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Fannie Mae & Freddie Mac: What Will The Feds Do?

by Charles Feldman on July 11, 2008 · 4 comments

  

Fannie Mae and Freddie Mac, combined, own or back up some $5 trillion dollars of debt. That is about half of ALL the mortgages in the U.S. They have already lost some $11 BILLION since the current mortgage/credit crisis began, so it is easy to see why there is profound concern about their fiscal health–or lack there of.

Concern turned to horror today after the New York Times reported that the U.S. government is thinking about a takeover of the mortgage giants–placing them in a conservatorship.

Should that happen, the shares of both could be worth almost nothing and taxpayers, you and me, would have to pick up the tab, says the Times, for “any losses on mortgages they own or guarantee–which could be staggering…”

This news brought about what the AFP news agency referred to in a headline as a “meltdown” of the share prices of both Fannie and Freddie.

According to Reuters, “Fannie shares closed at $10.25, down some 22 percent but well above the session low of $6.68. Freddie closed at $7.75, down 3 percent, after touching a low of $3.89 earlier in the session.”

And, here is the most amazing part of the story. Freddie and Fannie have lost almost 90 percent of their enture value just since August, says Reuters.

Doubts about bailout

As the day drew to a hectic close, Treasury Secretary Henry Paulson sent out signals that it is not likely there will be any federal bailout–However, Sen. Christopher Dodd of Connecticut, who is chairman of the Senate Banking Committee, said he spoke with both Paulson and Fed Chairman Ben Bernanke and that they are looking at options that would include “opening access to the discount window,” Reuters reports. The discount window allows the Fed to act as an emergency lender for the banking system.

Meantime, both Fannie Mae and Freddie Mac insisted they have enough capital to keep going and Sen. Dodd said both are “fundamentally sound and strong.”

Although both were originally formed by the federal government, they now function as private corporations, though there has always been an assumption that the government would never let either go under for fear of what might happen to the entire financial system in this country and, indeed, around the world.

How they got into trouble
To understand how they got into trouble, you must first understand what it is they do. Both buy up literally hundreds of billions of dollars in mortgages–then repackage them as securities.

In some cases, they hold on to these new securities, but they also sell them to investors.

That is why when the subprime mortgage crisis hit,Fannie and Freddie were hit hard. And, says the New York Times, “analysts expect the companies to announce a new round of write-downs and possibly be forced to raise capital by issuing additional shares.”

Stocks tumble then regain

At first, the fears of a Fannie/Freddie implosion plunged the Dow Jones Industrial Average down more than 200 points…but, by the end of the trading day, it closed down “just” 128.48 points.

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{ 4 comments… read them below or add one }

Mike Taylor July 12, 2008 at 5:12 am

I don’t think the market could handle anything like this from Freddie and Fannie on the heels of the IndyMac news. Although if it does happen, it might be better to just get it out all at once.

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Real Estate Saga July 12, 2008 at 10:07 pm

Every business contains a huge risk,that may come any time.Its better that the concern should work hard and make a way to get out of this problem

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Joshua Dorkin July 13, 2008 at 8:57 am

Saga – This is the 2nd comment of yours that makes no sense at all. Try to post relevant comments instead of nonsense, soley intended to promote your website. (BTW – I’ve removed all links to your site until you decide to start commenting with legit posts)

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Cliff Pape July 13, 2008 at 4:14 pm

I agree Saga your comment made no sense. As an economist here are my views on what would happen. How about no more mortgages at all! That’s right if they go under the biggest demander in the market for mortgage paper is gone. If they are gone then no cash can flow back to lender to lend. So you would essentially have a financial crisis.

Naturally the government would step in before that happens. In addition, Paulson and Bernanke are surely having a series of meeting to put in contingency plans in case Freddie and/or Fannie become insolvent.

If Freddie and/or Fannie become insolvent as an investor it would be great! Because this means that eventually foreclosed properties would hit the market at greatly undervalued prices. You only have to research the Savings and loan crisis to understand how real estate investors made a mint buying these types of properties.

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