Mortgage News

The recent steep decline of Fannie Mae and Freddie Mac are symptoms of what has been happening in the mortgage industry of late, not causes. Most people think that the crisis with these stocks has occurred primarily because of foolish lending practices, and there is certainly some truth to that. However, it would be misleading to suggest that the problems are caused primarily by the investors themselves.

Before I discuss this further, let's take a moment to review what Fannie Mae and Freddi Mac really are. Writing four years ago for The Motley Fool, Bill Mann wrote  a very useful description of what exactly they do. Take a look at this excerpt:

Fannie's full name is the Federal National Mortgage Association, and it was founded in the 1930s and privatized in the 1960s. It is a federally chartered corporation, owned by shareholders, that serves as a quasi-governmental agency. The company's charter gives it the objective of making sure there is money available for Americans who want to buy a home to get mortgages, but you cannot simply call up Fannie Mae and ask its loan officers about the going rate on a seven-year ARM; it doesn't loan money to retail home buyers. Instead, it provides liquidity for lenders by providing liquidity in the secondary mortgage market.

It works this way. Let's say that you get a mortgage on your new home from Wells Fargo Bank. Wells Fargo, like any bank, has limitations on how much money it can lend as a function of its asset base. If your loan sits on Wells Fargo's books, it constricts how much the bank can loan. But if Wells Fargo sells the rights to Fannie Mae, it turns that loan back into cash, which it can then go out and loan again. You keep making your loan payments to Wells Fargo, and it passes these funds on to Fannie Mae. Fannie Mae makes money because it can borrow funds at a lower interest rate than you can. So instead of a single loan tying up Wells Fargo's capital, it can turn around and make multiple loans all from the same original capital base. This, the theory goes, increases banks' willingness to loan in good times and in bad. As a result, nearly 70% of American families own their homes.

Both Fannie Mae and Freddie Mac are known as GSE's, short for "government sponsored enterprises." They were originally created by the Federal government to create easily accessible mortgage financing so that anyone could afford to buy a home. The motivation may seem noble, but the results created by these Federal fiduciaries have had mixed consequences. On the plus side, more people have bought homes than ever before. On the minus side, the ready availability of easy money provided by the Federal Reserve System and mandated by Congress in the form of easy credit regulations have helped to drive the real estate market through the roof since the 1930s creating horribly expensive housing. It has long been assumed that such growth was bound to happen anyway and that it would continue relatively unabated, because everyone needs a home. However, real estate prices have outstripped inflation during times when easy credit was being heavily injected into the system. Thus, people end up with homes purchased at prices that exceed true market values.

Most people don't realize that the recent real estate boom starting around the turn of the new millenium was not created by a huge natural increase in demand for housing. Rather, it was created by Federal Reserve stimulation of the economy. It's true that large numbers of people began to purchase homes at inflated prices, but to a large extent it's because they thought they were buying into a genuine boom market. The crash which began just last year is proof that the buyers' beliefs was actually based in folly, but how were they to know? With the Fed injecting easy credit at unprecedented rates, it's only natural that they wouldn't know, because most people don't understand what the Fed does and just how devastating the consequences are for all of us in the long run when the Fed stimulates the economy.

While a full examination of the Federal Reserve System is beyond the scope of this article, it's telling that even today, with all the quiet panic ensuing regarding the credit markets, most people (including people in the media) still have no idea why it's all happening. The media repeatedly report that it was irresponsible sub-prime lending practices which have caused large numbers of foreclosures and huge losses for lenders in recent years. There is no doubt that such lending practices were irresponsible, but there is almost no recognition that (a) those practices were mandated by the U.S. Federal government and (b) the money for that irresponsible lending was made available at the express order of the Federal Reserve Board of Governors. The Fed knew exactly what they were doing, but they didn't care. They don't have to pay the price themselves for their own mismanagement. They collect nice, fat paychecks regardless. This point is worth emphasizing: there are no negative consequences to Fed governors themselves for making poor decisions regarding the management of our monetary system. The Fed knows that it is other people who will pay the price for Fed disasters, not the Fed themselves.

Who will the latest patsies be? Apparently, according to news reports, it will be the American taxpayers. The Federal government is going even deeper into a national debt that already can't be paid off in order to "guarantee" Fannie Mae and Freddie Mac stock holdings of roughly $5 trillion in mortgages. That's about 55% of the entire national debt, so we're talking about a 55% increase in the national debt in order to truly guarantee it all. Of course, that's not the way Congress will write it up, but that's what the true obligation will amount to. The Associated Press is reporting today that, "The proposal would provide the Treasury Department the power to extend to Fannie Mae and Freddie Mac an unlimited line of credit and buy their stock for 18 months if necessary to bolster investor confidence in the two mortgage giants. Fannie and Freddie either guarantee or own more than $5 trillion of mortgages — almost half of the nation's total." Bloomberg is pointing out today that the deal, "authorizes Treasury Secretary Henry Paulson to bail out the mortgage-finance providers while placing few restrictions on the companies." And in a separate article, Bloomberg quotes commodities investment guru Dr. Marc Farber as saying, "What Freddie Mac and Fannie Mae should right away do is not obtain any federal aid, but issue additional shares" rather than use taxpayer funds to bailout the mortgage behemoths.