As rescue looms, questions raised

Fannie Mae and Freddie Mac play a critical - and complex - role in the health of the nation's housing market.

Here are answers to questions about their mission and the impact of the federal government's expected takeover of these companies.

Q. What are Fannie Mae and Freddie Mac?

A. Neither company makes home loans directly to consumers, but together they are the two most important institutions that help Americans buy homes. Fannie Mae was created in 1938 under President Franklin Roosevelt when it was difficult for many to buy homes and vast numbers of homeowners were facing foreclosure. Congress in 1968 rechartered Fannie Mae as a private company. In 1970, Congress established Freddie Mac as a private company to compete with Fannie Mae.

Q. So what do these companies do?

A. They both provide a constant source of funds to the mortgage market to ensure that loans are always available for homebuyers and for people who want to refinance their existing mortgages. The companies do so by purchasing loans from banks and mortgage companies, freeing up capital so these lenders can turn around and make more mortgages.

Fannie and Freddie together purchase three out of four of the mortgages made each year by US lenders. In some cases, Fannie and Freddie keep the mortgages in their portfolios, or they may sell them, in bundled packages, to investors and other financial institutions.

Q. Will a federal rescue make it easier to get a mortgage?

A. It should stop the rise in mortgage rates. A 30-year, fixed mortgage is now 6.4 percent, up from 5.5 percent in January. Rates have increased due to uncertainty about the financial condition of Fannie and Freddie.

Rates could even drop after the government intervenes, says Columbia Business School professor Charles Calomiris. Lower mortgage rates will make home purchases less expensive, allowing the housing market to work toward a turnaround.

Q. Why did the government take such a drastic step?

A. Early in this decade, an unprecedented, nationwide housing boom was in part fueled by mortgage companies that relaxed lending standards. In this era of easy money, many people who could not afford homes were able to buy them anyway. As a result, many of the mortgages that Fannie and Freddie purchased from lenders have become delinquent, as borrowers stopped making their monthly payments.

While Freddie Mac and Fannie Mae did not purchase the riskiest subprime mortgages, they did purchase no- and low-down payment mortgages that are now going into default. At the same time, many of the homes with mortgages in the companies' portfolios have declined in value, eroding the value of loans. This has caused enormous losses at both institutions and pushed them toward insolvency. In the second quarter, Fannie Mae lost $2.3 billion and Freddie Mac lost $821 million.

Q. What would happen if the federal government did not act?

A. The companies own or guarantee more than $5 trillion in mortgages - nearly half of all outstanding home loans in the United States.

If Fannie and Freddie could not purchase mortgages, this would not only dry up a primary source of mortgages but would also shatter confidence in the entire US financial system, the world's largest.