Mechanics of the Credit Markets

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Daniel Mudd, CEO fo the Federal National Mortgage Association (Fannie Mae)  is off to Asia And Eurpoe's financial centers. This trip is an annual event.  an annual trip and he is taking the opportunity because investors here are averse to investing in the credit markets here. Mudd said they aren't hurting for capital now. However, if things get worse here, they may have a need. But what does that mean to consumers?

It is helpful to understand the mechanics of the global credit markets in order to understand answer that question.

Atop all of our financing is the FED. The Federal Reserve is a system charged with maintaining a sound credit environment. They are also to devise and implement policies to help control inflation or deflation and help to keep the economy from disaster. The FED controls the flow of money by setting the cost of money. A reduction in the Fed Fund Rate does not equate to reduced mortgage rates as many believe.

The FED is a "regulating" body of Federal Reserve banks who make  decisions on monetary policy based on reading the economic "tea leaves."

Remember, that a mortgage along with the note is a negotiable instrument, that can bought or sold. Therefore, there has to be a "marketplace to do that" --a place to get cash so mortgages can exist. There aslo has to be buyers and sellers.  The largest marketplace for that is the SECONDARY mortgage market. It is the ultimate source for mortgage funds.

The Secondary market  is made up of insurance companies, pension funds, real estate investment trust and major wall street financial institutions. These  are the big players. The Largest "dealer" in that market place is Uncle Sam. So, there is buying and selling in this market place. But what happens when there are a lot of mortgages to purchase and all of a sudden, the big players decide that isn't too risky to  hold on to their current holdings and there is a flood of selling?

You get a mortgage crisis-it's like a run on a bank where people think if they don't get to the bank fast enough, they'll run out of money. When you have more sellers than buyers of these securities you have a "bear market." Liquidity dries up.

When there are defaults, when there are fewer investors, Fannie Mae and Freddie Mac have less capital to do their business.

Therefore, People like Mr. Mudd of Fannie Mae have to be about finding  other sources of capital--should they need it to keep things on an even keel.

(More on  Fannie Mae in the next post.)