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Federal financiers hope the government takeover of Fannie Mae and Freddie Mac will save other banks from failure as they weather the fallout of the mortgage crisis. But, what does the historic federal move mean closer to home?
In the short term, it should become easier to get a loan or refinance loans in the Cape Region, which might boost the housing market. But local banks do not expect to be negatively affected.
In a closely intertwined financial world, local banks are cushioned from the fracas.
Linda Messick, president of Community Bank Delaware, said, “People who should be borrowing money have always been able to borrow…If you can afford a mortgage payment and have credit, you can absolutely get the money to buy a home.”
Messick said the bailout of Fannie and Freddie would likely have little impact on community banks. Those primarily invest in the community and are not heavy investors in mortgage-backed securities. “Most of our deposits are loaned to the community,” she said. Large regional banks are the ones affected by the problems of Fannie Mae and Freddie Mac, she said.
“The federal bailout is meant to minimize the impact on debt holders of mortgage-backed securities. The treasury will become a preferred senior shareholder and will be able to put money into both Fannie Mae and Freddie Mac to make sure they are well capitalized by accepted standards,” she said.
Chris Carulli, mortgage broker with Dynamic Mortgage, said the takeover and the government guarantee of mortgages should spur more sales of mortgage-backed securities by lessening the risk associated with them. “When they are bought at a good clip, it pushes mortgage rates down,” he said.
That could be good news for people who want to refinance out of an adjustable-rate mortgage into a fixed one, or for people who want to refinance to a lower rate, Carulli said.
Liz Connors, loan officer with Wells Fargo Home Mortgage, said, “The government is saying this will ultimately make it easier to get loans.” When Fannie Mae and Freddie Mac were beginning to struggle, restrictions on getting loans were tightening. That meant it was becoming more difficult to get applications approved, she said.
“People who could get a loan a year ago could no longer get one as credit score requirements changed and rates increased,” she said.
“This could get people back into the housing market,” said Carulli. He said rates began dropping Monday, the first business day after the weekend takeover. If rates keep falling, that could be incentive for people, accustomed to the low rates of the last five or six years, to consider buying or refinancing, he said.
“In the short-term perspective, what the government just did will help housing,” Carulli said,
Federal Treasury Secretary Henry Paulson announced Saturday, Sept. 5, that the government was placing the nation’s two largest financial companies under conservatorship.
That means government officials have replaced the heads of those companies. They have taken preferred stock in each institution without handing over cash.
As preferred stockholders, the government can issue stock to support both institutions if it thinks either needs more money.
Messick said the federal plan is to begin to shrink Fannie Mae and Freddie Mac over the next few years. “Because they want to do it in a well-thought-out manner, they can’t do it quickly,” she said. Provisions of the federal Housing and Economic Recovery Act (HERA), passed earlier this year, will be in place until the end of 2009. Some of those provisions are meant to serve as a source of liquidity, so the government could wait until HERA expires to begin adjusting Fannie Mae and Freddie Mac, Messick said.
What do Fannie Mae and Freddie Mac do?
Fannie Mae and Freddie Mac grease the wheels of the finance world.
Banks that give out loans, from large national and regional banks to small local institutions, would eventually run out of money before the loans were paid back.
They give out large sums of money, but are paid back over long periods of time – 30 and even 40 years.
To keep money flowing back into the bank so the bank can keep lending, they package the mortgages they have and sell them.
Companies such as Fannie Mae and Freddie Mac purchase those packaged mortgages, putting money back into the hands of banks so more loans can be made.
Not lenders, they are the secondary mortgage market and can sell the packaged loans to investors globally.
Because they purchase mortgages from lenders, they help set the guidelines for what is required in order to get a loan, such as verification of employment and tax returns.
Making sure banks have enough money to lend helps drive home ownership and makes it easy for consumers to get loans quickly.
Together, Fannie and Freddie own or guarantee $5 trillion in home loans – nearly half the nation’s loans.
History of Fannie Mae and Freddie Mac
In 1938, Fannie Mae, the Federal National Mortgage Association, was established as part of President Franklin Delano Roosevelt’s New Deal.
It was designed to support and increase single-family homeownership and relieve the Depression-era housing crisis.
By giving local banks federal money to finance mortgages, Fannie Mae made it easier for people to get loans, and increased the availability of affordable housing.
Fannie Mae was authorized to buy mortgages insured by the Federal Housing Administration, which replenished the money banks had to lend. In 1954, private stockholders began buying into Fannie Mae. In what was largely a financing change that took Fannie Mae’s debt off the nation’s books, the company was made a private, shareholder-owned corporation in 1968. President Richard M. Nixon signed a bill in 1970 allowing Fannie Mae to purchase conventional mortgages. Freddie Mac was also intended to limit further monopolization on the secondary mortgage market by Fannie Mae.
That same year, stockholder-owned Federal Home Loan Mortgage Corporation, called Freddie Mac, was chartered by congress to support homeowners and renters. Freddie Mac purchases residential mortgages.
What went wrong for mortgage lending powerhouses?
Linda Messick, president of Community Bank, Delaware, said, “Fannie and Freddie got too big for their own capital.”
Not banks, Fannie Mae and Freddie Mac bought up original mortgages, then sold them to Wall Street as what are known as mortgage-backed securities, Messick said. Many were sold in groups and included low-interest rate loans and high pre-payment rate ones. Those mortgages were bought by mutual funds, investment houses and banks. Some banks got in trouble purchasing mortgages whose holders later could not pay them off.
Messick said institutions must have enough capital to withstand losses. When companies such as Fannie Mae and Freddie Mac bundle and sell mortgages so more can be issued, there is no problem as long as earnings on their portfolios are sufficient to withstand losses, she said.
“They got so large, the portfolio and any inherent risk became too great for the capital they had,” said Messick.
Chris Carulli, mortgage broker with Dynamic Mortgage, said, technically, by the rules the companies operate under, there was enough capital for now. When regulators examined the books, however, they saw a grim picture. “Because of the incredible numbers of foreclosure and defaults Fannie Mae and Freddie Mac were buying,” he said, “they saw they were losing a lot of capital, had lost and would lose more – enough to wipe out the capital they had. In the future, they did not see that capital would last.”
Carulli said the takeover was a way to prevent the failure bankers saw coming.
Messick said banks are typically cautious about how much of their portfolios they will dedicate to mortgage-backed securities because of the risk they carry.
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