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A Primer on Fannie and Freddie: What the Bailout Means

September 8, 2008 RSS Feed Print

The U.S. government takeover of Fannie Mae and Freddie Mac made history yesterday. So, what do you know about these mortgage giants? Here is a quick primer on the two players:

1. Think of Freddie and Fannie as hybrids. They are both government sponsored and shareholder owned. They do not have direct contact with consumers; instead, they work with lenders. The job of Fannie and Freddie is to buy mortgages from banks, savings and loans, credit unions, and other lenders to ensure that mortgage funds are consistently available. Together, they hold or guarantee about half of the country's outstanding home loans.

2. The difference between Fannie and Freddie lies primarily in origin: Fannie Mae (the common name for the Federal National Mortgage Association) was born in 1938 under the leadership of Franklin D. Roosevelt to ensure a supply of mortgage funds under all economic conditions and to help lower costs to buy a home. It became a shareholder-owned company in 1968. In 1970, Freddie Mac (the acronym for the Federal Home Loan Mortgage Corp.) was created to provide competition and essentially ensure that Fannie wouldn't have a monopoly on government-backed mortgages. Freddie basically does the same thing: "Reduce the costs of housing finance and expand housing opportunities for all families, including low-income and minority families," according to its website.

3. So, what spurred the government bailout? Steep home-price declines and a rise in mortgage delinquencies and foreclosures have badly hobbled Fannie and Freddie. The two firms have registered roughly $14 billion in losses over the past year. If they had failed, the damage to the mortgage and housing markets could have had a catastrophic effect on the economy (and could have hurt Americans' ability to secure home loans, auto loans, and other consumer credit, Treasury Secretary Henry Paulson said in a press conference yesterday). The stocks of both Freddie and Fannie (FNM and FRE, respectively) have plunged over the past year—each from the mid-$50s to the mid-single digits.

4. The government's rescue plan will deal some tough blows to shareholders of Fannie and Freddie, including mutual funds holding large stakes in the companies. These funds most likely include Dodge & Cox Stock, Legg Mason Value, Vanguard Wellington, Fidelity Select Home Finance, and several American funds (Growth Fund of America, Investment Co. of America, and Washington Mutual), which all held a hefty percentage of shares in one or both of the companies as of the end of June.

5. Investors not holding shares of Fannie or Freddie may get a much-needed boost to their portfolios today: World markets soared, and U.S. indexes jumped early Monday. However, the longer-term effects on the markets aren't clear yet. Morgan Stanley wrote in a note to clients that if the positive reaction lasts, the plan will very likely help reduce the slide in housing activity. What also isn't clear is what the bailout's ramifications are for U.S. taxpayers.

Tags:: Freddie Mac,; government intervention,; Fannie Mae,; housing market

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No one seems to want to audit these mortgage backed security trusts to determine which loans are good, vs. which ones are in default, underwater, foreclosed and or written off etc. This of course means that investors who purchased these bonds are left holding a security of questionable value. So the actual value of these bonds remains a secret. Thus we have trillions of dollars of bonds being held by investors around the world where no one really knows the actual value. In this writer’s opinion this is what creates an investor confidence problem in the Financial Markets and the U.S. Financial System.
In place of determining what these bonds are really worth, the U.S. Government decided to step in and blindly guarantee the “bad paper” held by Bear Stearns. Our Government took this action on the premise that a “collapse of Bear Stearns” would “stager the financial markets” and “undercut confidence in the “U.S. Financial System”.
As can be seen from events over the last three months this Bear Stearn’s bailout and Guarantee by our government did nothing much to reassure investor confidence in the bailout U.S. Financial System. Over the past week alone, the United States' two main mortgage-finance firms -- Fannie Mae and Freddie Mac, in place of filing in bankruptcy, were put into a “conservatorship” under government, while Lehman Brothers Holdings Inc. was being pushed by the Government into a possible take over by a rival, and probably foreign, bank in place of being forced into bankruptcy. A Bankruptcy proceeding by design would of course require a complete accounting of these firms assets to determine te value of assets vs. the liabilites = how much creditor claims, including bond holders, are really worth. Heaven forbid anyone knowing what their bond is really worth!
A Bankruptcy proceeding by design would of course require a complete accounting of these firms assets to determine te value of assets vs. the liabilites = how much creditor claims, including bond holders, are really worth. Heaven forbid anyone knowing what their bond is really worth!
The U.S. Government along with the management of these once prestigious firms went so far as attacking anyone who was publically warning people that these entities might acutally be insolvent or on the edge of insolvancy.
The stocks of other U. S. financial firms, including savings and loan giant Washington Mutual, Wall Street investment bank Merrill Lynch & Co. and insurance behemoth American International Group Inc. (AIG) have been whipsawed this week as investors fret about further dominoes to fall.
A bankrutpcy would clearly shed some light on just how much bad debt is held or guarenteed by these large U.S. financial firms and or their foreign counterparts. Let's just see what these assets that Lehman is carrying on its financial statements are really worth, before we flush Lehman down the toilet and let one of its rivals cherry pick its assets.

Kevin Lamson of MN 5:23PM September 14, 2008

Six months after U. S. regulators hoped a bailout of Bear Stearns Cos. would help put an end to the credit crisis, the worst could be yet to come as fresh fears about the viability of financial firms are rocking Wall Street. Now, Lehman Brothers, until recently the fourth-largest securities firm on Wall Street just ahead of Bear Stearns, is facing the same fate.
In order to stave off a loss of faith in U.S financial institutions the U.S. Government decided in underwrite a sale of Bear Stearns to JP. Morgan. A conservative estimate of the cost of this bail out was thirty billion dollars $30,000,000,000,00. This was promoted by the Bush Administration, the Federal Reserve and the U.S. Treasury as necessary because a “collapse of Bear Stearns” would “stager the financial markets” and “undercut confidence in the U.S. Financial System”.
However since the Bear Stearn’s bailout, the “financial markets” have continued to falter and both international and domestic confidence in U.S Financial System have continued to decline. And for good reason. For at least the past eight years U.S. Financial Institutions such as Banks and Investment Banks, and U.S. GSE’s like Fannie Mae and Freddie Mac have flipped trillions of dollars of bonds into the International Financial markets. These bonds were purportedly backed debts owed by millions of American homeowners and secured by mortgages against their homes. Many of these so-called “mortgage loans” were made to American’s who would not, because they could not, repay these loans. Because they simply did not have the financial capacity to repay the loans. Thus millions of these unqualified American borrowers have defaulted on their loans and millions more will. These loan defaults result in a foreclosure of the mortgage which secures the debt, which in turn results in the bond holders, through a trust, ending up owning an interest in real estate in place of holding an performing loan. The GSE’s, Banks and Investment Banks that sold or hold these bonds are in DEEP trouble. Because the income stream that was supposed to come from monthly instalment’s being made by American’ borrowers is simply not flowing in as promised. And the property that was supposed to secure the repayment of the loans are now selling for 30% to 80% of the amount secured. Couple this with the holding and foreclosure expense in taking back the property and in some cases the actual principal back to the bond holders might is significantly less than what the initial bond holder paid for the bond. In other words the actual asset value backing these bonds could be 40% to 90% less tan the bond holder invested. In cases where lenders made so-called home-equity loans and taken second or third mortgage positions the value of the security is ZERO. Many of these home equity loans have been written off completely because the property has no equity left after being foreclosed by a first mortgage lender.

KEVIN LAMSON of MN 5:09PM September 14, 2008

Why anyone would have continued to hold or invest in Fannie Mae or Freddie Mac after the the Office of Federal Housing Enterprise Oversight (or OFHEO), issued its 211 page report in 2004, wherein it concluded that Fannie Mae had a coprorate culture where "earnings manipulation" was "pervasive and willful" there were lax controls, perverse incentives, unjust bonuses. Then in May of 2006 the Securities and Exchange Commission (SEC) accused Fannie Mae of fraud and other misdeeds. Without admitting or denying wrongdoing, Fannie agreed to a $400 million settlement. That's right a FOUR HUNDRED MILLION DOLLAR ($400,000,000.00) fine. This was just over two years ago. Does this sound like a company anyone in their right mind would invest money in? Now that the chickens have finally come home to roost. It will be interesting to see if any Fannie Mae or Freddie Mac executives are indicted and or imprisoned now that Fannie Mae and Feeedie Mac seized by the U.S. Government. Probably not because these two companies have been run by executives and boards who were politically connected and appointed. When the average American taxpayer finds out how big this Fannie Mae and Feddie Mac financial debacle is and the fact that it got progressively worse since the OFHEO report in 2006, they will be outraged. The idea that our government is going to guarantee the bonds that were floated by Fannie Mae and Freddie Mac that back billions of dollars if not trillions of dollars of non-performing mortgages that were flipped to Fannie Mae and Freedie Mac by Wall Street is unconscionable. It is yet another example of how our government allowed Wall Street to privatised profits from public companies to its executives through bonuses, stock options, director fees etc. and now that these public companies financial schemes are collapsing our government has decided to socialize the losses to American tax payers. Privitizing profits socializing losses. That's the new game the U.S. Government is playing.

Kevin Lamson of MN 9:55AM September 09, 2008

A Primer on Fannie and Freddie: What the Bailout Means

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