It was announced on Sunday, September 7th that the federal government is officially taking control of mortgage giants Fannie Mae and Freddie Mac in a manner of “conservatorship” and that they will be regulated by the newly-created Federal Housing Finance Agency (FHFA). In standard practice, conservatorship usually applies to incapacitated persons, by virtue of health or mental illness, in which case another person is appointed as their conservator and serves to make decisions for that person and to act on their behalf. So much like a parent with a child, the government is Fannie’s and Freddie’s conservator.
A brief and simplified background: Fannie Mae (1938) and Freddie Mac (1970) were created to provide banks with continued liquidity of the bank’s money. Let me use an example. You go to your bank to get a loan for $500,000.00 to buy a house. When the bank lends you the $500,000.00, that money is essentially gone; they don’t have it any more because they lent it to you. But Fannie and Freddie, in some if not most cases and depending on certain criteria, steps in and buys that $500,000.00 loan from the bank, giving the bank the opportunity to keep that money and to turn it back around to lend to someone else. Fannie and Freddie package all those purchased loans and then sell them as mortgage-backed securities to traders and investors, creating a constant cycle of money in our national and global economy.
The reason Fannie and Freddie started getting into trouble is for the same reason other banks are in trouble. They made and bought loans that were risky and that people are now defaulting on (getting behind on their payments), creating great financial loss and write-offs and leading to concern that they were going to fail completely, until the government stepped in.
A major aspect of the official statement is that this action will bring not just increased capital to Fannie and Freddie but increased confidence to that market. With renewed confidence will come stimulated trading of mortgage-backed securities which hopefully will translate into decreased mortgage interest rates. My guess as to what will happen now is that the FHFA will create more conservative guidelines for lending but also the potential for decreased interest rates. If you’d like to read the official statement, the link is here: http://www.ofheo.gov/newsroom.aspx?ID=456&q1=1&q2=None
