by Nancy Osborne, COO of ERATE®
Sep 17, 2008 - It was announced in early September that the government would take control of GSE giants Fannie Mae and Freddie Mac and that both companies would be placed in conservatorship under the authority of the newly created Federal Housing Finance Agency (FHFA) which was established by Congress over the summer to assume that responsibility from the Office of Federal Housing Enterprise Oversight (OFHEO). The CEOs of both Fannie and Freddie will be replaced by two former vice chairmen tapped from Merrill Lynch and US Bancorp following a period of transition. As part of the deal, all lobbying activities of both the GSEs (Government Sponsored Enterprise) would cease immediately, activities which may have prevented Congress from acting sooner to avoid the catastrophe from occurring in the first place. The GSEs troubles stem from the implied government backing the pair enjoyed which allowed them to borrow as cheaply as the government but take risks to maximize returns for their private shareholders seemingly at the public's expense.
The Treasury (backed by the taxpayers) will become a buyer of newly issued GSE mortgage-backed securities in an effort to inject liquidity into the mortgage market and keep interest rates low. Both the GSEs are expected to continue providing liquidity to the mortgage markets to deflect the credit crisis by purchasing mortgages until the end of 2009 by which time it is hoped the housing market will have recovered. This expansion of their relative mortgage holdings is expected to increase from a current level of $1.5 trillion to $1.7 trillion. By the end of 2009, the Treasury will then begin to sell off 10% of their portfolios per year until they have shrunk to approximately $250 billion in holdings for each GSE. The Treasury, under Secretary Paulson, a former Wall Street head of Goldman Sachs, will also make available a line of credit for both GSEs to tap into if needed. The Treasury (AKA the taxpayers) will become an investor in Fannie and Freddie with a position superior to that of the company's private shareholders. Payouts of current private shareholder dividends will cease to be made, sparring taxpayers approximately $2 billion annually. At the conclusion of this process, Secretary Paulson is hopeful that the take over of both GSE's debt will not reach the projected cost of $25-$50 billion for the taxpayers. Under the terms of the bailout, the government was given warrants (similar to options) for an near 80% stake in the GSEs which are likely become profitable again and taxpayers should profit from the preferred shares received paying out 10% interest by each company. Though this intervention is viewed as a short term solution and it will be up to the next President and Congress to come up with a longer term vision for the GSEs. But in the end the ultimate cost borne by the taxpayers will likely hinge upon how quickly the overall economy and housing market recovers.
The primary benefit of the government bailout for the prospective mortgage borrower is that the spread between Fannie-Freddie debt and Treasury debt will shrink, producing lower mortgage rates for consumers. If the government allowed the mortgage giants to fail, the consumer's ability to obtain all types of credit from mortgages to auto loans or any type of basic consumer financing would have been hindered. The financial turmoil that the failure of the two giants could have generated in both the domestic and international financial markets was unthinkable. Providing a government backstop for the GSEs insures that funds will be available to purchase conforming mortgage loans from lenders in the primary market so these lenders can in turn free up capital to extend new loans. However it seems that the recovery of the housing market may depend far more on the availability of credit than on lower mortgage rates. For the financial markets to re-establish liquidity, banks must repair their balance sheets so they feel comfortable lending again. With the take over of Fannie and Freddie, clearly some of the uncertainty has been removed from the market, reflected in the narrowing of securities spreads. The conforming loan limit was raised by Congress earlier in the year to a maximum of $729,750 (based on HUD determined regional median home prices) until the end of the year when it will then top off at $625,550. Up until now, Fannie and Freddie had held back on acquiring many mortgages at the new limit while they struggled to shore up their own balance sheets. However given the new reinforcement of a government sponsored backstop, the GSEs should be able to pursue this assigned task more aggressively now. Fannie and Freddie are not permitted to convert true non-conforming (or jumbo) loans to guaranteed securities and as a result those mortgages are far more expensive and difficult to find, however the take over should at least prevent the spreads between non-conforming and conforming loans from widening further.
Mortgage loan applications were already down 27% from the same period a year ago as both mortgage giants had increased their fees in an effort to help correct their own finances. They had also begun implementing higher surcharges (up to 2.25%) for loans extended to less credit worthy borrowers and require that applicants having FICO scores under 660 increase the size of their down payment up to 20%. Fannie and Freddie had also done away with many of the types of loan programs which contributed greatly to their losses, such as loans allowing no down payment, lax income verification documentation and weaker FICO scores. It seems likely that in the role of conservator, the government may request some of the more restrictive changes the GSEs had made to their guidelines be eased somewhat in an effort to facilitate greater access to mortgage credit until the housing crisis comes to an end.
Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.
"I am addicted to Bloomberg TV" says Nancy.
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