July 8th, 2010 11:42 AM by Richard T. Cirelli
Who Would Finance Mortgages If Fannie, Freddie Disbanded?
Our Government has struggled with what to do with Fannie Mae and Freddie Mac. Remember, these are the two major providers of mortgage money in our country. They became nationalized about two years ago when they failed to remain solvent during the mortgage meltdown of 2008. Now the U.S would like to get rid of these two money-losing entities that are responsible for providing standard underwriting guidelines and are the source of money to almost every mortgage lender and borrower.
As the system works now with the two entities, Fannie and Freddie, banks write the mortgages, but they rarely hold them. The mortgages are sold off into pools, known as Mortgage-Backed Securities (MBS's). Fannie and Freddie guarantee the mortgage payments, so that the MBS buyer, be it the Chinese government or an American pension plan, has the security of the US government behind them. Their only risk is in the interest rate.
This system worked great for years. In fact, so great that Fannie and Freddie shareholders got rich because the companies borrowed money in the markets with an implied government guarantee.
But without the guarantees, there would be no securitization, no capital from the rest of the world for long-term fixed rate mortgages and banks would have to hold their mortgages indefinitely, decreasing the availability of mortgage money to others.
Our leaders have been meeting to decide how to ultimately divest the Government of these two entities. I'm sure it will be a long time before it's decided. First, the housing and the economy must recover. Earlier this year, Treasury Secretary Tim Geithner laid out a general outline for how the Obama Administration would reform Freddie and Fannie. "While the form of the housing finance system will change, government has a key role to play in shaping the future of the nation's housing finance system," said Geithner.
Other experts, including Edward DeMarco, director of the Federal Housing Finance Agency (FHFA), contend that ending the subsidies that Fannie and Freddie provide could cause a catastrophe if it's done too quickly or their functions are not replaced. Mortgage rates would go up 2% to 3% and home prices would drop precipitously-between 10 percent and 30 percent-according to some experts.
To avert problems and allow private firms to re-enter the $10 trillion mortgage market, DeMarco suggests a transition phase in which a new infrastructure for the home financing system is put in place.
In the meantime, while we don't necessarily like the stricter underwriting guidelines created by Fannie Mae and Freddie Mac over the past couple of years, we need these entities to continue providing liquidity and mortgage money to our fragile economy. And while the fate of Fannie and Freddie are debated, Mortgage Rates are at an All-Time Low!
Mortgage Rate Update: