Freddie, Fannie Troubles Continue

Fannie Mae and Freddie Mac stock values are down again Friday. Investors are worried that the two home mortgage giants may collapse from the burden of homeowners defaulting on their mortgages. Already, the two companies have posted $11 billion in losses.

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MELISSA BLOCK, host:

And again, there are indications today that the Federal Reserve is prepared to throw a lifeline to Fannie Mae and Freddie Mac. As we mentioned, a report from Reuters News Service suggests the two companies would be allowed to get emergency loans at the Fed's discount window.

Fannie and Freddie are crucial players in the nation's mortgage market. They either own or guarantee $5.2 trillion in mortgages. That's equal to about half the value of all the mortgages in the United States. And NPR's John Ydstie joins us to talk about the companies and their problems. Hi, John.

JOHN YDSTIE: Hi, Melissa.

BLOCK: And first of all, what does this news of the potential aid from the Fed for Fannie Mae and Freddie Mac, what does it mean?

YDSTIE: Well, I think the report suggests that the Fed may be trying to calm the jitters over whether Fannie and Freddie might fail by allowing them to get these low-interest loans from the Fed's discount window. It's the same thing that the Fed did for Wall Street investment banks to calm the credit markets after the collapse of Bear Stearns.

BLOCK: And getting loans from the discount window, is that the same thing as a bailout?

YDSTIE: Well, I think this stuff could be called less than a bailout. Even though it puts some taxpayer money at risk, and despite all the panic in the financial markets over this, some analysts and government officials are still saying a bailout is unlikely. They say there's still time for Fannie and Freddie to get additional capital in the private markets.

In fact, yesterday the agency that regulates Fannie and Freddie said they still have adequate capital to operate, and Secretary of the Treasury Paulson agreed. Today he said they should remain in their current form as shareholder-owned companies, but I think it's safe to say in a situation like this things can change pretty rapidly.

BLOCK: Back us up a bit, John, to the long and complicated history of Fannie Mae and Freddie Mac. For those not in this world, it's really hard to figure out what these guys do.

YDSTIE: Well, they were created by the government to help make more money available for home loans. Fannie Mae was created back in the Depression in 1938, and then it was turned into a shareholder company in 1968. A couple years later Freddie Mac was created to provide some competition. And what they do is buy mortgage loans from banks and mortgage companies. They package them into investments called mortgage-backed securities, and then they sell them to investors, and that injects a lot of investment money into the mortgage pool. But here's the big thing. Freddie and Fannie guarantee all the loans they sell to investors.

So if a homeowner defaults on their mortgage, Fannie and Freddie will step in and make good on the loan, and as you said, they're guaranteeing trillions of dollars worth of loans, so if they failed it would be a huge mess.

BLOCK: And since we know what's been going on with the mortgage markets and the housing markets, we can extrapolate why Fannie Mae and Freddie Mac are in such trouble right now.

YDSTIE: Exactly. They're in trouble because homeowners are defaulting and being foreclosed on at alarming rates. So Fannie and Freddie are being forced to make good on those guarantees. Already they've posted $11 billion in losses, and investors are just worried more is to come.

BLOCK: And is that why investors are selling off the shares, why Fannie Mae and Freddie Mac have been tumbling so low?

YDSTIE: Well, that's one reason. Another is that earlier this week a former Federal Reserve governor said Fannie and Freddie were already insolvent, and he urged the government to take them over.

Of course, if the government takes them over, shareholders are likely get little or nothing, so investors have been scrambling to sell their shares, and the share price is now 80 percent below where it was a year ago.

Right now these companies are really fighting a psychological battle, trying to convince investors that things aren't really that bad when investors seem to be convinced things are only going to get worse, and of course that can become a self-fulfilling prophecy.

For financial firms, it's very hard to win back confidence once the market turns against you.

BLOCK: How many stakeholders, shareholders, are we talking about here?

YDSTIE: Well, there are a lot of stakeholders. These are very widely held stocks, and millions and millions of shareholders are obviously losing money, and that includes a lot of people with 401Ks and mutual funds who don't know they own these stocks.

But there's an even bigger issue. If investors lose faith in Fannie and Freddie guarantees and refuse to buy the mortgage-backed securities they package, it could freeze up the mortgage market and make it very difficult to buy or sell a house. That's one reason people have been urging the government to step in quickly.

BLOCK: And briefly, John, is it the case that the government backs these loans from Fannie Mae and Freddie Mac?

YDSTIE: Well, the law that created Fannie and Freddie says the government does not guarantee these loans, but I think we're finding out that the government does stand behind them.

We heard from many government officials what appears to be obviously - obvious, that they're too big and important to go under, and that strongly suggests the government guarantees them.

BLOCK: Okay, NPR's John Ydstie. Thanks so much.

YDSTIE: You're welcome.

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Why Fears About Fannie And Freddie Are Growing

Concerns about the financial stability of housing finance giants Fannie Mae and Freddie Mac — and whether they might need a federal bailout — have sent shares of the two companies tumbling.

The two firms, which have a quasi-governmental status, were chartered by Congress to help make money for home mortgages more readily available. Together they hold or guarantee about $5 trillion worth of mortgages, making them key players in the nation's housing market. As credit markets have dried up, Fannie and Freddie have played a pivotal role in keeping mortgage markets afloat. The fear is that the failure of one or both would wreak havoc on the nation's financial system — and the broader economy as well.

Here, a look at concerns about Fannie and Freddie.

Why are investors so worried now about Fannie Mae and Freddie Mac?

Fannie Mae and Freddie Mac are the largest buyers of home loans in the nation. They buy home loans from lenders, then hold them in their portfolios or repackage them into bonds — known as mortgage-backed securities — that are traded on Wall Street.

But the big thing they do is guarantee all the loans that they sell to investors. So if a homeowner defaults on a mortgage, Fannie and Freddie will step in and make good on the loan. Right now, they are guaranteeing trillions of dollars' worth of loans.

Of course, now homeowners are defaulting and being foreclosed on at alarming rates, so Fannie and Freddie are being forced to make good on those guarantees to investors. Already they've posted combined losses of $11 billion, and investors are worried there's much more to come.

How much financial trouble are the firms in?

Fannie and Freddie are clearly suffering from the problems in the mortgage industry, says William Seidman, publisher of Bank Director magazine and former chairman of the Federal Deposit Insurance Corp.

"At the present time, from all we know, they are not insolvent, but they are certainly weakened," he says.

On Thursday, the agency that regulates Fannie and Freddie — the Office of Federal Housing Enterprise Oversight — said the two companies had enough cash on hand to keep doing business. Treasury Secretary Henry Paulson agreed.

What sparked the sell-off in shares of Fannie and Freddie?

Shares of the two firms have been dropping for months as the housing downturn has worsened. This week's slide was sparked in part by a report from Lehman Brothers analyst Bruce W. Harting. He warned that a proposed accounting rule change would require the two companies to keep a lot more capital on hand. Fannie would have to add $46 billion to its reserves; Freddie would need to add $29 billion.

The large sums spooked investors, who worried about the firms' abilities to raise that kind of cash in the current tight credit market. And the sell-off began. Then later in the week, a former Federal Reserve governor, long a critic of Fannie and Freddie, said they were already insolvent, and he urged the government to take them over. Of course, if the government takes over, shareholders are likely to get nothing, so investors have been scrambling to sell their shares. Both stocks are at historic lows, with steep declines of more than 80 percent from a year ago.

So is a government bailout likely?

Some analysts say a bailout is unlikely and that in any event, it shouldn't be hurried. They say there's still time for Fannie and Freddie to raise additional capital. Others say the time to act is now, before things get even worse.

On Friday, Secretary Paulson signaled that a government takeover wouldn't be necessary, saying that Fannie and Freddie should continue as shareholder-owned companies.

What if Fannie Mae and Freddie Mac failed?

Fannie and Freddie's role is particularly important nowadays: With the credit market drying up, the firms have often been the "buyer of last resort" for a mortgage at a time "when a broad-based buyers' strike threatened to paralyze the markets," Lehman Brothers' Harting writes in a research note. Any threat that they might fail, he says, "could trigger a meltdown in credit markets."

William Seidman adds that if the two firms' guarantee was considered "no good," it would result in "huge losses throughout the world" among financial systems that own their bonds and hold their guarantees.

What about the practical effect on the housing market if these mortgage giants were to go under?

If they went out of business, it would totally disorient the private housing markets, Seidman says. "It would be as close to a disaster as I can think of," he says. "If they could no longer package and guarantee mortgages, funding availability for housing in the United States would be drastically reduced."

I'm still not clear on this: Does the government back these loans?

Well, the law that created Fannie and Freddie explicitly says the government does not guarantee the loans. But many government officials have said that Fannie and Freddie are too important to allow them to fail. New York Sen. Charles Schumer (D), chairman of the Joint Economic Committee, has said that "it would be devastating to the economy" if Fannie Mae and Freddie Mac went under. If they need additional support, he said, "the federal lifeline has always been there."

Compiled from NPR staff reports. The Associated Press contributed to this report.

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