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Staring Into A Very Deep Hole - Can The Government Allow Fannie Mae or Freddie Mac To Go Belly Up?

Last Friday morning I turned on CNBC to watch the business news and the coverage was centered on the crisis at Fannie Mae and Freddie Mac. As I sat there listening to the talking heads discussing the possibility of Fannie Mae and Freddie Mac going belly up, my own belly was doing back flips.

While I agreed with the commentators who expressed the opinion that Fannie and Freddie were too big to fail and that the government would have no choice but to step in and rescue them, I couldn't get over the fact that there was serious discussion going on about the possibilities of their demise!

I guess that over the years that I had drank the Kool-aid. To me, Fannie and Freddie were as solid as the US Government itself. While I didn't agree with everything that they did, they did seem like well run companies that had solid business models. While some others debated whether it was fair for Fannie and Freddie to have the privileged position that they did as Government Sponsored Enterprises, I believed in their existence and their purpose.

To me, the economic advantages that came with their GSE status was more than a fair trade off because Fannie and Freddie did a good job of providing liquidity to the housing markets. They were the bedrock that the entire real estate and mortgage industries were built upon.

Now here I was listening to some bald headed guy tell me how it would be better if the government agreed to let them fail if that's what it came to. To say the least, I was dumbfounded!

Had I been wrong about Fannie and Freddie? From everything that I had read it hadn't been the loans that were underwritten to Fannie/Freddie standards that were causing the problems (from my understanding the default rate on the "A" paper Fannie/Freddie mortgages was slightly higher than 1.7%).

Even the "Alt A" loans that Fannie and Freddie did (the level approvals) were performing well with a foreclosure rate of less than 2.4%.

So, what gives? Why are Fannie and Freddie in trouble?

I'll be honest, I spent a fair amount of time this morning attempting to research this question and I wasn't able to come up with a good answer.

From what I could tell, part of the problem at Fannie and Freddie is that they got into the business of guaranteeing mortgages that weren't underwritten to their own standards, including a fair amount of sub-prime mortgages. I also understand that they actually invested in sub-prime mortgages themselves, both as Mortgage Backed Securities and by purchasing Collateralized Debt Obligations (CDO's) as well as other mortgage investment vehicles.

The end result is that Fannie is going to lose something like 53 Billion dollars this year! This got me to thinking...how would Fannie and/or Freddie going belly up affect my business?

What I concluded wasn't very pleasant. If Fannie and/or Freddie goes belly up and the government doesn't come to their rescue, then I think that we're hosed! Not just those of us in the real estate and mortgage businesses, but rather WE'RE ALL HOSED!

The house of cards that is our economy right now won't be able to handle an impact this large. Housing values will drop (even further and faster than they already have) and while eventually somebody would step in to the niche that Fannie and/or Freddie now fills, this wouldn't be for years as the markets settle and without the advantages of being a GSE, their rates would be higher and terms less advantageous.

In the mean time, only the very strongest borrowers would be able to finance a home purchase and even these folks would probably be required to put at least 20% down in order to protect the lenders interests in the event that values do continue to fall. In short, the real estate market as we know it would cease to exist!

And it wouldn't only be the real estate and mortgage markets that would be affected. The rest of the economy would come crashing down with the real estate markets because people (who are already feeling economically pressured) would realize that they are indeed broke and broke people don't spend money!

I don't mean to be an alarmist, but with this kind of talk going around, we're looking straight into a very deep hole that we're in danger of falling into!

I hope that it doesn't come to this and my gut tells me that the government won't allow it to come to this. At least I hope not. I'm curious what you all think? Am I being too pessimistic here? What do you think will happen if the government were to allow Fannie and/or Freddie to go bankrupt? Let me know.

R.B. "Bob" Mitchell

ValueList Real Estate Services, Inc.

Bob Mitchell is president of ValueList Real Estate Services, St. Louis' largest discount/full-service real estate and mortgage company. If you would like to find out more about Bob, ValueList or our flat-fee listing program, please feel free to visit our web site at valuelistre.com

Posted by Bob Mitchell - Realtor St. Louis on 07/16/2008 05:02 PM

Comments (23)

fannie mae bailout, freddie mac bailout, mortgage meltdown, real estate values

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23 Comments on Staring Into A Very Deep Hole - Can The Government Allow Fannie Mae or Freddie Mac To Go Belly Up?

JUL

2008

It is a scary proposition -- thanks for the insight.

Sharon: It is indeed scary! I hope that we can hang on long enough to work through this without too much pain and suffering! Thank you for your comment!

Bob Mitchell

ValueList Real Estate Services, Inc.

If anyone remembers their history, Fannie Mae and Freddie Mac were originally government agencies. Someone had the bright idea in about 1968 to allow them to go public. I'm sure the government, meaning us, will help them out in whatever way is deemed necessary. Hang in there. Veronica

I believe part of the problem, were "VERY GREEDY BANKERS"... Bankers only interested in the bottom line, "profits" and gave loans to anyone who showed up at their banks or lending institutions. They created the procedures for the MAC'S to okay their loans.

When you look at our economy, many jobs were lost to "cheaper wages" elsewhere, meaning in other countries. And many people, due to their lost jobs and reduced home appraisals "walking away" from their responsibilities. Very similar to the corporate giants who also slowly left our country 10-20 years ago their responsibilities to the American public due to high wages and lower work ethics.

We are the ultimate bailouts of the "MAC'S", through HIGHER TAXES AND LACK OF SERVICES.

The bottom line, our lives, our familes and our future country are based on HOW ARE COUNTRY survives this ECONOMIC NIGHTMARE, which is going to get worse, before it gets better

Bob, It's hard to imagine what would happen if these two were just allowed to crumble. I have been watching the reports this week with my jaw hanging down. I have to do some more thinking on all of this stuff.

JUL

2008

What worries me in the most immediate sense is a bunch of idiot neocons trying to derail the bailout under the notion that "free markets" will set it all right in the end....God save us all from these loonies.

BOB - You are not being too pessimistic at all. If Fannie and Freddie were to go belly up, so would the rest of the nation. It would likely crumble the U.S. economy, and most of us would be out of the real estate biz. Think about the effect of adding a large percentage real estate professionals to the unemployment rate. There wouldn't be enough jobs to go around. I know that many people don't believe in government bailouts, but I don't think that all bailouts are created equally. Now, I also believe that this crisis was blown out of proportion. The main problem is that Fannie and Freddie couldn't survive if all of their loans were in default. Does anyone really believe that every loan is going to go into default at the same time? I'm sure that there are problems, and that we haven't heard the last of this, but hopefully, it will not come close to being as dire as the talking heads have made it out to be.

Veronica: I did read the history of Fannie and Freddie and I have to admit, I don't quite understand why they were spun off as private enterprises. When I read about this it made me wonder who benefited from this spin off. Did the government sell stock in these companies and put the money back into the treasury or did they simply give it away? I'll have to see if there is a history of Fannie and Freddie that I might be able to read. I also think that you're right that the government is going to come in and rescue them if that proves neccesary. Thank you for your comment.

Ann-Marie: I'll also admit that I was surprised that Fannie and Freddie were involved in the sub-prime market at all. I had no idea that they were "guaranteeing" the performance of any sub-prime mortgages or that they had bought CDO's as an investment. It seems to me that if anybody should have known better, then it should have been Fannie and Freddie!

Bryant: I know just how you feel!

Ruthmarie: My background is in economics and I'll admit that I'm a big fan of the free markets, but what the "free-market loonies" don't seem to acknowledge is that there is a legitimate role for government other than subsidizing the oil industry. (whoops, that probably sounded sarcastic, didn't it?;-)

Providing for the general welfare, as outlined in the preamble to the US Constitution, would cover the government creating these entities, in my opinion. Others may disagree with me.

Should the government have gotten into the mortgage business back in the 30's? I don't know, but I do know that they are in it now and that if they decide to get out of it by letting Fannie and Freddie crash and burn that our entire economy is going to suffer if not completely crash.

The "Free Market Loonies" need to acknowledge this before they run off at the mouth. Thanks for your comment.

Adam: From what I understand the foreclosure rates on the loans that Fannie and Freddie underwrote to their own standards aren't the problem here. It was the guaranteeing of the sub-prime mortgages and their investment in sub-prime that is causing them problems.

Again, from what I understand and if anybody knows better, please comment or write me, Fannie and Freddie are in danger because they are currently losing money and their share price has dropped to the point where they are having problems rasing the capital needed to stay in business.

If this is the case, let's tighten our belt elsewhere....maybe suspend the oil companies subsidies or cut our losses in Iraq and give Fannie and Freddie a helping hand to get them through this crises. Yeah, they screwed up, but everyone deserves a second chance. Especially when that someone is as important to the economy as Fannie and Freddie are. Thanks for your comment!

Bob Mitchell

ValueList Real Estate Services, Inc.

I think this is another example of greed at play and lack of management control.

The questions that needs to be fully answered (and people need to be held accountable) is why were loans guarenteed that did not conform to Fannie and Freddie's own standards?

It seems like even senior management got caught up in the hysteria and irrational excitement seen in the boom days of the market.

Stewart: As I mentioned in the post, I attempted to figure out what went wrong as Fannie and Freddie and wasn't really able to get a handle on it. Most of the articles pointed to the increase in foreclosures as being the problem. When I dug deeper, it was only in passing that Fannie and Freddie's involvement in the sub-prime markets was even mentioned. Even then, the articles didn't go into much detail.

Right now, I'm curious as to what the real story is. If it is indeed as I suspect, then you're right. Senior management did get caught up in the hysteria and irrational excitement of the times. Even then, I don't think that we can afford to let them go belly up!

Maybe it's time to take a look at their practices and make sure that they keep their purpose of providing liquidity to the housing markets in front of increasing profits on their priorities list! Thanks for your comment!

Bob Mitchell

ValueList Real Estate Services, Inc.

With the exception of the military anything the government gets involved in is doomed to failure and still folks want them to take over health care.

I do really believe this country is in trouble Bob. And by reading your post about Freddie and Fannie I do believe there in trouble too!

Robert Swetz

JUL

2008

Hugh: Were you ever in the military? They screw that up too! ;-) Actually, while they are not very efficient, we do have the best military in the world and I appreciate their efforts.

Regarding your point about health care, while I don't want a nationalized health service, I do want nationalized health insurance. The current system is WAY broke and totally unfair. The only reason that it continues to exist in it's current form is because the insurance companies are wealthy enough to pay congress off in order to keep it the way that it is. But this is another argument...thanks for your comment.

Robert: It's funny, this morning on CNBC they had a talking head on that was harping about how strong our economy is and how everything is really just peachy keen. That the only problem is that people have lost confidence. I was like, "What planet is this guy talking about?"

Things are downright scary right now and I just hope that we are able to muddle our way through it without too much pain. Thanks for your comment.

Bob Mitchell

ValueList Real Estate Services, Inc.

JUL

2008

Fanny May and Freddy Mac are like the pillars our economy are built on...with out these institutions the economy will crumble. the US government better save both of these institutions, or we are in BIG trouble.

Jon: I agree whole heartedly! While there are those that are philosophically opposed to the existence of Fannie and Freddie, I think that that good that they have done is more than enough reason to rescue them if it becomes necessary! Thanks for your comment!

Bob Mitchell

ValueList Real Estate Services, Inc.

JUL

2008

Ultimately, if Fanny and Freddie get saved by the US Government, the general American gets hosed. Who's paying? Tax payers and American's. It's simple econ 101. What a joke.

To make money in this economy, you need to have your dollars doing something else besides having them sit around US currency, going long on the S&P and the Dow or having them in bonds. The Dow's going under 10,000 and that's not Chicken little speaking. If it stays above 10K, it's because of people are ignoring fundamentals or believing our mass media like CNN to fill us full of BS that everything is ok.

Ryan - How do you support your statement that the Dow is going under 10,000 points? That's a huge statement which should be substantiated with facts.

CNN is not portraying that everything is okay. In fact, the media often overplays bad news becasue that stirrs up more interest.

Stewart, unfortunately I can't back that up since the Dow does not move purely on solid economic data. My wording was off and a tad strong and strictly opinion based. The following charts can paint a clearer picture of actual GDP growth, unemployment, money supply, and the shadow CPI and can back my opinion.

http://images.moneyandmarkets.com/1023/dow-critical-support.gif

http://images.moneyandmarkets.com/1019/official-GDP-growth.gif

http://images.moneyandmarkets.com/1019/shadow-unemployment.gif

http://images.moneyandmarkets.com/1019/money-supply-m3.gif

http://images.moneyandmarkets.com/1019/shadow-cpi2.gif

JUL

2008

http://www.youtube.com/watch?v=vWa9AfkjwoY

AUG

2008

Ryan: Personally, I don't think that the the government backing Fannie and Freddie up and thereby allowing them to get by this crises is going to cost the tax payers anything in the long haul.

I feel this way because their fundemental business model is solid. Did they screw up and get too involved with the sub-prime markets...oh yeah! But they didn't screw up on purpose and I would hope that they have learned their lesson.

The flip side is that if you do let them go belly up, then we WILL all get screwed because housing prices will tumble because their won't be a Fannie or a Freddie to provide liquidity to the housing markets. Housing makes up a big enough share of the country's economy that if it fails completely...as would happen if Fannie and Freddie are allowed to go belly up....then all kinds of nasties will happen.

I do agree with you on the dow going below 10,000 though. I called this back in January 08 when I made my new years predicitions...check them out and thanks for your comment.

Stewart: Check out the link above and tell me what you think! Thanks for your comments too!

Bob Mitchell

ValueList Real Estate Services, Inc.

Read your blog post from Jan 08. You had a couple funny ones in there too! Good stuff.

Thanks Bob for this information and to all the rest for your comments. I have been quite concerned about the direction we are going in.

I appreciate your input and agree that we are ALL "hosed" if Fannie/Freddie to under.

Marie

Mortgage Processing Solutions

"The Solution you've been looking for"

www.mortgageprocessingsolutions.biz

Ryan: I'm glad that you enjoyed it. I was trying to make some points, but be funny at the same time!

Marie: It's kind of scary that we're even talking about this sort of thing! As it looks, I think that Fannie and Freddie are going to make it. Too bad that I didn't have some extra money to invest when there was all that talk!

Bob Mitchell

ValueList Real Estate Services,Inc.

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