Why should you care about Fannie and Freddie?
Posted
Jul 16 2008, 10:48 AM
by
Todd Harrison
Rating:
Given the daily barrage of bad news about the credit crunch, the mortgage crisis and failing banks, you'd think things would be a lot easier for someone who actually wants to take out a simple home loan.
As a matter of fact, just this morning you read an article about two mortgage companies, one with a name that sounds like what they call your grandmother at her retirement community, the other like some up-and-coming DJ. Fannie Mae and Freddie Mac, could that be it? They ran out of money, apparently, which could make it even harder for you to get a mortgage in the future.
Harder? Is that some kind of cruel joke? How could taking out a mortgage be any more painful than it already is?
Fannie Mae and Freddie Mac, collectively referred to as the government-sponsored enterprises, or GSEs, account for roughly half the $10 to $12 trillion market for home loans in the U.S. Now that banks like Citigroup and JPMorgan Chase have their hands full with ugly balance sheets and the aforementioned crises, the GSEs fund around 80% of new mortgages.
The government established Fannie Mae in 1938 to promote affordable housing as part of the New Deal. In 1968, it ceased being a government initiative and became a private entity. Two years later, Washington gave birth to Freddie Mac, also publicly traded, to serve a similar function.
Because the GSEs were established by the government, it was assumed they would receive federal support if they ever got into trouble. This implicit guarantee allowed Fannie and Freddie to borrow and lend cheaply (more on this later).
The GSEs control a portion of the mortgage industry which rarely makes the headlines: The "conforming loans" market - loans made to borrowers with good credit and money in the bank.
Fannie and Freddie, being the adorable couple they are, buy these loans from banks, bundle them into packages and sell them to investors. These packages are called mortgage-backed securities. Investors (large institutions, foreign banks, hedge funds, you name it) who buy these bonds pay a fee to Fannie and Freddie for guaranteeing those loans.
Fannie and Freddie's primary role is to keep mortgage rates low by ensuring there will always be a willing buyer for those mortgages. As long as banks can easily sell new loans, they can offer low rates. If the loans become difficult to sell, however, banks are forced to assume more risk on each new loan they write - and to demand additional compensation in the form of higher interest rates.
Without GSEs, you'd probably be staring at a much higher rate and more superfluous, wallet-assaulting processing fees - in addition to all that paperwork.
But wait just one second. If Fannie and Freddie deal in only the safest of loans, why are they in trouble?
Top Stocks blogging partner Todd Harrison is founder & CEO of Minyanville.com. This article was a contribution by the Minyanville Staff, check out the full article here. See also:
How To Stop Fannie, Freddie Bailout
Bailouts, Bank Failures and Rumor Mills
Mortgage Reform: Why Government Intelligence is Oxymoron
