The Importance of Fannie Mae and Freddie Mac

Fannie Mae, the Federal National Mortgage Corporation, and Freddie Mac, the Federal Home Loan Mortgage Corporation, are the 2 largest guarantors of conventional mortgages. Their importance was highlighted by the government’s rescue package, should they not have enough capital to continue to package and sell homeowners’ mortgages to investors.

Both Fannie Mae and Freddie Mac were set up by Congress for precisely the current situation, when commercial banks and investors are unwilling or unable to originate mortgages to homeowners. Fannie Mae saved thousands of home mortgages during the Great Depression, for example, without costing the taxpayers any money. That is why they are two of four Government Sponsored Enterprises—the other two being the Federal Housing (FHA) and Veteran (VA) Administrations that make loans to entry-level homebuyers and veterans.

They were also given a special status, such as tax exempt privileges for their debt that enabled them to keep costs low, as well as lower capital requirements. This was because they carried less risk than commercial banks who originate a mix of consumer and commercial loans that require more capital and loss reserves. And so their mortgage rates are lower than for comparable jumbo mortgage amounts.

The question is can they continue to do business given the current panic-driven environment that threatens to cut off all credit, which is the lifeblood of any economy? The answer of course is that the government will make sure they can continue to operate, given that they now originate more than 70 percent of all home loans, with safer underwriting guidelines that keep their default rate at 1 percent, less than one-quarter of the default rate for all conventional mortgages.

Most pundits continue to say we are not yet in a recession, even though 438,000 payroll jobs have been lost through the first six months of 2008. The unemployment rate held at 5.5 percent in June, as a shrinking labor force cancelled out the job losses in the Labor Department’s Household survey.

So can we expect a recovery this year? The job situation is one indicator. The Conference Board’s Employment Trends Index, which attempts to signal future hiring trends, has fallen 8 percent since July 2007. “The steep decline of the employment trends index in recent months, and the fact that its weakness is spread throughout all of its components, does not leave much room for optimism,” said its senior economist.

Another key to predicting a recovery are the twin manufacturing and service sector surveys put out by the Institute for Supply Management (ISM). Employment in both sectors plunged. What is the culprit? It was surging costs, with prices paid for purchased materials and services increasing for the 61^st consecutive month in the service sector. The rise in material prices from May to June was 7.5 percent.

Housing has historically been one of the first markets to recover after a slowdown or recession, according to UCLA economist Ed Leamer. But the backlog of unsold, vacant homes has to first decline. Harvard’s 2008 Joint Housing Task Force report estimates that there is an 800,000 “overhang” of vacant, for-sale units nationally that have first to be sold.

Fannie Mae and Freddie Mac will be in a position to help with a housing recovery. Their so-called ‘jumbo-conforming’ products with a maximum $729,750 loan amount now offer 30 and 15-year fixed rate programs, a 5-year fixed rate ARM with interest only option at just one-quarter percent higher than Fannie and Freddie’s conforming loan amounts. That could save the day for many California homeowners.

© Harlan Green 2008