A good article on Fannie Mae & Freddie Mac

An article by Josh Cantwell.

Also see: www.strategicrealestatecoach.com

Where Do We Go From Here?

I remember selling life insurance just out of college and telling prospects that the interest rate on the product I wanted them to buy wasn't going anywhere. I remember saying, "As long as the financial system of the US doesn't collapse, you'll get a high return." Laughing, I'd conclude, "If the financial system does collapse, you, me and the whole country has bigger problems to deal with."

I'm no longer laughing.

While the United States is still the most dominant economy in the world, we've got some serious economic vulnerabilities to resolve. We're not a "banana republic," but investors around the world have shown that they question our commitment and our ability as a nation to back our debts. The takeover of Fannie and Freddie is just the latest chapter in a story line that has been unfolding these past several years.

What happened this past weekend surprised me, although it shouldn't have. In July legislation was passed that included giving the authority to Treasury Secretary Henry Paulson to possibly take equity positions in Fannie and Freddie. I remember hearing on the radio that Paulson made a point to give the assurance that this authority would never be used.

Two months later, he made his move.

So what's happened, how did this happen, and what are we in for?

Here are the basics: Fannie and Freddie gave us the 30 year fixed mortgage, something not found in any other country. Unfortunately, they got fat, and took too many risks with mortgages that went bad. Keep in mind that these guys have 5 trillion in debt - larger than any country in the world except for the US. They backed 3/4 of home loans in the US and earlier this year accounted for 80 percent market share of new home loans. (It's now much less.)

Oh yeah . . . they ferociously fought any attempts by Congress to rein them in and regulate their business so that something like this wouldn't happen. I guess when you spend $174 billion in ten years to lobby...err...buy Republicans and Democrats, you've got the muscle to throw your weight around. Not anymore. This week Fannie and Freddie were ordered to suspend all lobbying efforts until the government decides what to do with them.

Since July, the housing market continued to deteriorate. This past weekend, Fannie and Freddie were placed into a conservatorship by the Bush Administration: Their CEOs have been replaced as have their board of directors. Billions are slated to prop them up with the hope that the housing market charges back.

Treasury Secretary Paulson pulled the trigger when he realized that things weren't getting better with the market and that Fannie and Freddie didn't have enough cash on hand to sustain the losses headed their way. His move secures mortgages, protects taxpayers, and has kept the financial system (ours and the world) from collapsing.

Good move.

Paulson saw that investors both here and around the world stopped investing in Fannie and Freddie...a major concern. Investors have long bought Fannie and Freddie debt because it was backed by the full faith and credit of the US (sorta like Treasury bonds). Apparently, they had second thoughts --- even after Congress gave Paulson unlimited authority to pay off Fannie and Freddie's debts should the need arise -- no one was buying.

This is a big deal. With our significant national debt, the stability of our dollar is hooked to the willingness of foreign banks to lend to the US. Bad things happen when they don't . . . like rising interest rates, expensive mortgages and more pressure on a poor economy.

So here's the good news. By taking this extreme measure, chances are good that not only will mortgages remain a viable way to buy houses, but mortgage rates will decline, and possible help our ailing housing market to recover. Lower mortgage rates potentially mean more houses being sold.

And so far, we've already seen a drop in mortgage rates down to 2005 levels -- below 6%. Investors have responded to the Fannie and Freddie takeover by purchasing US home loans and driving down interest rates.

If this continues, we'll know that this measure is working.

Also, the whole deal was structured to protect the taxpayers, especially if taxpayer money is used to buy preferred stock. Should losses occur, the original shareholders will take the first hit.

The bad news...if the housing market continues to deteriorate we could all be on the hook for up to 100 billion dollars. Although, the Congressional Budget Office states that the number will probably be only 25 billion.

Don't forget...we still have a housing crisis, and chances are good that it will take more than the 300 billion of taxpayer dollars (what the July legislation permits) to get us out of that mess. I've even seen where one economist predicts that the true cost of the housing crisis to be a trillion to a trillion and a half!

Gee . . . what could we spend that money on in the US . . . Health care? Schools? Renewable energy? An aging infrastructure?

There's a reason why we need to regulate industry whether it be the financial industry or any other of the major players. We are now seeing the effects of a deregulation mindset from the past 25 years on many different levels. Treasury Secretary Paulson has been able to reinforce the dam, but we need to make some decisions. We can start by deciding if we really want to maintain government support for private profit.

This doesn't mean that I don't support the current action being taken . . .it's necessary. Many people are upset that the taxpayer is being put on the hook, potentially, to help out some fat cats at the top.

What they need to realize is that if Paulson let Fannie and Freddie fail, financial institutions here and around the world would get trashed. Credit markets would seize because so many banks own Fannie and Freddie bonds (anyone read about the Chinese National Bank this weekend?) and borrowing would stop. Without access to credit, the economy would stop. It would take decades to recover.

The right steps have been taken. Unfortunately, what this tells us is that our reputation has taken a hit. The US is no longer seen as a force of stability and investors may continue to shy away. Our government leaders need to find a way to run our finances with some sense of accountability.

We've got some work to do.