Some historic news yesterday. The government has officially bailed out and taken over Fannie Mae and Freddie Mac. There has been speculation over the last month that this could happen. It brings both good news and bad news. The good news is that it will allow banks to recover from more than $500 billion in subprime mortgages. This will increase liquidity and confidence in the mortgage market and may end the mortgage liquidity crisis. There is a very good chance that mortgage rates will decline as we have already seen some significant drop in interest rates today. Some experts are saying that 30 year rates may get down to 5.0 to 5.125%. However, there is still going to be an issue with loan guidelines as it doesn't matter how low the rates are if no one can get qualified. I suspect that we will see some gradual easing of mortgage guidelines as banks start to have more money to lend and can therefore take on some riskier loan programs. Finally, on a bad side....how is the government going to pay for all of this? Who is going to ultimately pay..... the taxpayer.
Here is a breakdown on why the bailout happened:
Fannie Mae and Freddie Mac both have issued many 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 have reduced investor appetite to purchase these Bonds...and that's where the trouble begins. Without the ability to sell new Bonds, Fannie and Freddie are less able to meet the capital requirements to pay off the maturing Bonds. And that's the big fear. If Fannie and Freddie were to default and become insolvent, it would throw the beleaguered mortgage and housing markets even deeper into the abyss.
Additionally, the recent lack of appetite for Fannie Mae and Freddie Mac Bonds caused the two mortgage giants to have to do something 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 Fannie and Freddie, reducing 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. Think about it. For a higher rate of return, investors can now buy Mortgage Bonds with the same guarantee as lower yielding Treasury Bonds. A win for investors and a win for comsumers in lower interest rates. Wahsington has finally address the real issue!
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