Fannie, Freddie deal narrows investor options

The federal government announced Sept. 7 that it is stepping in temporarily to take over the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp, known respectively as Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE).

The two companies, which buy mortgages from banks and repackage them as investment securities, own more than $5 trillion in home loans nationwide, and the plan puts the two companies into a conservatorship that will be overseen by the Federal Housing Finance Agency.

The agency, created by the Housing and Economic Recovery Act of 2008, will run the two publicly traded companies until the economy stabilizes.

The plan is intended to prevent a failure of the two companies, which have been hit by more than $12 billion in losses in the last year due to declining home prices and rising delinquency and foreclosure rates.

‘Too big to fail’

“The housing correction … is a drag on our economic growth and at the heart of the turmoil and stress for our financial markets and financial institutions,” FHFA Director Jim Lockhart said in a Sept. 7 statement. “Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing.”

Jeffrey Layman, chief investment officer for BKD Wealth Advisors LLC, said the impact of Fannie and Freddie extends well beyond the housing market.

“These lenders are extremely important not only to the mortgage market but to the economy as a whole,” Layman said. “That’s where the concept of ‘too big to fail’ comes in. The outstanding debt that they back is more than $5 trillion – roughly the same as what the U.S. Treasury has outstanding. It’s really a situation where letting them fail is not an option.”

The most immediate impact is on stock owners – per-share prices of both Fannie Mae and Freddie Mac have dropped 98.9 percent since October 2007.

And while the federal government’s move may help shore up the mortgage market, Layman cautioned against jumping into purchases of other lenders’ stock.

“Some have a whole lot of bad mortgage credits on the balance sheets, and this doesn’t change that,” Layman said. “For the well-capitalized, solid banks that weather this storm better, conditions at the other end of the pipe will be better and there’ll be an environment of better profitability. But it doesn’t change that too much in the near term.”

Layman, however, said that the impact could be considerably more positive for bondholders. With the government’s takeover, the two companies’ outstanding debt will most likely keep the same AAA rating held by the federal government.

“There’s been a little uncertainty about whether this implied backing of the government agencies would hold up in a time of difficulty like this. This move creates a lot of stability for the bondholders,” Layman said.

Homeowners

The news is also positive for homeowners and potential homebuyers, according to Scott Noskowiak, vice president of the mortgage department at Springfield-based Guaranty Bank. He said the takeover should help push down interest rates, especially on long-term mortgages.

“Hopefully (the FHFA) will be able to analyze the fees that are paid to Fannie and Freddie, so that it will lower the amount the banks have to pay to ship mortgages to Fannie and Freddie,” Noskowiak said. “(That) should keep down the rates going to the consumer.”

Layman said the federal intervention also should allow mortgage lenders more leeway to lower their rates; he noted that the Federal Reserve’s lending rate has been lowered by more than 3 percent in the last year, while average mortgage rates have remained virtually unchanged.

“(The Fed) can’t make banks lend the money; they can just decrease the cost of it,” Layman said. “This ought to bring mortgage rates down some.”

That drop in interest rates already is under way; Noskowiak said rates for 30-year fixed-rate mortgages were between 6.25 and 6.5 percent as late as Sept. 1, but had dropped by about half a percentage point by Sept. 10.

Noskowiak called the change in rates a significant one, especially for long-term mortgage rates that tend to move more slowly. He added that it’s unclear whether rates will drop further or the drop was a “knee-jerk reaction” to the government’s announcement.

“We don’t have a crystal ball, but we know the market will stay steady for at least the next year,” he said. “They need to stabilize the market and get rid of some of this surplus of homes we have on the market right now.”

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