and Facing the Mortgage Crisis can help connect you to the people who provide it.
Want to learn more about Fannie and Freddie? Links to two helpful stories from NPR:
Below is a short video with advice for first-time homebuyers