Jul. 14, 2008 - WHY ALL THE FUSS OVER FANNIE MAE & FREDDIE MAC
The Federal National Mortgage Association (FNMA or “Fannie Mae”) and Federal Home Loan Mortgage Corporation (FHLMC or “Freddie Mac”) are back making headlines for the second time in four years (does anyone remember the scandal arising from a lack of auditing oversight that led to a huge restatement of their financials in ’04, accompanied by the outrageous compensation plans for company executives?) but people don’t really know what these companies do and why they are so important. See if this clarifies things a bit.
Fannie Mae began in 1938 as part of FDR’s New Deal initiative to provide liquidity in the secondary mortgage market. It operated essentially as a monopoly until the government “spun-it” off the books in 1968.
No longer a government agency, it was transformed into what is known as a Government Sponsored Enterprise (GSE)—privately owned, publically chartered and because of its relationship with the Federal Government, a greater sense of financial security.
Freddie Mac began in 1970 to provide essentially the same services and eliminate Fannie Mae’s monopolistic hold on the secondary mortgage market.
Together these two serve an important function: They buy mortgages from banks, typically packaging and reselling many of them with a guarantee of repayment. The banks selling the loans receive an infusion of cash to continue lending. And the market buys the mortgage-backed products that pay higher rates of return than Federal bonds with an implied repayment guarantee. Thus, the two GSEs provide a smooth, liquid market for mortgages.
The problem now is that even though Fannie Mae and Freddie Mac purchase mortgages with more stringent lending requirements (i.e., higher down payments, proof of income, lower debt payment ratios, etc.) even those borrowers have begun to default on their mortgages. And this is the reason for concern.
If too many of those borrowers start defaulting, the question becomes just how bad is the market exactly? And how soon will it be before they Federal Government steps in to help these two companies that possess only 1.5% in reserves ($81B in capital to cover $5.3T in loans) to cover all these mortgage-backed products? And if a bailout is necessary, just how high with mortgage rates rise and how much money will be available for mortgage lenders to actually lend?
This is a scary situation for us as Realtors and for the general public at large. In the Metro New York Arena the market has not yet hit rock bottom and on a daily basis I get asked the question how is the housing market?
