Bush administration moves to bolster mortgage system

McClatchy NewspapersJuly 13, 2008 

WASHINGTON — The Bush administration announced Sunday that it would seek congressional approval that would allow it to buy stock in Fannie Mae and Freddie Mac and vastly increase the amount of funds the government could make available to the two giant mortgage finance institutions that are key to the way the U.S. home mortgage market works.

In announcing the new plan to seek congressional authorization that would allow the government to increase its stake in the two institutions, Treasury Secretary Henry Paulson made it clear the the failure of either would have dramatic impact on the world economy.

Fannie Mae and Freddie Mac "debt is held by financial institutions around the world," he said. Maintaining their "continued strength is important to maintaining confidence and stability in our financial markets."

The announcement came ahead of what had been expected to be a volatile day Monday on Wall Street, where the share price of Fannie Mae and Freddie Mac has been taking a hit amid growing concerns that they do not have the financial resources to cover billions of dollars in housing loans they've purchased should those loans go bad.

Freddie Mac is scheduled to try to raise $3 billion in short-term debt. If it fails to find buyers, that would renew doubts about both institutions, and Monday could have been be an ugly day for the U.S. economy. And it might still be.

The statement did not say precisely how much new federal backing would be made available to the two companies or how soon Congress would be required to act. Paulson said that in recent days he had consulted with a variety of government agencies, including the Securities and Exchange Commission, the Federal Reserve, members of Congress and officers of the two mortgage-finance institutions, to develop the plan.

He described the increase in the line of government credit the two institutions and the U.S. government purchase of additional stock as "temporary" to ensure that the institutions have "sufficient capital to continue to serve their mission."

He said a third step would be legislation that would give the Federal Reserve a larger role in overseeing regulation of the two institutions' investment decisions. That is part of a growing push by the administration for increased regulation of financial markets after a generation of deregulation efforts.

While Freddie Mac and Fannie Mae play a critical role in the U.S. mortgage market, few people outside the financial community are familiar with their workings. Here in question and answer format are some of the critical issues facing these important institutions.

Q: Why are investors suddenly sour on Fannie and Freddie?

A: It's less a sudden change of heart than a long, steady erosion of confidence that parallels the nationwide housing crisis. These two financial institutions package mortgages belonging to the healthiest borrowers and sell them as securities, long considered the safest of bets. The two own or guarantee almost half of all outstanding U.S. mortgage debt. The steep decline in housing prices across much of the nation, and fears of greater declines to come, have investors worried that Fannie and Freddie may be vulnerable to losses.

Q: Is there evidence that Fannie and Freddie are taking the kind of losses suffered by commercial mortgage lenders?

A: No, their losses are within historical norms. But the perception that they could face huge credit losses has driven their share prices to 16-year lows and led shares of each to lose more than 80 percent of their value since July 2007.

Q: Why was Monday so important?

A: Monday would tell whether they'll be able to continue raising capital for their short-term needs. If investors frown on the roughly $3 billion in new debt, their stock would take an even tougher hit. The Bush administration actions Sunday were intended to head that off.

Q: Are the Bush steps enough?

A: Only time will tell. Investors have long assumed that Fannie and Freddie are too big to fail, and that's led to an implicit assumption that the federal government won't stand by idle if they sink into trouble. The Treasury Department's decision to both buy stock and lend the company more money may be the strong signal investors want. But no numbers were attached to Sunday's announcement, which also made clear that the administration believes the two institutions should remain private.

Q: How do problems at Fannie and Freddie affect consumers?

A: When Fannie and Freddie sell debt, they use the proceeds to buy mortgages from commercial lenders. An inability to sell debt would thus inhibit them from buying more mortgages. Commercial banks would be forced to decide whether to carry home loans on their own balance sheets or shun the risk and simply not lend.

The purchase of commercial mortgages by Fannie and Freddie is like the skeletal structure of mortgage lending. If they are in crisis, the housing downturn will deepen, as will the nation's economic woes.

Q: Are there other ways the problems at Fannie and Freddie affect consumers?

A: Even if things go smoothly this week for Fannie and Freddie, Wall Street is signaling clearly that it wants the two to have more cash on hand to offset the possibility of a serious up-tick in loan defaults. If the two institutions put more cash into reserves, it means they'll be purchasing fewer loans from commercial lenders. Translation: home sales would slow further and prices might drop further.

Another possible effect on consumers is that buyers of bonds from Fannie and Freddie might demand higher yields because they perceive more risk. This higher cost for Fannie and Freddie would likely get passed through to commercial lenders and translate into higher interest rates on mortgages.

For more on the credit crisis gripping financial markets:

Credit crisis expands, hitting all kinds of consumer loans

For more on the nation's economic crisis:

Bust, boom or treading water? What's up with the economy?

Economy faces that '70s feeling again; Fed has a big challenge

For questions about this story or any other economic question, go to McClatchy's economics Q and A.

McClatchy Newspapers 2008

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