Sustainable Land Development Today - January 2009 - (Page 16)

SLDT FINANCE What Happened to Fannie and Freddie? A reflection and projection of two mortgage giants. By Paul Silver annie Mae (FNM) and Freddie Mac (FRE), the now infamous mortgage finance companies, have witnessed their share prices plummet more than 98 percent from a year ago. Eroding investor confidence stemming from the faltering U.S. housing market and the subprime mortgage crisis drove the share prices of these two former mortgage giants under a dollar. By late August 2008, concerns about Fannie and Freddie’s financial stability had reached critical levels. More importantly, the anticipated disastrous impact on the global economy from a failure of either entity made it evident that something had to be done in order to stave off an even bigger crisis. On September 7, 2008, the Bush administration seized control of the two companies, placing them in a government conservatorship. The rescue package, which could become the most expensive financial bailout in American history, was deemed necessary to prevent further turmoil in the financial markets and provide some relief to the crippled housing market. Fannie and Freddie have played pivotal roles in keeping the mortgage markets afloat as credit markets have dried up. Together, they are the largest buyers of home loans in the U.S., holding or guaranteeing approximately $5.2 trillion worth of mortgages, representing approximately one half of the country’s $12 trillion of outstanding home loan debt. Almost all U.S. mortgage lenders, from huge financial institutions like Citigroup to small, local banks, rely on Fannie and Freddie. F Fannie and Freddie raise cash to buy mortgages from lenders by selling bonds, and either hold them in their portfolios or pool them together as mortgage backed securities for sale to investors. By linking mortgage lenders with investors, the two firms keep the supply of money widely available and at a lower cost. The problem is that they guarantee all the loans that they sell to investors, so if a homeowner defaults on a loan, Fannie and Freddie will step in and make good on the loan. As a result of increasing numbers of defaults and foreclosures, they have lost approximately $11 billion in recent months with the expectation by many that the worst is yet to come. Most experts agree that the failure of one or both of these entities “ A fatal elixir of thin capitalization, high credit ratings, and preferential government treatment has created a system that privatizes profits but socializes losses. would send the financial system and the overall economy into a tailspin. Fannie Mae was created in 1938 as part of Franklin Delano Roosevelt’s New Deal. The collapse of the national housing market in the wake of the Great Depression discouraged private lenders from investing in home loans. Fannie Mae was established in order to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing. ” Initially, Fannie Mae operated like a national savings and loan, allowing local banks to charge low interest rates on mortgages for the benefit of the home buyer. This led to the development of what is now known as the secondary mortgage market. Within the secondary mortgage market, companies such as Fannie Mae are able to borrow money from foreign investors at low interest rates because of the financial support that they receive from the U.S. Government. It is this ability to borrow at low rates that allows Fannie Mae to provide fixed interest rate mortgages with low down payments to home buyers. Fannie Mae makes a profit from the difference between the interest rates homeowners pay and foreign lenders charge. For the first thirty years following its inception, Fannie Mae held a veritable monopoly over the secondary mortgage market. In 1968, due to fiscal pressures created by the Vietnam War, Lyndon B. Johnson privatized Fannie Mae in order to remove it from the national budget. At that point, Fannie Mae began operating as a government-sponsored enterprise (GSE); generating profits for stock holders while enjoying the benefits of exemption from taxation and oversight as well as implied government backing. In order to prevent any further monopolization of the market, a second GSE known as the Federal Home Loan Mortgage Corp., or Freddie Mac, was created in 1970. Up until that time, the home mortgage industry was characterized by regional variations in interest rates and lending criteria that made it difficult for 16 January 2009 Sustainable Land Development Today

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Sustainable Land Development Today - January 2009 Contents Our Voice Your Voice The BottomLine SLDI in Focus Calendar Industry Rebound Will Require Balanced Approach What Happened to Fannie and Freddie? Added Value in Entitlements Industry Spotlights Technology Wastewater Innovation Classifieds Advertiser Index Editorial Board SLDT Resources Last Word

Sustainable Land Development Today - January 2009

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