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Treasury Bails Out Fannie, Freddie
GRAND RAPIDS — Mortgage rates dropped 50 basis points the day after the U.S. Treasury announced it was bailing out behemoth mortgage financiers Fannie Mae and Freddie Mac, and that was the desired effect the federal government was looking for. Time will tell whether the move will actually resuscitate the hobbled housing market.
When Treasury placed Fannie and Freddie into a government conservatorship controlled by the Federal Housing Finance Agency on Sept. 7, it effectively shifted to U.S. taxpayers the liability for losses that might arise from the more than $5 trillion in mortgages the two mortgage giants collectively held — roughly half of the nation’s mortgage debt.
The action was meant to protect Fannie Mae and Freddie Mac from foreclosure loss, as well as give them the means to be more flexible to write and process more loans. According to plans, Treasury will temporarily increase its credit line to both Fannie and Freddie and they, in turn, help shore up the beaten down housing market by buying or insuring more and more mortgages between now and the end of 2009. Then, in 2010, they’ll start decreasing their portfolios at a rate of 10 percent per year.
“Treasury has not nationalized Fannie Mae and Freddie Mac, but what they have done is create a process where they may, over time, invest as much as $100 billion into each of those two agencies, so that is really the limit of the tax payer obligation under the worse-case scenario,” explained Dana Johnson, chief economist for Comerica Bank. “It’s definitely the case that some taxpayer money is being put at risk, but the far bigger risk would have been to let the housing market dry up.”
Earlier this year, Fannie and Freddie combined were the ultimate source of funds for about 70 percent of the new mortgages that were being written in the United States. The greatest fear was that Fannie and Freddie wouldn’t be able to continue to borrow, wouldn’t have the money to continue operating and, thus, the typical American consumer wouldn’t be able to get a mortgage.
“That would have put tremendous downward pressure on the housing market. That would have been, in all likelihood, a disastrous outcome for the housing market in terms of prices, sales and further foreclosures,” Johnson observed.
Johnson doesn’t think the program laid out by Treasury creates the prospect of a huge upside potential in the housing market near term, but it will avoid a negative effect on the housing market. And it does allow housing prices to play out against a more settled financial background that wouldn’t have been the case if Fannie and Freddie had stopped lending, Johnson said. The whole idea was to stabilize the overall economy by stabilizing the housing market, which is an important component of the financial system, he added.
People who were holding Fannie and Freddie’s debt will benefit because, in effect, the government has put itself in a position where, if there are losses, it will prevent them from hurting Fannie and Freddie bond holders, he noted.
“But the biggest beneficiary of this is the U.S. economy, because the potential for a really big crisis in the housing market has been avoided,” Johnson said. “If Fannie and Freddie had collapsed, that important part of the economy would have collapsed along with them, and that would have made the economic weakness here quite a bit more severe. So any business that’s part of the U.S. economy is going to find that the economy is looking better than it otherwise would have, but certainly not brilliant. ”
Mitch Stapley, chief fixed income officer for Fifth Third Asset Management, said when the Fed started the interest rate easing cycle a couple months ago, it believed that lowering the federal fund rate would trigger lower mortgage rates. Lower mortgage rates would have made housing more affordable but credit conditions didn’t ease at all: They’re actually higher now then when the Fed started easing. But shortly after the Treasury Department intervened with Fannie Mae and Freddie Mac, there was a decline in mortgage rates.
“That’s the most tangible evidence of something good coming out of this thing right off the bat, and that’s what we really need — lower mortgage rates,” Stapley said. “We’re going through this epic credit crisis, and this is a good step. This is not the silver bullet: It does not cure everything, but to the things it can control, it helps get some bit of confidence going in the market if it brings down rates somewhat. Things progressed nicely on day one and hopefully it will continue, but let’s face it: The jury is probably going to be out for a while.”
As Stapley sees it, Treasury’s action is most advantageous to prospective homeowners because it makes mortgages more affordable, and to existing homeowners with adjustable rate mortgages who would like to refinance into a lower fixed-rate mortgage. It doesn’t slow the pace of foreclosures or stop the decline in home prices, but it is helpful to the degree that it gets more people out there looking for mortgages and driving up demand. It’s also generally good news for banks because it helps get liquidity going in the marketplace in the general exchange of credit and the cost of credit, he said. Indirectly, business benefits, too, because anything that gives the economy a shot in the arm helps business.
“When you look at the overall size of these two mortgage financiers and the financial shadow that they cast, if one or the other of them went into a real freefall, the impact to the global financial markets would be enormous — and then it gets back to business and banks and everything, and lending gets even tighter than it is now,” Stapley observed. “To the degree that you prevent that kind of nuclear meltdown scenario, I thing everybody benefits.”
According to the Treasury, while many institutions hold common or preferred shares of Fannie Mae and Freddie Mac, a limited number of smaller institutions have holdings that are significant compared to their capital, and that could result in an after-tax hit to their earnings. Ionia-based Independent Bank Corp., for example, filed a form 8-K with the Securities and Exchange Commission Monday indicating that, at June 30, the company had $6.2 million of Fannie Mae and Freddie Mac preferred stock included in its trading securities. On Sept. 8, the fair value of those securities had declined to approximately $0.5 million due largely to Treasury’s bail out of Fannie Mae and Freddie Mac, the company reported.