Fannie Mae and Freddie Mac both issued Bonds which over time mature, and Fannie and Freddie need to pay back the principal on the maturing Bonds.
The way they raise capital to pay these maturing Bonds is to issue new Bonds. This happens every month.
And as long as Fannie and Freddie can sell new Bonds this system works well. But the problems in the mortgage industry reduced investor appetite to purchase these Bonds... Without the ability to sell new Bonds, Fannie and Freddie are less able to meet the capital requirements to pay off the maturing Bonds.
The government's fear was - if Fannie and Freddie were to default and become insolvent, it would throw the beleaguered mortgage and housing markets even deeper into the abyss.
They recently had to make their Bonds more attractive...so they offered their bonds at higher yields to gain more investor interest. However, since they couldn't go back and raise rates on loans that had already been closed, it sucked even more profits out of them reducing their capital even further, and exacerbating the problem.
That's why the Treasury has stepped in and said that they will back the payments on these Bonds. This action has given investors a lot of confidence to step in and now buy Mortgage Bonds.
For a higher rate of return, investors can now buy Mortgage Bonds with the same guarantee as lower yielding Treasury Bonds!
Mortgage rates have reacted this morning with a huge DROP to a national average of 5.93%! We have not seen a mortgage rate drop below a 6% national average since 2005! Many lenders are quoting 5.75% this morning! However - I don't think it will be enough to forestall a collapse in home prices.
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