Fannie Mae and Freddie Mac were created as government sponsored entities (GSEs) to purchase and securitize mortgages, making the GSEs fundamental providers of liquidity and gatekeepers of the mortgage market. In essence, both determine who will be able to get a mortgage and how much that mortgage will ultimately cost.
In the chaos of the subprime mortgage collapse in 2008 which fatally threatened the solvency of the GSEs, both were placed under a government conservatorship administered by the Federal Housing Finance Agency (FHFA). However, even on life-support by the government, together the GSEs continue to own or guarantee close to 31 million mortgages nationally, approximately half of all mortgages in the nation.
Between the two of them, the GSEs have already received $130 billion in federal support. Fannie has recorded an $8.4 billion dollar loss in the first quarter of 2010 and Freddie has similarly recorded a $6.7 billion loss. Freddie now claims it will require yet another $10.6 billion to stay solvent. But how did Freddie and Fannie get in this unprecedented mess?
Loan delinquencies continue to erode Freddie’s balance sheet. The percentage of conventional loans with serious delinquencies (more than 90 days late) grew to 4.13%, up from 2.41% last year. Not surprisingly, Freddie’s adjustable-rate mortgage (ARM) loan products are faring even worse. Delinquencies on Alt-A loans (a middle-of-the-road loan product riskier than a prime, A-paper loan but less risky than a subprime loan) totaled 12.84%. Delinquencies on interest-only mortgages are at 18.5% and delinquencies on option ARMS are at 19.8%.
Additionally, Freddie’s inventory of foreclosed properties is close to 54,000 units, up from 29,145 in March 2009. On average, properties disposed of by Freddie before or after foreclosure create a loss of 39%.
As for Fannie, 5.5% of its borrowers were at least three months delinquent on their mortgage payments in March 2010.
To compound matters, the GSEs are stuck in a paradoxical catch-22 in which they must balance two diametrically opposed goals. They must both provide liquidity to the mortgage market by buying loans from banks, but they must also aggressively protect themselves against additional credit losses wrought by unqualified borrowers – all in an attempt to avoid siphoning more taxpayer dollars from an increasingly impatient nation.
Tip the scales too far toward lending fundamentals and funding becomes too difficult (or costly) to obtain, unsettling potential borrowers and further dampening the real estate market. Tip the scales too far toward more funding, and Freddie will mutate into an immortal financial vampire, sucking federal money provided by taxpayers for years to come.
Presently, the scales seem to favor more funding, as evidenced by the frequent taxpayer bailouts with no discernible end in sight. Also consider the fact that the US Treasury removed the $400 billion ceiling on the federal credit line available to both GSEs on December 24th, 2009 (Santa Claus was particularly generous that fateful Christmas Eve). In effect, the government has implicitly guaranteed to provide unlimited support to both GSEs through 2012, the date when the ceiling will be restored.
However, not all the financial support paid to these mortgage giants will remain unreturned. Fannie must pay the US Treasury $8.5 billion in dividends each year. For perspective, $8.5 billion exceeds Fannie’s net income for the previous eight years.
first tuesday take: Until market fundamentals return after the devastating wounds of the 2008 subprime meltdown fully heal, the existence and continued support of Fannie and Freddie is absolutely necessary. The federal government is the lender of last resort when privately-owned lending institutions – our mortgage bankers – are spooked and unwilling to declare their portfolio losses and lend again, as is currently the case. This same condition mirrors the uncomplimentary environments of Japan and Mexico following their last financial crises some 20 years ago from which their property values have not yet fully recovered.
When the secondary mortgage market is in distress, only the federal government – as the provider of all money – is able to control financial management and take prompt and uniform action to keep cash flowing into a healthy mortgage market. Though recurring bailouts may be unpleasant for taxpayers, they are necessary to keep the blood consistently pumping in America’s capitalistic heart—until, that is, the private bankers get their collective acts together and return to the martketplace.