U.S. govt takes over
two mortgage giants
Guarantees bondholders investments
BY BRIAN WILLIAMS
The U.S. government on September 7 seized control of Fannie Mae and Freddie Mac in an effort to bail out the mortgage industry. As two of the largest financial agencies, Fannie Mae and Freddie Mac fund about three-quarters of new home mortgages. They hold or back $5.3 trillion of the $12 trillion in outstanding U.S. home mortgages.
In response to the takeover, the Dow Jones industrial average shot up 290 points the following day and 30-year fixed-rate mortgage rates declined by about one-third of a percent. But all this was virtually erased September 9 when stocks fell again, including a 45 percent plunge in share values of Lehman Brothers, the fourth largest Wall Street investment bank.
Lehman Brothers stock has declined nearly 91 percent this year, down to less than $8 a share from more than $60 in February. Like other Wall Street firms, Lehman Brothers made billions over the past decade speculating on securities based on mortgages and other debt, which today are largely worthless.
U.S. treasury secretary Henry Paulson described the housing crisis as the biggest risk to our economy and warned that the failure to act would cause great turmoil in our financial markets here at home and around the globe. Rising home foreclosures and defaults have led to losses at both companies of almost $15 billion over the past year. The bailout has received bipartisan support.
Paulson pledged to provide Fannie Mae and Freddie Mac with as much as $200 billion to cover losses from mortgage defaults. He also said that the government will initially use $5 billion to buy mortgage securities. He claimed that this will lower interest rates for those seeking home loans.
Fannie Mae and Freddie Mac buy billions of dollars in mortgages each month from banks and other commercial lenders. They then package them as mortgage-backed securities and resell them to investors. They also borrow funds from foreign and domestic investors at rates far lower than the interest rates homeowners with mortgages pay. According to Paulson, more than $5 trillion of debt and securities issued by Fannie Mae and Freddie Mac is owned by central banks and other investors worldwide.
The bailout of the two mortgage giants leaves stockholders just 20 percent of the value of each company, with the other 80 percent now owned by the government. The plan eliminates dividend payments to current shareholders. Both companies were essentially insolvent prior to the bailout with stocks having declined by more than 90 percent during the past year.
Washingtons takeover, the September 8 Wall Street Journal wrote, is likely to leave a trail of billions of dollars in losses for stockholders, including some major banks. But it protects the investments of bondholders, including mutual funds, foreign central banks, and government investment funds that own huge amounts of debt issued by the two companies.
In March the Federal Reserve, the U.S. governments central bank, made $29 billion available to assist J.P. Morgan Chase in buying out Bear Stearns, the fifth largest Wall Street investment bank, which had collapsed. That buyout could pale in comparison with the rescue of Fannie and Freddie, in which the funds at risk are in the hundreds of billions of dollars, stated the Washington Post.
Fannie Mae was set up in 1938 in the midst of massive mortgage defaults. It was reorganized as a private government-sponsored entity in 1968. Freddie Mac came into existence in 1970. Fannie Mae pitches itself as an agency that enables working people to achieve the American Dream of homeownership. However, the housing crisis is tearing this myth apart. Some 9.2 percent of home mortgages were at least a month overdue or in the foreclosure process in the second quarter of 2008, according to the Mortgage Bankers Association. This is the highest percentage in the 39 years that the group has been doing surveys.
Official unemployment jumps to 6.1 percent