For some time now, communities across the US have been experiencing an historic rise in the number of foreclosures because of defaults on mortgage payments. Texas, while certainly not totally immune to this situation, has dodged the full brunt of the subprime collapse. In fact, in many areas, the real estate market remains reasonably healthy and prosperous.
This relatively good position is due in many respects to the state’s diverse and friendly business climate which has enabled countless businesses to expand their operations and create new jobs. It is also a reflection of the fact that Texas did not overbuild as much as other areas, and local developers pulled back when the problems began to surface. Unfortunately, this is not the case in most other parts of the country and, as a result, the housing industry has been undergoing a negative metamorphosis.
Sometimes, when faced with extraordinary difficulties, extraordinary measures must be taken. Such is the case in what happened this weekend when the US government placed the nation’s top two mortgage lending institutions in conservatorship.
To right the wavering housing market, the government took over Fannie Mae and Freddie Mac, which together either own or guarantee approximately half of the nation’s home loans (currently estimated to total around $5 trillion) and an even larger percentage of those being granted at present.
A variety of requirements were instituted as a part of the government’s new role in the housing industry, all of which are designed to diminish the turmoil in the nation’s financial markets and improve the ability of Americans to obtain loans. Although the total costs of this federal intervention into private enterprises are not yet known, no taxpayer loans or investments are on the immediate horizon.
Over the past year, the two mortgage giants combined lost some $14 billion, and the decision was made at the nation’s highest level to try to plug this drain. Even with the takeover, however, additional losses are likely to continue while the housing market strives to recover, but perhaps the leaking will eventually turn into only a slow drip.
A new government entity, the Federal Housing Finance Agency (FHFA), which was recently created by Congress, will now oversee the conservatorship. When US lawmakers formed the FHFA this summer, the Treasury Department was given greater power to make loans to Fannie and Freddie and to purchase their stock. With this takeover, the government will now have nearly 80% ownership of each.
To keep the companies from going broke and to bolster their capital cushion, the government is prepared to inject as much as $100 billion into each. Moreover, additional funds will be available if these changes fail to improve the housing situation and reinforce the national economy.
Fannie Mae and Freddie Mac buy home loans from various lending institutions and then repackage them as mortgage-backed securities which they either keep or sell to investors. Foreign investors, which in many cases include foreign governments, own about $1.5 trillion of the debt issued by the two corporations, as well as a few other agencies.
Many US financial institutions also have common or preferred stock in Fannie and Freddie. Just like with any marketable security in a bank’s portfolio, when the value of investment drops, the bank’s capital is affected. According to an assessment by the government, it appears that only a limited number of smaller institutions have holdings in these two entities large enough to impact their capital strength.
Both Fannie and Freddie have recently experienced a substantial drop in the value of their common stock. The conservatorship action does not eliminate this stock, but it does suspend dividends and places common stock shareholders on the bottom rung in terms of claims on the enterprises’ assets.
In recent weeks, borrowers with any credit blemishes have been finding it a bit more difficult to qualify for home loans, a process quite different from that which led to the current mortgage crisis. The takeover by the government is not expected to immediately create significant changes in the procedures for obtaining loans, but some analysts hope that the fees being charged by Fannie and Freddie (which have been passed on to borrowers) may soon be reduced. It is only fair to note that it wasn’t indulgence in lower quality, subprime loans that caused the problem. It was, rather, the steepness of the drop in the residential markets in some parts of the country that made even traditional loans become upside down.
The historic attempt by the government to reassure investors and keep borrowing costs from climbing upward is certainly not a full-fledged cure for the housing market maladies. However, it is a positive step, and over time, the results will provide an opportunity to review this matter more closely. Decisions yet to be made by Congress regarding the future of Fannie Mae and Freddie Mac will undoubtedly present a clearer picture of the wisdom of this unprecedented action. It was apparent, however, that something had to be done.