Monday, July 14, 2008
You may have heard of them, but you probably don't know a whole lot about them. They are your good friends in the area of housing, and their names are Freddie and Fannie. That would be Freddie Mac and Fannie Mae, to be more precise, and as Treasury Secretary Henry Paulson was quoted recently they "play a central role in the housing system and must continue to do so in their current form...". On Sunday, Treasury and the Federal Reserve moved to secure the finances of the two giants, to ensure that they do not drown under the weight of what is termed the current 'correction' in the housing market. Freddie Mac is the Federal Home Loan Mortgage Corporation, a mortgage finance system that makes home ownership and quality rentals a reality for more American families, reducing the costs and expanding the choices by linking Americans to the world financial capital markets. It is stockholder-owned, and is authorized to make loans and loan guarantees. Freddie Mac was chartered by Congress back in 1968 in order to provide competition for Fannie Mae, so the two are not so much a couple as they are competitors in the housing capital market. Fannie Mae is the Federal National Mortgage Association, which was founded back in 1938 as a part of Franklin Roosevelt's 'New Deal' programs. Fannie is also a stockholder-owned company that is authorized to make loans and loan guarantees. The basic premise is that both of these Federally designed, but publicly owned, corporations provide the money that props up the U.S. secondary mortgage markets. Stay with me for a quickie and simplistic lesson on the process here. For instance, you own your home and you have a mortgage with your bank for the financing of that home. Your mortgage is bundled in with a group of others to form what is known as a 'collateralized mortgage obligation', or CMO. This basically reduces the risk for the lending institutions, since the larger group is less susceptible to individual mortgages being defaulted on if a homeowner fails to meet their obligation of paying the mortgage. The grouping is then further sold to other investors as a product called a collateralized debt obligation, or CDO. These CDO's can then often be bundled with other CDO's to make giant CDO's made up of numerous mortgages. The CDO's are then publicly traded as investment products. So when housing is going good, the value of mortgages go up, and the value of the CDO's goes up as well. When housing prices and sales fall, the value of your mortgage declines, and thus the value of the larger CDO's also declines. Fannie Mae and Freddie Mac's role is that, for a fee, they guarantee that the money on each mortgage will be paid back, regardless of whether the actual individual mortgage-holder every really pays back their particular mortgage. Investors in CDO's with Fannie & Freddie allow the two to keep the fees based on this guarantee. However, when particularly nasty down markets occur, such as is happening now, many individuals default on their mortgages and walk away, never to pay them off. Fannie & Freddie are stuck with having to payoff these obligations, and thus the risk is very real for these corporations in a poor market. On Sunday, the government moved through the Treasury Department and the Federal Reserve Bank to ensure that Fannie & Freddie would be able to remain solvent today. Both corporations have a $2.25 billion dollar line of credit with Treasury that is designed to get them through tough times until the market can turn around again, which it historically has always done. However, this downturn has been so severe that both Fannie & Freddie could exhaust these lines of credit this week. So today, Freddie Mac is planning to attempt to sell $3 billion worth of securities on Wall Street for financing. There is real fear that they will not be able to sell these securities, and that this failure would set off a crisis of confidence in the world markets, and a worldwide sell off in all types of securities. If investors don't believe that they will get paid back on their investments, they will sell. That is where we are at. This is all high finance stuff, but it is all backed and affected by your own individual mortgages. The Sunday moves by the Fed and Treasury ensure that, should these debt securities sales fail, Fannie & Freddie will still be supported by the increased federal credit lines. Bottom line for the long haul is that what is needed is for the market to again turn around, as it always has, and begin another upturn. This will happen again at some point, but the sooner the better for the stability of American and world markets, as well as for individual mortgage holders.