Will taxpayers be on the hook for subprime crisis?
Federally linked entities like Fannie Mae now back 98 percent of home loans sold by banks.
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Those two enterprises, plus the FHA, have long been titanic forces in housing (see chart). But today they have become even more important. Without them, new credit for home loans would have virtually dried up. That’s because losses on defaulting loans are prompting banks to retrench and investors to stop buying mortgage debts that don’t carry a guarantee from Fannie or Freddie, or FHA insurance.Skip to next paragraph
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Rather than holding on to home loans, mortgage lenders sell most of them. In 1995, Fannie and Freddie bought the bulk of those loans and then resold them to investors. At the peak of the real estate boom, other investment firms competed for that business, churning out complicated investments laden with subprime loans, where the bulk of defaults and foreclosures are occurring today. Now that competing business has dried up, leaving Fannie and Freddie accounting for the lion’s share of current activity.
“It’s going to take a long time for volumes to come back” in private mortgage-backed investments, says Timothy Crandall, senior vice president of US Bank Home Mortgage in Minneapolis. For quite a while, he predicts, the reliance on so-called GSEs (government-sponsored enterprises) will continue.
In a bid to ease the housing crisis, politicians are calling on the GSEs to ramp up lending and refinancing activity.
They have authorized Fannie Mae to guarantee “jumbo” loans of up to $730,000 in high-cost markets such as California that are now struggling. And they have criticized Fannie Mae for not following through faster on this mandate.
But regulators and lawmakers also hope to limit the downside risks for taxpayers and for the GSE shareholders.
The Bush administration has argued that it can expand refinancing activity without new legislation such as the FHA program being considered this week in the House. In an effort to keep President Bush from vetoing the bill, Rep. Barney Frank (D) of Massachusetts has moved to package it with other measures supported by the president, such as strengthening regulatory oversight of Fannie and Freddie.
Many analysts say new efforts by Fannie, Freddie, and the FHA need not involve a large taxpayer tab if the process is carefully managed. Still, the risk is significant.
Fannie and Freddie have been moving to raise new capital in order to retain a required cushion as mortgage defaults rise. But some analysts say they have been allowed to operate with capital reserves that are much lower than those of ordinary banks. Between them, the two enterprises have $90 billion in capital, compared with a mortgage business valued at $5 trillion.
Before taxpayers would take any hit, shareholders in Fannie Mae and Freddie Mac stand to lose. Both corporations’ stock-market value has plunged over the past year. Dividend payments have been reduced.
Also, mortgage bankers now have to pay higher fees to channel their loans to the GSEs.
“The cost to us has almost doubled,” says Mr. Crandall.