So The Government Takes Over Fannie and Freddie – Why Should I Care?

As you’ve no doubt heard by now, on Sunday, the United States Treasury announced that it will take control of Fannie Mae and Freddie Mac. The reason stated for the take over is the government feels they will no longer be able to meet their mission statement, which is to provide liquidity, stability, and affordability to the mortgage and housing markets.

This will benefit both homeowners and aspiring homeowners alike by lowering interest rates. In an earlier article entitled Fed Rate Cuts Don’t Necessarily Mean Lower Mortgage Rates I explained how Fannie Mae and Freddie Mac mortgage bonds affect mortgage rates so I won’t go into that again, but it is important to note that the biggest purchasers of mortgage-backed securities, which drive mortgage rates, are foreign investors. For the last 6 months or so foreign investors have been less interested in buying mortgage bonds due to the current state of our housing market and level of delinquency and foreclosure. When the demand for mortgage bonds goes down, the price of mortgage bonds drops and interest rates rise. Foreign investors are concerned that they won’t get their money back, let alone the interest they are expecting.

In order to restore confidence in mortgage bonds, back in July 2008 Treasury Secretary, Henry Paulson, announced that the Treasury would guarantee all debt repayments of the two mortgage giants. That announcement seemed to make investors feel better and the purchase of mortgage bonds resumed. However, not at the pace the government expected. Foreign investors generally purchase about 65% to 75% of the bonds in an auction and since the first of the year that number has been more like 40% to 50%. When bond auctions are dealing with billions of dollars, that is a significant drop and one that Fannie Mae and Freddie Mac can’t afford. Fannie and Freddie issue mortgage bonds today to pay off mortgage bonds that mature today from an earlier purchase. The old rob Peter to pay Paul philosophy.

Sunday’s action by the Treasury was really nothing more than a way to guarantee the guarantee. It’s like this. If I owe you $100,000 and you are concerned about whether or not I can pay you back, will you continue to loan me money? What if the United Stated Treasury tells you that they will pay back all the money I owe you plus interest? Are you still concerned about loaning me money? Maybe, but certainly not as concerned. Now, if the government takes over my note with you for the $100,000 are you concerned about getting your money back? You shouldn’t be because one thing that the United Stated government has never done is fail to pay back a debt. That is essentially what happened in this take over.

Now, any investors, whether foreign or domestic, can rest assured that their investment is safe and will more than likely purchase more and more mortgage bonds, which will potentially drive mortgage rates down. I say potentially because there are other economic factors that drive mortgage rates, but on Sunday’s news alone mortgage rates dropped by as much as 0.375% on conforming loan amounts (those under $417,000). Some predict we could see an overall drop in interest rates of as much as a 1%. That sounds a little generous to me but only time will tell.

I do expect the tightening of lending guidelines to continue so it will still be more difficult to obtain a mortgage, which isn’t necessarily a bad thing. It’s just that there won’t be a shortage of money available to borrow, as there has been over the last year or so, which can serve to drive mortgage rates higher as well.

This is good news and is just one more step in the right direction on the road to recovery of the housing market. The only thing that will save this market is house sales and making more money available at lower interest rates will certainly increase house purchase activity going forward, which will then stabilize house values, restore a little confidence and bring an end to this current downturn in the market.