1. Well, it actually is kind of official today that Fannie Mae and Freddie Mac are bankrupt. CNN has the low down on why it happened. The unfortunate part is that they really are not bankrupt. I think its interesting how two organizations that were started by the U.S Government are now being bailed out by the U.S Government. It really makes me want to say “WTF?”
2. Fannie Mae and Freddie Mac were set in place to help free up more money for banks to lend too. In the good old days, banks could only lend in mortgages what they had in their own accounts. As an example, the money they could lend would come from the money you deposited with them for your checking or savings account. The bank would pay you a small rate of return on your money and would lend it out. This is a very sound business model and in my eyes should be the only business model. Well, what happens is that interest rates rise and fall and banks did not want to give out all of the money they had invested in a 30 year fixed mortgage. They instead would not mind giving you a 30 year mortgage but it had to be at an adjustable rate to weather any fluctuations with interest rates. Of course people taking out mortgages do not like the idea of their monthly mortgage payment going up at any given time. So what happened was Fannie Mae and Freddie Mac were created to help sell these loans as bonds on the secondary market. They would essentially insure the loans as bonds and take a percentage of the loan amounts as payment and put it into a reserve fund to make payments on loans in case home buyers defaulted on their mortgage. What this did do was free up money for the banks to lend to go out and make more loans.
3. This system worked well for a number of years and Fannie Mae and Freddie Mac were pretty close to becoming monopolies. They control almost half of the U.S $12 trillion of mortgage debt. Pretty sick when you see that two companies control half of anything. Even though Fannie Mae and Freddie Mac do not receive any U.S Government funding they are still considered a “Government Sponsored Enterprise” or “GSE.” And anything with the word “Government” in it should bring suspicion up that something behind the scenes is going on.
4. With Fannie Mae and Freddie Mac being taken over again by the U.S Government it means that both of these companies have come full circle. Its interesting that if you look at a chart of Fannie Mae over the past 10 years you will see that it was a pretty good stock to own. It was always going up and down in the $50-$90 range with very good dividends for its shareholders. That is until the hosing crisis. I think its funny how something like the refi boom should have been great for companies like Fannie Mae and Freddie Mac and which all it really did was lead to their demise. Their stock price alone today has dropped over 80%.
5. Anybody who owns Fannie Mae or Freddie Mac shares is probably the maddest they have ever been today. Losing 80% of anything is not good. I guess the reason behind this is that when the U.S Government steps in to bail anybody out it causes stock prices to drop immediately because the company has proven it is not going to be doing any new business and the rules to which it is being run have changed. I do not think I own any shares of those two companies in any of my mutual funds but I better check.
6. I was reading that this is going to be a good thing for interest rates on mortgages. I guess it is supposed to lower rates and maybe by up to 1% on a 30 year home loan. That’s great news…or is it? The theory behind this is that since the U.S Government is running both of the major players in the mortgage industry now that insure the bonds that are sold it makes owning these less of a risk to investors. Investors like seeing that the U.S Government is backing these bonds because if somebody defaults on the loan guess who is there to bail them out? If you guessed “The Man,” you are right. Now the investors can limit their losses because the insurer can just print up more money. Fannie Mae and Freddie Mac cannot print up money. Geez, I wish I had a printing press in my basement that I could just print up $100 dollar bills and head out to the bar when I so pleased.
7. This does not really do anything for the credit markets though. Banks are going to realize that they still assume a lot of the risk when making mortgages. There should be no reason to bring back sub-prime mortgages or home equity loans over 100% of the value of ones home. Even with lower interest rates for mortgages it still really is not going to make a difference for people looking to refinace their mortgage. Most of them are not going to be able to get approved on a mortgage anyway. I remember when I was working for a mortgage company I think that around 80% of my past clients owed around 90% of the value of their homes. This was over a year and a half ago. With home prices dropping all over the country I know that all of those people probably owe near 100% of the value of their home. Most mortgage companies will not even look at refinancing a home unless it is below 90% loan to value.
8. The only bright spot I can see from this in the short term is if interest rates do go down and it looks like they will (got a friend at a mortgage company that said 30 year fixed mortgage rates for Sept 9, 2008 dropped .5%) it could help some first time home buyers get approved on a mortgage now. A lot of times their DTI (debt to income ratio) would be just too high to get approved and that could of been the determining factor. If you are a first time home buyer and that is all that was stopping you I would call up your mortgage company and see if you can get approved now. Who knows how long this dip in interest rates will go.
9. I am a big supporter of less government. I think that the U.S Government has proven time and time again that it usually messes more things up than fixing things. This whole refi boom and then mortgage mess was created when the Federal Reserve lowered interest rates to historically low levels to try and spark some new business to get the country to stop thinking about 9/11. It did and everybody was jumping on the cheap interest rate train. Homes were going up at record paces and the economy was booming…or was it? It really wasn’t. Cheap happened and it backfired on all of us in a short period of time. I am reminded of the analogy of “Good ain’t cheap and cheap ain’t good.” It turns out that we knew this was going to happen before this even happened.
10. I do not like the way the mortgage markets are created and even though I understand why Fannie Mae and Freddie Mac were created it does nothing but set people up for failure. I get that banks do not want to lend all of the money they have in their accounts to anybody over a 30 year period because then it takes the money away from them. I’m sure they like the new system where they essentially own the note but a bond is created by Fannie Mae to insure the loan in case of default. Banks get that money back and pay a small premium to them to insure the loan. Its a safe bet…right? Obviously no as from what was proven today. Even with interest rates dropping how does this affect the person that has done everything correctly by not buying a house that was too big for themselves or living with in their means? You get hosed. The U.S Government is opening up their wallet (might as well be your wallet) and producing more money (which weakens the U.S currency) which makes us go more into debt because that money is going to have to be paid back by taxes or selling of more bonds. It would have been better if Fannie Mae and Freddie Mac would have just been left to fail and close their doors just like every other major company. Let the people that pay their bills on time pay them and the ones that go into foreclosure go into foreclosure. This mortgage and real estate mess is not going away any time soon and with the government stepping in is not going to help anything. We need to change our policies to have even tighter credit standards. Make banks lend their own money from their deposits and not have the U.S Government get in the way. Let banks fail. Otherwise, nobody learns.