The passage of yesterday’s massive housing bail-out bill by Congress was inevitable. Without it, the two government-sponsored mortgage companies the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) could have seen a mass liquidation of their equity and bank debt sending you and me into a world of hurt. You see without these two behemoths to intercede on our behalf, most banks or other institutional investors would be wary of lending us great sums of money for up to 30 years on a hope and a prayer—and that’s on a good day.
Fannie Mae was set up back in the 1930s when banks weren’t lending anybody money (sound familiar). FDR knew that if middle-class Americans were shut out of the mortgage market and denied their dream of owning a home he would have a revolution on his hands. Yet, for the government to loan money directly to the people smacked of Bolshevism (the Russian Revolution was alive and well back then) so instead Fannie and then Freddie (which was founded in 1970), became intermediaries, guaranteeing mortgages and lending money to the lenders like your local bank. In exchange, your bank sells some or the entire mortgage to Fannie and Freddie. Because the pair can borrow at a lower interest rate than your bank (due to their government-sponsored status) they can buy your mortgage and make a profit on the so-called interest rate spread.
The scheme worked well for years and everyone was happy. Home buyers benefited since they could now borrow long-term and still pay reasonable rates for that privilege. Without the backing of Fannie and Freddie, mortgage rates would be substantially higher and the number of qualified borrowers who qualify for credit would drop precipitously. And then the sub-prime problems began to appear.
As the crisis mounted, Fannie and Freddie were used by the financial system as the “buyer of last resort” for the mounting billions in bad mortgages. Back in February the government raised the limit on the number and size of the loans they were able to hold and a month later allowed both companies to reduce the amount of surplus capital they needed to back each loan. This made it possible for the duo to increase their mortgage portfolios by over $200 billion and to expand the number of mortgages they guaranteed to over $2 trillion. These moves enabled them to buy an even greater number of the burgeoning supply of bad mortgages until now they hold $6.9 billon of foreclosed homes compared to $8.56 billion held by all 8,500 commercial banks and S&L s in the country. Overall, it is estimated that they now hold about half of the $12 trillion mortgages in the U.S. and 81% of all mortgages originated this year. In essence, as home owners, our futures are inextricably entwined with the fortunes of Fannie and Freddie.
Over the last month, investors worldwide became increasingly concerned over the mortgage companies dwindling capital base and the escalating number of sub-prime loans on their books. Overseas investors, which hold a substantial portion of their $782 billion in debt, started dumping bonds. At one point last week it appeared as if bankruptcy was a real possibility as both company’s stocks plummeted to new lows. This sent shock waves across the financial markets. It was at that point the government came to the rescue.
Both the administration and lawmakers in both parties joined in to pass a $300 billion rescue bill that both addresses the housing crisis and the woes of Fannie and Freddie. President Busch, after first balking, over an additional $3.9 billion in the bill which would go toward helping neighborhoods hit hardest by foreclosure said he would sign it. The measure would enable as many as 400,000 at-risk borrowers to refinance their unaffordable mortgages into new lower-cost fixed rate loans insured by the Federal Housing Administration.
The bail-out bill also gave the Treasury Department temporary power (the next 18 months) to extend both Fannie and Freddie an unlimited line of credit while giving the government permission to buy their stock if it became necessary to support the companies. At the same time, the bill would create a new regulator for the mortgage companies that would tighten oversight on credit quality and loan limits. Congressional Budget Office Director peter Orszac estimated that if the companies needed the government’s help it might well cost taxpayers $25 billion although there is a ”… significant chance—probably better than 50%–that the proposed new Treasury authority would not be used”.
Somehow, given the on-going troubles in the housing market, I expect they will need it before all is said and done. Still, I guess the alternative would have been far worse for all of us.