Fannie and Freddie: Your new best friends
In case you haven’t heard yet, you’ve just entered into a friendship with Fannie and Freddie, maybe forever. Yep, every American taxpayer is going to do his/her part to salvage Fannie Mae and Freddie Mac, which, if we’re lucky, will help to settle down the housing market and keep our foreign investors interested. But who exactly are Fannie and Freddie, how did they get in trouble and what does it all mean to us?
Fannie Mae and Freddie Mac are privately owned and run government sponsored enterprises that provide capital to banks that in turn lend money to aspiring homeowners. Unlike the savings and loans of older generations that held their mortgages for 30 years, today’s lending institutions sell their loans in order to free up additional capital so they can make more mortgage money available. Fannie and Freddie buy these mortgages from the banks, package them as securties and sell them to investors around the world.
In order for banks to be able to sell their mortgages to Fannie and Freddie, they must follow certain lending standards. In the run up of the housing market and with the encouragement of both Congress and lobbyists, many of the lending standards were redesigned to allow for more Americans to become homeowners. This was a principal based on the premise that housing prices would never fall in America, which proved to be incorrect.
Now, Fannie Mae and Freddie Mac are in a heap of trouble with billions of dollars of non-performing loans putting the federal government in the position of bailing them out or risk a national and world-wide crisis. Last week Secretary of the Treasury Henry Paulson said, "Fannie Mae and Freddie Mac are crucial to turning the corner on housing," and has taken the bold step of placing the two giants in conservatorship under the Federal Housing Finance Agency.
As in every financial crisis, there are winners and losers, and the Fannie and Freddie debacle is no different. Homeowners and future homeowners could come out ahead with declining interest rates for both fixed and adjustable rate mortgages. Since the government isn’t interested in owning your home, it can cut mortgage payments or extend terms to as much as 45 years. This will both keep more foreclosed homes off the market and encourage buyers to take advantage of lower rates.
However, and this is actually good news, there will be tighter lending standards. Credit scores above 700 are the new gold standard, up from 620 not so long ago, and 20 percent down payments are back. If you have a credit score between 640 and 659 it will cost you more in fees than previously, and you won’t see any more of those zero down mortgages.
Fannie Mae and Freddie Mac stockholders are in for some trouble, but the stock market in general rebounded the day after the takeover was announced, sensing a leveling off of the housing crisis. The federal government and the Treasury Department in particular are looking like heroes for taking quick and decisive measures to avert a catastrophe, but again the poor American tax payer gets to pay the price.
So you might as well accept that Fannie and Freddie are your new best friends. They may not be like your old best friends who liked to play jump rope and jacks. They’re more like the new kids on the block who stole your bike and got you in trouble with the teacher. But just like when you were a kid, you’ll have to get through it until they grow up and move away.