The Fed Takes Over Fannie Mae and Freddie Mac

by Tyler Osby on September 8, 2008

Come Out With Your Hands Up!

Fannie and Freddie, Seized.

It’s official.  Fannie Mae and Freddie Mac are now under control by the US Government.  Formally a individually operated (but government sponsored) Fannie and Freddie got a little over their heads.  After showing enormous losses and unable to raise enough capital to keep their heads above water, the tax payers are going to foot the bill.

Why Did This Happen?

If you haven’t been following the story, Fannie Mae and Freddie Mac have been facing the same concerns that many subprime struggled with.  Liquidity.  If a bank/financial institution cannot make margin calls, keep capital requirements, etc – they can’t operate.  It’s obvious it’s been an issue for Fannie and Freddie, but they tried their own go at raising capital.  Unfortunately, they were unable to do it themselves.

It could have gotten super-ugly if the goverment wouldn’t have stepped in, so let’s just say we dodged a bullet.  Yea, it goes without saying – it’s horrible it came to this.  I wish that I never had to write about this, but here we are.

What Does This Mean To You?

Well, first off – it depends on WHO you are!  Also, there is obviously a lot of speculation since this is new news, so check things out as they progress.  I’ve always found Wall Street Journal a great resource.

If You’re a Regular Consumer:
Business will continue as usual (for now at least).  Money will continue to flow, guidelines will likely continue to get a little tougher and costs may increase slightly.

Mortgage rates will likely push slightly higher, but only on a rally out of the stock market.  I might be wrong, but follow me to find out.  Nobody knows until Monday (as I write this Sunday, September 7th).

If You’re a Common Stock Holder:
I hope you needed some fancy new wall paper.  As the Wall Street Journal quoted it, common share stock will likely loose 50%-75% of it’s value on the news.  This could potentially happen overnight.  I’m sure these stockholders knew they were walking on pretty choppy water to begin with (yea, walking water…sure).

If You’re a Preferred Stock Holder:
You’re in a little better shape than the common stock holder, but not out in the clear.  Again, according to Wall Street Journal, preferred stock will likely be worth 70% of what it was worth on Friday.

Why Did They Fall So Fast?

In short, they moved outside of their comfort zone when they started loosing market share.  They started originating outside of their ‘A paper’ loan category. ‘A paper’ is a loan with full documentation and a decent credit file (not perfect, but pretty darn good).  Normally a borrower with over a 680 credit score that can document their income and assets with normal requirements.

Fannie Mae and Freddie Mac both noticed that there were a lot of ‘Alt-A’ loans that started taking some of their market share.  ‘Alt-A’ is a loan where a borrower still has a reputable credit score (over 680, sometimes 700), but cannot document all of their income or assets (often self-employed individuals with hefty tax deductions, etc).   These loans were not ugly enough to be considered ‘Sub Prime’ so they received the label ‘Alt-A’.  Cool?

Okay, back to the story – Fannie and Freddie stated seeing other banks closing ‘Alt-A’ loans and making money hand over fist.  Who wouldn’t get a little curious, right?  Well, Fannie and Freddie decided they wanted a piece of the pie.  They created similar programs and joined the ‘in’ crowd.  In full disclosure, Fannie and Freddie were much more conservative than other banks in the ‘Alt-A’ arena, but ultimately greed put them in that market.

Where Does That Leave Them Now?

I told that story to tell you this – 10% of Fannie and Freddie’s loan portfolio is ‘Alt-A’ loans.

Are You Ready for this?….

That 10% of their portfolio accounted for 50% of their credit losses in their 2nd quarter.  Crazy.  Risk vs. Reward.  Ouch.  Again, these numbers according to Wall Street Journal.

As you can tell, things will likely get worse before they get better with Fannie and Freddie’s portfolio.  That’s why the government had to step in.  There really was no other choice (in my humble opinion).

The Big(ger) Picture

Let’s not be shy about this.  There’s a lot of foreign money in our debt markets.  A lot of our mortgages are funded by investors from outside of the US.  Don’t be scared, it’s been this way for a long time.

Getting back to the point, investors knees were starting to shake a little bit.  If their investments were in danger of failing, they could pull out.  If we loose confidence of investors that put billions of dollars into our economy, we’d have some serious issues.  Much, MUCH bigger than our mortgage situation.

The government cannot let Fannie and Freddie fail.  There’s just too much riding on the line.  The government did what they had to do.  I’m not going the fact that Fannie and Freddie went into territory they shouldn’t’ have.  I think they should have stuck to ‘A Paper’ and seen a fraction of the losses.  However, the mistakes have been made and now we have to act (hopefully that saves us a bunch of trolling comments).

Much more to come, without question.  This is a story that will continue to develop.  I’ll keep you posted.  Just follow the ‘Fannie Mae & Freddie Mac’ category.

Additional Reading

  1. The Eulogy for Fannie Mae and Freddie Mac – so eloquently done by fellow mortgage blogger Tod Vanderwell.
  2. You can find the heavy reading about the US Seizing the mortgage giants at Wall Street Journal Online.
  3. explains Paulson’s decision.

Original Photo Kudos

{ 2 comments… read them below or add one }

Rhonda Porter September 8, 2008 at 4:26 am

It should be very interesting tomorrow morning (and the days to follow) as to how this all unfolds. What historic times our industry is in.

tylerosby September 8, 2008 at 4:53 am

@Rhonda – You’re not kidding. It’s exciting to see the mortgage landscape change. I’m not sure if it will get ‘better’ or ‘worse’. One thing’s for sure, it will be getting ‘something’! 😉

Thanks for joining the conversation. Good luck tomorrow!

Leave a Comment

Previous post:

Next post: