When Dorothy skipped along the Yellow Brick Road with her pals, she was seeking the wisdom of the Wizard to get her back home. But as she and we all learned, the answer was within… plus a little bit of help from her friends.
I’m trying to make some sense out of all this mortgage liquidity crisis stuff (any help from ATLANTABLOG readers is appreciated… just “Comment”). As I understand it, Banks and mortgage brokers would originate mortgage loans, and sell them, ultimately, to “investors.”
TOGETHER THEY BACK HALF OF ALL US MORTGAGES
Fannie Mae and its smaller sibling Freddie Mac are the largest “next steps” in the mortgage conduit towards the end investors. Together they either carry, or insure, $5.2 trillion dollars in US mortgages… 1 out of every two in the US. When I say “carry,” I mean they buy them and keep them as direct investments. When I say “insure,” I mean they guarantee to investors that even if the mortgage borrower defaults, the investors will get paid back principal and interest. Bundles of guaranteed mortgages were sold as “Mortgage Backed Securities” (MBS’s) and sold on Wall Street (aka the “secondary mortgage market”) by companies such as Bear Stearns.
Do keep in find that Fannie and Freddie and Bear (Stearns) understand that some mortgages are riskier than others, and they sold them to investors based on the risk. The old adage “higher risk, higher return; lower risk, lower return” was/is at play here. Investors seeking a higher rate of return on their investment dollar would gravitate to the higher risk “traunches” of MBS’s. Investors who shied away from higher risk traunches were getting lower returns on their investment dollar.
All as it should be, except Bear Stearns got itself into trouble by continuing to promote higher risk, higher return MBS’s as being safer than they knew them to be when payment deterioration became evident. A short and fascinating government report on the demise of Bear Stearns can be found here.
A TRIPLE WHAMMY
But I digress. With Fannie and Freddie either holding or insuring half of the mortgages in the US, when some of those mortgages started to get in trouble, Wall Street woke up one day in August 2007 and just stopped buying. So F & F got hit with a triple whammy: 1) deterioration in their own portfolio, 2) nowhere to sell what had been planned to be sold, and 3) still on the hook to pay investors’ P&I per their guarantee.
Then another type of investor, one who owns shares of Fannie and / or Freddie themselves, freaked since they saw huge losses being posted by F & F, and they feared neither F nor F could raise enough capital to keep afloat. Stock prices of F & F fell like a rock.
YOUR MORTGAGE PAID? F & F STILL MATTER!
This is a real source of consternation. If the two primary purchasers of mortgages are weak and essentially “out of the business,” how can ANYONE afford a home?
www.LKBrealestate.com blogged recently about supply and demand (scroll down if you missed it: “IT’S A BEAUTY CONTEST!”). With that basic economic concept in mind, consider this Armageddon scenario: even ready, willing and able buyers cannot obtain mortgages. Results in no demand. Results in flooded supply. Prices go to zero. Even if your mortgage is paid in full, the health of Fannie and Freddie is important to your economic well being, because the value of your home depends on what the next buyer is willing to pay. And if no one can buy it because they can’t get a mortgage, the value of your house tumults to nothing.
SOLUTION?
First, we have to determine if there really IS a problem. When their stock prices tanked, it was because investors worried that they would not be able to raise capital (issue stock, issue bonds, borrow money) sufficient to meet their growing needs. Plus, both Fannie and Freddie have minimum capital requirements imposed on them by federal regulation. In other words, money was going out the door, but there is a required minimum they have to have. What if they can’t meet the requirements?
Now steps in the government. Federal Reserve Chairman Ben Bernanke testified before the House Financial Services committee on July 11, 2008, “in general, healthy economic growth depends on well-functioning financial markets. Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority.”
US Treasury Department Secretary Henry Paulson Jr. told the Senate Banking Committee on July 15, “Our plan addresses current market challenges by ensuring, on a temporary basis, access to both liquidity and capital, while also ensuring that the GSEs can fulfill their mission — a mission that remains critical to homeowners and homebuyers across the country, especially during this housing correction.”
Together, they propose: 1) Treasury might buy Fannie and / or Freddie stock to provide cash, 2) Fannie and Freddie can borrow cheaply at the Fed discount window, and 3) Treasury will give a temporary increase in their Lines of Credit, just in case.
So, it looks like there’s a problem.
NOT A PROBLEM, THEN?
‘Taint necessarily so. The same day Paulson was drumming up support for a Housing Relief program, Fannie’s President and CEO Daniel H. Mudd released a statement saying “We continue to hold more than adequate capital reserves and maintain access to liquidity from the capital markets.”
And Freddie’s Chairman and CEO Richard F. Syron gave similar assurances in a statement “As Freddie Mac and OFHEO Director Lockhart have affirmed, the company is adequately capitalized, has a large liquidity portfolio and access to the world’s debt markets.”
So here’s my take: Fannie and Freddie get hammered from all sides, and investors panic. At the same time, government pressures the two to stabilize housing by continuing to provide mortgages even if the secondary mortgage market is out of the game for awhile. So they step in and say that, if necessary, “I’m from the Government, and I’m here to help.”
Fannie and Freddie say, thanks, don’t need it, but appreciate the support. Investors feel better, and stocks of not only Fannie and Freddie, but Banks, too, go up.
IGNORE THAT MAN
Back to the Wizard of Oz, where we started: Fannie and Freddie believe in themselves, but certainly don’t mind a little bit of help from their friends in government.
But in that same July 15 testimony before the Senate Banking Committee, Paulson said the Bush administration has no immediate plans to extend emergency loans to mortgage giants Freddie Mae and Freddie Mac or to purchase the stock of the two companies. Sort of like saying “ignore that man behind the curtain.”
As Dorothy said, There’s No Place Like Homes, Townhomes and Condos in Atlanta GA! (What did you expect? This is an Atlanta Real Estate blog!)
Thanks for visiting us today. www.LKBrealestate.com
I took a look at 2008, month by month. Same story. Atlanta is stable, overall housing is down a bit, but the stock market is, ah, really down. Don’t even ASK me about my 401(k)!
Atlanta Market Trends 