09/07/2008 - The US
Government takes over Fannie Mae and Freddie Mac.
The takeover will protect the mortgage market from the failure of
the two companies. Between Fannie and Freddie - they control almost
45% of the $12 trillion dollar mortgage market – or $5.2 trillion of
mortgage-backed securities, and they are writing approximately 70%
of the new loans. (note: FHA has approximately the other 30%)
Treasury Secretary Henry Paulson said the plan was implemented
because “Fannie Mae and Freddie Mac are so large and so interwoven
in our financial system that a failure of either of them would cause
great turmoil in our financial markets here at home and around the
globe. A failure would affect the ability of Americans to get home
loans, auto loans and other consumer credit and business finance.”
What do Fannie Mae and Freddie Mac do?
Fannie and Freddie provide an outlet for mortgage companies to sell
their loans. They always have a price set for what they will pay for
a conforming mortgage loan. Some call them the buyer of last resort
– because their window to buy loans is always open. Mortgage
companies are then more likely to lend money to consumers, because
there is always a buyer for that loan. Essentially Fannie and
Freddie provide liquidity for the mortgage markets.
Consider if Fannie and Freddie did not exist – mortgage companies
would be less likely to loan money, because the mortgage company
could be stuck with the loan, as opposed to always having a buyer.
Since this is a risk, the mortgage companies would only lend at
higher mortgage interest rates. Higher mortgage rates would further
slow the housing market. Thus – Fannie Mae and Freddie Mac help keep
mortgage rates low and help our economy.
Fannie and Freddie raise the money to buy the loans with Mortgage
backed securities and bonds – essentially by issuing debt to the
public markets. Their cost of borrowing money determines interest
rates for mortgages. The higher their cost of borrowing, the higher
mortgage rates will be.
What is causing this to happen?
This plan followed a report Friday by the Mortgage Bankers
Association that more than 4 million American homeowners with a
mortgage, a record 9 percent, were either behind on their payments
or in foreclosure at the end of June.
That confirmed what investors saw in Fannie and Freddie's recent
financial results: trouble in the mortgage market has shifted to
homeowners who had solid credit but took out exotic loans with
little or no proof of their income and assets.
In recent weeks, investors have been less willing to buy Fannie and
Freddie debt. For the risk of buying Fannie and Freddie debt, they
are demanding a higher rate of return. This means interest rates on
the debt are higher for Fannie and Freddie. This has directly raised
the costs for consumers taking out mortgage loans.
While Fannie and Freddie still have capital above the minimum
requirements set by the government, and even though the company’s
financial picture was better than investors assumed, it has become
clear the market would not accept that the stability is there. The
concern is Fannie and Freddie’s cost of borrowing will continue to
increase, and thus increase mortgage rates, which further depresses
the housing market.
What is the Government’s plan?
The plan places the firms under a conservatorship, a legal status
giving the government time to restructure and revive the companies.
The conservatorship will be run by the Federal Housing Finance
Agency, the new agency created by congress this summer to regulate
Fannie Mae and Freddie Mac. Placing the companies in
conservatorship, rather than receivership, could signal that the
government does not intend to nationalize or liquidate Fannie Mae
and Freddie Mac. Instead, under the terms of a federal law passed
this summer, conservatorship is designed to allow the government to
restructure the companies and return them to private control.
Treasury officials have previously compared the process to Chapter
11 bankruptcy.
The goal of the plan is to provide confidence to the investors in
the mortgage market, so the pipeline for lending continues.
What does it mean for you?
If the government plan succeeds, and it should, the uncertainty
around Fannie and Freddie could ease, making it easier for the
companies to access funds at lower rates – thus lowering mortgage
rates. That will have a spillover effect on the housing market –
lower interest rates will help the housing market.
It’s estimated that mortgage rates are almost a point higher than
they should be at this point in time due to increased borrowing
costs by Fannie Mae and Freddie Mac.
Since this plan has costs, and the desire of the government is not
to pass on all these costs to the taxpayers, it is unknown if rates
will come down, or if this will just prevent an abnormal rise in
rates that would have been on the horizon had Fannie Mae and Freddie
Mac collapsed.
If you are considering buying a home – now is a great time. Not only
are there tax benefits, this may be the bottom of the housing market
– so you can make a profit on your home. If rates drop, you can
always refinance in the future.
If you are considering a refinance to consolidate debt or to change
the terms of your loan – it’s a good time to consider this move. If
this plan has the desired affect, the housing market will pick up,
as will the economy, and rates will start to rise. Consider a 15
year loan to pay off your home early, or perhaps a 5/1 ARM if you
are thinking about moving in a few years.
FHA Loans are available for consumers with less equity or a more
challenged credit situation.
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