Fannie and Freddie – a thing of the past
How does that Chinese proverb go again? "May you live interesting times." Well, it doesn’t get too much more interesting than right now, and Fannie Mae and Freddie Mac may be the most interesting of all.
In order to understand Fannie and Freddie’s position and responsibility in our present financial meltdown, let’s explain exactly what they are and their function. Fannie Mae was established in 1938 after the Great Depression to create a liquid secondary mortgage market. In 1968 Fannie Mae was converted into a private shareholder corporation in order to separate itself from the government’s federal budget. It was subsequently split into other lending entities, including Freddie Mac and Ginnie Mae, which supported FHA and VA home loans.
The purpose of Freddie and Fannie was not to actually make loans, but rather to purchase loans from banks and other originators providing money for these organizations to make more loans and keep down interest rates. They were established as a means to help Americans buy homes, which has increased American home ownership enormously over the last 50 years. The simple premise was that if Fannie or Freddie backed the loan, it was guaranteed by the federal government, which promised to repay the loan originators in the case of default, a win-win for the lender. Now, however, the win-win for lenders is a lose-lose for the American taxpayer.
Fannie and Freddie, which were overseen by the Congress, made it their mission to back as many home mortgages as possible in order for Americans to fulfill their dream of home ownership. Unfortunately, as we now know, many of the funds allocated towards this end were given to borrowers who could not really afford to carry the mortgage, not to mention the Fannie and Freddie executives, who earned obscene salaries to oversee failure.
As more and more homeowners defaulted, the agencies were forced to make good on their guarantee to the lender and take back the loan. In September 2008, Fannie and Freddie were seized by the federal government in order to keep the mortgage market liquid and prevent a further crisis, leaving their stockholders with practically worthless holdings.
According to the New York Times, Fannie and Freddie took over a foreclosed home roughly every 90 seconds during the first three months of the year. At the end of March they owned 163,82. It costs the government about $10,000 per house just to maintain the property and get it ready for sale, not counting that it is recouping less than 60 percent of the money the borrower failed to repay. It is estimated by the Congressional Budget Office (CBO) that the final cost of taking over Fannie and Freddie could cost the taxpayers $389 billion, likely more than rescuing the banks and Wall Street.
In view of their performance, should Fannie and Freddie continue to be backed by taxpayer funds, or is it time to return to the days of banks making loans directly to homeowners? They sure would have vetted burrowers a lot better knowing the federal government wasn’t going to guarantee the loan. Last week I mentioned that as part of the recent financial regulation bill passed by Congress, the Fannie Mae and Freddie Mac failures were not addressed, go figure.
I think the Chinese proverb is really a curse. If these are interesting times, get me a time machine.
