Fannie Mae and Freddie Mac in the Financial Crisis
October 1st, 2008 | by admin |
In September 2008, the Federal Housing Finance Agency (FHFA) announced the federal takeover of mortgage giants Fannie Mae and Freddie Mac. The bailout of the two government sponsored enterprises (GSEs) occurred in the midst of the current credit crisis, further fueling anxiety of the US market as well as concern about the possibility of impending recession.
Fannie Mae (Federal National Mortgage Association) was established in 1938, and its brother company Freddie Mac (Federal Home Loan Mortgage Corporation) was founded in 1968. Both Fannie Mae and Freddie Mac were created to expand home ownership and to provide a secondary home loan market for buyers. At the time of the takeover, Fannie and Freddie owned or guaranteed about half of all American home loans and had total obligations of $5 trillion, making their conservatorship one of the largest and potentially costliest federal bailouts of private companies in US history.
There are many variables that may have contributed to the downfall of the two mortgagors. Some market experts believe that ultra low rates and securitization are the main reasons for the current housing crisis and the failure of Fannie and Freddie. Others believe it was improper money management of the two firms. It is widely known that during the four years prior to the government bailout, Fannie Mae purchased or guaranteed $270 billion in home loans to risky borrowers.
At that time, Fannie Mae was under extreme pressure from Countrywide Financial, the largest mortgage lender in the US, to buy Countrywide’s riskier home loans. Further persuasion from Congress to extend more loans to home buyers with low incomes and from managers of hedge funds to take more chances in pursuit of profit may have led to the company to engage in unsafe financial activities and become over-leveraged.
The financial collapse of the two over-capitalized firms has heavily disrupted the already volatile housing market and affected the US economy. Furthermore, as many US banking institutions own stock in Fannie Mae and Freddie Mac, all are now facing suspended dividends in addition to a dramatic loss in share value. Some banks may also have problems with capitalization due to the related loss of invested funds.
Where the credit default swap (CDS) market is concerned, the federal bailout of Fannie Mae and Freddie Mac being looked on as a type of bankruptcy. In fact, due to the enormity of the situation, a new protocol is being developed to accurately evaluate and settle Fannie and Freddie’s credit default swaps.
Although the US Treasury has made a solid $200 billion commitment to sustain financial operations and support mortgage guarantees, stockholders will endure any initial losses and taxpayers may eventually be in danger of covering the firms’ combined liabilities. The heavily supported government conservatorship, however, is intended to increase the financial stability and capitalization of both Fannie Mae and Freddie Mac as well as to prevent further losses when possible.