This past Sunday, the U.S. Treasury seized control of behemoth mortgage companies Fannie Mae and Freddie Mac in a move aimed at averting collapse of the two organizations and the potential snowball effect on credit markets here and abroad. The takeover solves an immediate problem but raises many more questions. First and foremost, is the government’s latest move enough to stem the tide of the troubled financial industry? And what is the fate of Fannie Mae and Freddie Mac? What is the future impact on everyday Americans?
By way of background, The Federal National Mortgage Association, better known as Fannie Mae, was founded in 1938 as part of President Franklin D. Roosevelt’s New Deal. The purpose was to provide liquidity to the mortgage market and stimulate the economy during post Depression era. The Federal Home Mortgage Corporation, better known as Freddie Mac, was established in 1970. Together, Fannie and Freddie own or guarantee almost half of the $12 trillion in U.S. home loans. Both organizations are Government Sponsored Enterprises (GSE) which means they are federally sponsored; privately-owned (publicly traded stock); with the risks covered by the taxpayers. This odd structure means that when times are good, the company executives and shareholders and bondholders flourish but when disaster strikes, the federal government rushes in to save the day…at least for the bondholders. The CEO’s of both organizations received their walking papers and both common stockholders and preferred stockholders will, very likely, lose most or all of their investment. What the government has done is protect the bondholders and infused the two organizations with $1 billion to keep them afloat. This takeover represents approximately an 80% ownership stake with commitments to inject up to $200 billion if needed. Some sources suggest that the problem may eventually require more than $300 billion.
The take-over of Fannie May and Freddie Mac is the latest in a series of unprecedented moves by the federal government:
- February- $160 billion economic stimulus give-away package signed by President Bush.
- March- Secretary of the Treasury, Henry Paulson, orchestrates the $30 billion bailout of Bear Stearns.
- March- Federal Reserve opens its discount window to non-FDIC banks in an effort to create a cash transfusion for troubled mega brokerage firms.
It’s impossible to tell if this latest bailout will be sufficient to tame the current economic tsunami and the government is saying, “No more!” to yet another major crisis in less than a week, the faltering Lehman Brothers.
As to the fate of Fannie Mae and Freddie Mac, there are three possible outcomes.
- The government fully nationalizes the two organizations, meaning they become a full-fledged government agency.
- The government fully privatizes them, meaning they sell them off in part or whole to private enterprise.
- The government returns them to their former Government Sponsored Enterprise (GSE) status.
What does all this mean for everyday Americans? In the short term, the government has again averted a financial meltdown that could have rivaled the Great Depression. If the government chooses to privatize Fannie Mae and Freddie Mac, it would likely be the end of the 30-year mortgage. For the moment, mortgage rates have dropped to the lowest they’ve been in several years. If you are considering buying a home or refinancing, now may be the opportunity of a lifetime.