Product Spotlight (Special White Edition)

Product Spotlight (Special White Paper Edition)Volume 14

By Mark Teteris, Chairman and CEO - Lakeland Mortgage Corporation

Government Announces Takeover of Fannie Mae/Freddie Mac

Regulators responsible for oversight of the giant mortgage companies, the Federal Housing Finance Agency (FHFA), in concert with the U.S. Treasury, have placed the companies into conservatorships (akin to chapter 11 bankruptcy reorganization). Here we attempt to explain the who, why, and what, as well as identify the immediate and potential impacts of these events on the home mortgage and housing markets.

WHO is involved?

FNMA and FHLMC are government sponsored enterprises (GSE) chartered by congress to provide an expanded market for home mortgages. Both are stock companies and are publicly traded on the NYSE. Their primary function is to purchase mortgage loans and repackage the obligations into securities (notes and bonds), which are guaranteed by the GSE, and then sell the resulting bonds to the public, including large institutional investors worldwide. There are approximately $5 trillion of these securities outstanding today. Providing this large liquid market allows mortgage originators such as banks and mortgage banking companies to replenish their capital and provide more new home mortgages to home buyers and to homeowners seeking to refinance existing mortgages to tap into equity and/or take advantage of lower interest rates.

WHY is this happening?

Investors have been willing to purchase these guaranteed mortgage bonds with yields (interest rates) only slightly above the rates available by purchasing U.S. Treasury notes and bonds. This difference in rate is called a risk premium. Because the U.S. congress authorized the creation of the GSE, investors have long believed that the GSE guarantee of the securities they issued was also backed by an implicit guarantee supported by the full faith and credit of the U.S. Treasury. However this U.S. guarantee never officially existed. Meanwhile, other issuers of mortgage securities, often containing sub-prime and other exotic mortgages, began to experience rapidly rising defaults as the white-hot housing market began to cool. As investor confidence in these securities began to falter, investors in the GSE-issued securities felt safe as they clung to their belief in the implicit guarantee. When the credit and housing downturn became more severe however, investors began to lose confidence in the existence of the implicit guarantee and demanded an ever higher risk premium for mortgage backed securities. This is why mortgage rates have remained stubbornly high above 6 percent even as the Federal Reserve lowered its benchmark interest rates.