Putting The Fannie Mae & Freddie Mac Situation In Context genre: Econ-Recon


Today, the stock market reacted negatively to speculation that the U.S. government could be forced to bail out the nations two largest sources of mortgage funding, Fannie Mae and Freddie Mac. Of the 12 trillion in mortgage debt, the two giants account for slightly less than 50 percent...a full 5 plus trillion dollars. Put into context, that number is equal to half of the entire accumulated debt of the United States.

From CNN:

NEW YORK (CNNMoney.com) -- The anxiety over Fannie Mae and Freddie Mac, crucial to a recovery of the battered housing market and the economy as a whole, reached a fever pitch on Friday and took shares of the companies and the broader markets on a wild ride.

They play a central role in the U.S. housing market, providing a crucial source of funding for banks and other home lenders, especially since a credit market crisis last summer left them the only major players in packaging pools of mortgage loans into securities for sale to investors.

If they were unable to do so, it would significantly raise the cost and restrict the availability of mortgage loans, causing significantly more problems for already battered housing prices and sales. That in turn would be another significant problem for the overall U.S. economy, as well as global credit markets.

The New York Times reported Friday that senior Bush administration officials are considering a plan to have the government take over one or both of the companies if their problems worsen.

But Paulson said Friday that the government's primary focus is making sure that Fannie and Freddie remain "in their current form."

"Fannie Mae and Freddie Mac have lost investor confidence evidenced by the rapid brutal sell-off in their stocks, which could dramatically hinder their ability to raise any additional capital going forward," wrote Richard Hofmann of research firm CreditSights in a note Friday.

Hoffmann added that the firms' ability to function normally "remain at the core of government efforts to stabilize the mortgage markets."

If any of this sounds familiar, allow me to remind readers of the source. Back in the late 1980's, the Savings and Loan industry experienced a meltdown that resulted in the seizure of numerous financial institutions by the government and the subsequent creation of the Resolution Trust Corporation (RTC) in order to liquidate the assets and allow the government to tally up the price tag taxpayers would have to cover.

With that said, the next step is to attempt to draw some comparisons between what happened during the S & L scandal and what could happen if Fannie Mae and Freddie Mac were to fail. To appreciate the gravity of today's situation, it's important to look at the numbers and the impact of the S & L scandal. The following excerpts are from the FDIC's summary report.

From FDIC:

As of December 31, 1999, total direct costs attributable to the closing of insolvent thrift institutions over the 1986-1995 period amounted to $145.7 billion. Indirect costs due to the loss of Treasury revenue because of the tax benefits that accrued to acquirers of failed institutions under past FSLIC resolutions amounted to $6.3 billion. An additional $1.0 billion of indirect costs was incurred because interest expenses were higher with the use of REFCORP bonds than with Treasury financing. Thus, the combined total for all direct and indirect losses of FSLIC and RTC resolutions was an estimated $152.9 billion. Of this amount, U.S. taxpayer losses amounted to $123.8 billion, or 81 percent of the total costs. The thrift industry losses amounted to $29.1 billion, or 19 percent of the total.

The accumulated losses of $152.9 billion were higher than the official and private forecasts of the late1980s but lower than those made by the government and others during the early to mid-1990s. As mentioned above, during the late 1980s the full extent ofthe problem was unknown until the cleanup began; thus, many early forecasts underestimated the size of the problem.

The savings and loan crisis of the 1980s and early1990s produced the greatest collapse of U.S. financial institutions since the Great Depression. Over the1986-1995 period, 1,043 thrifts with total assets of over $500 billion failed. The large number of failures overwhelmed the resources of the FSLIC, so U.S. taxpayers were required to back up the commitment extended to insured depositors of the failed institutions.

As we see from the report, the financial risk for the S & L fiasco never exceeded 500 billion dollars in assets...which is one tenth of the five trillion that is at risk should the government be forced to step in and resolve the feared Fannie Mae and Freddie Mac insolvency. I repeat, one tenth.

Now that you've started to breathe again, let's try this again...this time by extracting the FDIC's closing statement from the above excerpt. The report concluded, "The savings and loan crisis of the 1980s and early1990s produced the greatest collapse of U.S. financial institutions since the Great Depression". I repeat, since the Great Depression.

To understand the full impact of a collapse by these two financial giants, one must realize that single family residences, by and large, were not the type of assets at play in the S & L crisis. The distinction is significant. Yes, taxpayers ultimately footed the bill for the S & L scandal, but their own well-being was never in serious jeopardy.

While home values weren't spared by the S & L meltdown, this current crisis would be a direct hit to homeowners. Essentially, the government would either be forced to establish an entity to liquidate the assets (single family homes) or elect to forgive huge amounts of debt and allow homeowners to retain their properties. Either way, the welfare of individual families would hang in the balance.

At the same time, whatever action the government would take would adversely affect home values and the ability to sell one's residence. The market would be flooded with repossessed properties, at discount prices, as the government attempted to recoup the debt it would have assumed with the takeover. Looking at current predictions, the general consensus is that the housing market isn't apt to recover any time soon. Unfortunately, those predictions do not take into account the possibility of government intervention and the impact it would have on the market. In my estimation, were that to happen, we would be a number of years away from any meaningful recovery of home values.

Now toss in the residual economic impact of such a crisis and one can easily imagine the downward spiral that could ensue. Every sector of the economy would be drawn into the mess and the pieces would begin to fall like dominoes. Until that process were played out, the prospect of a recovery would be out of the question.

I want to close with one final observation. The Bush administration has argued for years, as part and parcel of its grandiose vision of an "ownership society", that more and more Americans have been able to join the ranks of home ownership. They failed to note that it was being accomplished through artificially low interest rates, gimmick mortgages, and non-existent lending restraint. So much for George Bush's "ownership society" now that the bubble has burst, eh?


1 On April 18, 2009 at 5:11 AM, Daniela H wrote —

It's welcome relief for homeowners struggling with mortgage payments. Loan modification is a solution for homeowners who have or are facing having a mortgage in trouble. If you have delinquent payments and meet the requirements you can apply for the Federal Loan Modification program. Requirements are defined – you must be able to prove hardship. You also have to have gotten the mortgage before Jan 1st, 2009. If your mortgage is through Fannie Mae or Freddie Mac, your window of opportunity closes in 2010, if not then you have until 2012 to file an application. If your mortgage or personal loans are in trouble, then you would do well to get assistance with loan modification.

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