Mortgage giants falter

Trouble at Fannie Mae and Freddie Mac could have broad impact.

from the July 14, 2008 edition

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"They are very highly leveraged," Mr. Zandi says. Their assets may be 30 times capital or greater, he says, "depending on how you do the math."

And in today's housing market, with rising delinquencies and falling home prices, even the safer sides of the mortgage business carry risks. A$5 trillion book of business leaves lots of room for losses to seep into quarterly reports.

A key concern for Fannie and Freddie shareholders: how much new capital the firms will need and whether they'll be able to raise it without government help. By some estimates, they may need $75 billion in new money.

They can raise capital by reducing dividends or by tapping private investors. The expectation of such moves – and the risk of a worst-case scenario in which a government rescue effectively wipes out private shareholders – has hurt the value of current shares.

But many experts say it's far from clear that a formal rescue will be needed.

"We are not in a crisis at this point," says Susan Wachter, a mortgage market expert at the University of Pennsylvania's Wharton School. "This is a moment of lack of confidence."

One positive sign: The companies so far have been able to continue borrowing as usual to fund their operations.

On Friday, statements from government officials and the companies themselves sought to quell public anxiety. Share prices closed far above their lows of the day.

Sen. Charles Schumer, a New York Democrat involved in congressional oversight of the industry, said the firms' "fundamentals, as they look now, provide no reason to think they will fail."

If federal support became necessary, he added, it could come in ways that are much less extreme than a government takeover. That may be of only modest comfort to investors, but such statements do offer some important reassurance for the economy.

"Mortgage markets will keep functioning," whether government help is needed or not, Ms. Wachter says. Still, she says, the trials at Fannie and Freddie have already pushed up mortgage interest rates somewhat for all Americans.

"It makes mortgages more expensive and harder to get," she says. If their finances weaken, "there would be higher costs in the short run and maybe even for the long run."

If loans cost more, that challenges a housing market that already has unusually large inventories of homes for sale. Ultimately, it pushes home values down for all homeowners, because the pool of buyers can't afford to bid as much on houses.

"This certainly delays the day when the housing market turns the corner," Mr. Zandi says. He sees significant risk that the trends of tightening credit conditions, rising unemployment, and runaway mortgage defaults feed on one another and deepen the economy's slump.

"You may not want to let this drag on," he says, suggesting that policymakers try to tame rising defaults and record foreclosures.

The Senate voted Friday in favor of one such measure, designed to allow many at-risk loans to be refinanced, with government insurance, so that cash-strapped borrowers don't default.

It's not clear whether the measure will make it into law.

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