Fannie/Freddie Bailout: What does it mean?

By now you’ve probably heard that the government has “seized” Fannie Mae and Freddie Mac. Rumors and speculation had been swirling since Friday evening that the takeover could come as soon as this weekend. Sure enough, on Sunday morning, it was announced that the two mortgage giants would be placed into “conservatorship” by the government, at least for the next year. I watched the live news conference at 11am EST on Sunday morning, where Treasury Secretary Henry Paulson and Federal Housing Finance Agency Director James Lockhart outlined the terms of the takeover.

So what does all this mean? First, a brief education on just what it is that Fannie Mae and Freddie Mac do. They are unique In that they’re private companies, but they’re “sponsored” by the US Government, and supported by them. They are mega-companies – some of the largest in the world. They provide what’s called a “secondary market” for home mortgages. (The “primary market” is where loans are originated: where a bank or lender loans money to a borrower to finance a real estate transaction. This is what I do for a living.) The secondary market, then, is what happens to the loans after the money has been loaned to the borrower. Banks pool together a whole bunch of those loans, package them together in bundles, and sell them to investors. On the secondary market, they’re called “Mortgage Backed Securities”, or MBS. This is how banks can replenish their funds and make more mortgages to borrowers. MBS are tracked very closely by mortgage professionals such as myself, as interest rates are tied to the price of MBS. So, this is where Fannie and Freddie come in. They are a major buyer of these packaged loans. Once they’ve bought them, they either re-sell them on the open market as Mortgage Backed Securities, or they hold some and keep them on their books. At any given time they’ve purchased as much as 80% of all conforming mortgage loans. So as you can see, our entire mortgage system is very closely tied to these two giants., as they're sort of the "clearinghouse" if you will for mortgages. If they go down, our entire mortgage infrastructure collapses, and we’re in big trouble.

But the government is smart enough to know that they could NEVER let these two companies fail, so they have a plan. And while I won’t bore you with all the intricate details of the plan, the question most consumers want to know is… how does this affect me?

I’d be lying if I said I knew exactly how this would all play out. But we can make some educated assumptions based on the information we’ve been given. First, a government seizure means that it’s “business as usual” in the mortgage world. When your day starts today, nothing changes. Loans are still being made. Homes are still getting sold. This is a good thing. Second, we should see some reaction in the stock market. This will be widely viewed as a very good and necessary step taken by the government, and it will restore confidence not only in us Americans, but worldwide, as foreign investors make up a very significant chunk of who has been buying these loans on the secondary market. Third, we should indeed see rates trickle down. How fast? I have no idea. I won’t even pretend to. Some economists say it will be over the next few weeks. It could be in the next couple of days even. We’ll just have to watch and see. It will certainly be a wild ride in the coming days, as the stock and bond markets try to figure out what they think it means.

For homeowners, or someone considering buying a home, I’d be calling my mortgage broker TODAY to discuss this with them. The government takeover should create some opportunities to refinance into a lower rate, especially if you have a rate in the mid-6’s. Any mortgage broker worth his or her salt should be able to calculate your cost savings over time by refinancing. If there’s a benefit, go for it and don’t look back. Don’t haggle over .125% in rate… rates will be very volatile for a while and they’ll probably change very rapidly. If you find a rate you think is good and that you can live with, lock it in and move on. And if you’ve been sitting on the fence about buying a home, I believe the time is NOW. Call your Realtor!

Good things can come from bad situations, so look at the bright side of this government bailout, and take advantage.

Questions? I can be reached at 919-303-8612 or joey@carolinaequity.com.