Who exactly are Freddie and Fannie – MoneyWeek

Ontopofthat,thetwocompaniesalsopackageupthemortgagestheybuyandresellthemasmortgage-backedsecurities(MBS)toinstitutionslookingforarelativelysafeplacetoinvestcash。

FreddieandFanniethemselvesraisetheirfinancefromamixtureofbondandsharesales,justlikeanyotherpubliccompany,exceptthattheiruniquestatus–bothcarrythespecialbadge,“GovernmentSponsoredEnterprise”(GSE)–denotestheimpliedbackingoftheUSgovernment,somethingthatenablesthemtoborrowcheaply。

Wheredidtheycomefrom?

Fannie,initiallyagovernmentagencyestablishedunderFranklinDRoosevelt’spresidencybackin1938,istheelderandlargersisterofFreddie,whicharrivedin1970。

Thetwoaretechnicallyrivals,eachapublic,listedcompanytradingontheNewYorkStockExchange(NYSE:FNMandNYSE:FRE)。

However,theyweresetupwithidenticalchartersandhandedthesamemandatefromtheUSCongress,summarisedbytheWashingtonPostas“bringingstabilitytotheUSmortgagemarket”–somethingthattheirsupportofthemortgagemarkethaslongdone。

Fanniewasspawnedtosolvethelendingcrunchcreatedbythe1930sGreatDepression,whereasFreddiewastaskedlaterwithironingoutthehugeregionalvariationsininterestratesandlendingcriteriathatpreventedmanyAmericansfromclamberingontothehousingladder。

Today,saysBarron’s,theyguaranteeorownoverhalftheUSmortgagemarket,wortharound$11trn。

Whyaretheyinthenews?

Theyarebothinbigtrouble。

Fannie’ssharepriceisdownaround60%sincethecreditcrunchstruckinAugust,whileFreddie’shasundergonewhatTheWashingtonTimescallsa“stunningdecline”,byhalvinginunderamonth。

Onceconsideredeconomicbastions,thepairmanagedtolose$6。

1bninthefourthquarterof2007aloneandFreddiehasbeenforcedtoraise$14bninbondsalesthisyear。

Inshort,investorshavewokenuptothefactthatbotharenowbeingbadlybatteredbythecreditcrunch。

Asaresult,thedifference,or“spread”,betweentheratetheypaytoinvestorsontheirownbondsandsaferUSTreasurieshasshotuptoa20-yearhigh–despitetheirimplicitgovernmentguarantee。

Howaretheyregulated?

Uniquely。

A1992actcreatedaspecialregulatoryframeworkforGSEs,wherebytheGovernmentDepartmentofHousingandUrbanDevelopmentoverseestheir“housingmission”andcapitaladequacyseparatelyfromotherfinancialinstitutions。

Between2005and2008theybothhadtheiraffordablehousingremitshugelyexpandedtocoverswathesofpreviouslyineligiblelow-income,high-riskborrowers。

Theresult,saysBarron’s,wasa“speculativeforayintosubprimeandAlt-Aloans(wherethereislittleornoproofofincome)”,leavingthemwithbalancesheets“lardedwithsoftassetsandunderstatedliabilities”。

Inspiteofthis,FreddieandFannieenjoylessstringentcapitaladequacy(or“rainyday”)requirementsthanotherUSlendersandgiveawaylessinformationaboutwhattheyareuptobecausefullSECdisclosurerequirementsdon’tapply。

Howbadcoulditget?

Nooneknows。

TakingjustFannieMae,Barron’sestimatesthatevenifitonlysuffers“conservative”defaultratesof40%onit’s$133bnsubprimeloanbook,12。

5%onAlt-Amortgagesandjust4%onitsremaining$2trnprimehomeloans,futurecreditlossescouldexceed$50bn。

LastAugustitwasunthinkablethateitherofthesetwocouldeveractuallygobust–butnow,shouldtheyhavetotakeanymorebighits(marketvaluationsforallmortgage-backeddebtareinfreefall),itistechnicallypossible,saysBarron’s。

Thetworaised$13bnfromshareissueslastyear,butthattrickwon’tberepeatedinthesemarkets。

Thatsaid,theprevailingviewremainsthattheyaretoobigtofail,notjustbecauseoftheircoreroleinthemortgagemarkets,butbecausecrucialtradepartners–suchasChinaandJapan–arebiginvestors。

ExpecttoseeagovernmentbailoutthatwillmakethesumsspentintheUKonNorthernRocklooklikechickenfeed。

Thenewageof“upside-down”mortgages

Upuntilthecreditcrunchstruck,homebuyersandlenders–bothhereandintheUS–agreedhugemortgagesbasedontheeuphoricassumptionthathousepricescouldneverfall,leavingtheborrowerwithanassetworthcomfortablymorethanthemortgage–ajoyouseraof“positiveequity”。

However,accordingtoLewrockwell。

com,ifUShousepricesfallanother10%nationally,aminimumof20millionhouseholds–oranestimated43%ofallmortgagedUSpropertyowners–willbestuckwith“upsidedown”mortgagesexceedingthevalueoftheirhomes。

Whattodo?

Manywillsellup,butthatalreadytakesonaveragealmostayear。

Otherswillsimplysittight。

Withanaverageforeclosurecosting$50,000,andlendersill-preparedforthedelugeofmortgagedefaults,manystrugglingborrowerswilloptoutofmortgagepaymentsand“liverent-free”instead。

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