Why the US is backing Fannie, Freddie, and what could happen if it chose not to
In the annals of government bailouts, the rescue of
Though they are both publicly traded companies, the
Q. If I don't own stock in Fannie Mae or Freddie Mac, why should I care about their problems?
A. Both Fannie and Freddie rely on sales of stock and debt to finance their operations, buying mortgages from lenders who then can plow the proceeds back into making new loans. The companies and some analysts say both have enough money in reserve to cover ongoing losses related to bad loans. But a fear is that their share prices could fall so low it could cause them trouble raising capital they need in the future. That could force them to scale back their support of bank lending, and in turn, limit what banks can loan to individuals. Since the highs of last summer, shares of both companies have fallen nearly 90 percent.
Q. Why does this matter to me if I'm not looking for a mortgage right now?
A. Because Fannie and Freddie make the housing market work, which is central to the economy. If their ability to make loans is impaired, then the already slow housing market could fall into a more severe downtown. Barry Habib of mortgagemarketguide.com, a New Jersey mortgage services company, estimates average mortgage interest rates could rise half a percent or more if the companies were to become insolvent. That would mean at least 50,000 fewer homes sold, a big hit on a sector that accounts for about 15 percent of national output.
Moreover, as the collapse of the subprime mortgage market showed last summer, problems in one business sector can easily spread to others, making it harder for businesses to get loans to expand or reducing the amount of money consumers can spend on goods and services.
Q. So what is the government proposing to do about this?
A. A plan by the Federal Reserve and the Treasury Department would extend up to several hundred billion dollars to both organizations in emergency credit which, should it be needed, would allow them to continue buying blocks of mortgages and paying off existing debt holders as notes mature. The Treasury Department could also buy equity directly in either company. This would allow mortgage markets to continue to operate with banks making loans, confident that they could resell them. The plan would resemble the $30 billion in emergency credit the Fed offered to enable the sale of Bear Stearns & Co. in March. Yesterday, congressional Democrats including US Representative Barney Frank, Democrat of Massachusetts, said they would aim to include similar legislation in a bill they seek to pass as soon as this week.
Q. Doesn't this raise risks for me as a taxpayer?
A. Leaders of both major parties hope the emergency credit won't be needed and that its existence alone will shore up investor confidence to the point where both institutions could continue functioning on their own. Even if they're wrong, both judge the spending to be worth it to address broader risks to the economy. In the worst case, the institutions could fail despite the credit and the government could take control of the assets the companies might have pledged as collateral. To put these scenarios into perspective, the bailout of savings and loan institutions starting in the mid-1980s cost the government around $124 billion, and in 1979, Chrysler Corp. borrowed $1.2 billion from the government at a time when it had no other financing available.
Q. What do investors make of all this?
A. It depends which type of investor you ask. Freddie Mac received strong demand for $3 billion worth of short-term notes it sold yesterday morning as bond investors bet the government's steps were the right ones. But shares in both Freddie Mac and Fannie Mae declined on concerns that any bailout wouldn't help stock owners. Shares of Freddie Mac closed at $7.11 yesterday, down 64 cents, or 8.3 percent. Shares of Fannie Mae closed at $9.73 yesterday, down 52 cents, or 5.1 percent.
Kevin Cronin, chief investment officer of Putnam Investments, said he skipped the auctions yesterday morning but is still buying mortgage-backed securities from both companies. He believes officials consider them too important to be allowed to fail. "We think they're going to be around for a long while," Cronin said.
Ross Kerber can be reached at kerber@globe.com.
