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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.

By Staff writer of The Christian Science Monitor / May 8, 2008

SOURCE: UBS/Rich Clabaugh–STAFF

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With a nationwide housing crisis far from over, the risk of future mortgage losses is rapidly shifting from the private sector toward government – and potentially US taxpayers.

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This is occurring partly by choice, as policymakers try to stop a wave of foreclosures.

It is also happening by circumstance, as the crisis has left government-linked entities as the lenders of last resort in a troubled marketplace.

One symbol of rising risks came on Tuesday, as mortgage giant Fannie Mae announced a $2.2 billion loss for the year’s first quarter. The Federal National Mortgage Association, the official name that has been shortened to Fannie Mae for convenience, is not officially part of the government.

But its public charter, created in the wake of the Depression, is to help make sure that home loans remain available in bad times as well as good. That mission has helped avoid a total shutdown of mortgage markets over the past year. But it means that Fannie, along with entities with a similar mission, are assuming the risks that come with making loans at a time when house prices continue to fall.

“They are fulfilling their mission ... but concentrating risks on themselves,” Edward DeMarco, deputy director of the Office of Federal Housing Enterprise Oversight, told a conference of mortgage bankers this week in Boston.

Home prices have been falling by double-digit rates in many metro areas, yet the inventory of homes for sale remains sky-high.

The great worry is that, rather than stabilizing, the housing market will spiral downward. Homeowners default in greater numbers when their loan balances exceed the value of their homes. That, in turn, results in more foreclosures and downward pressure on prices.

This explains the pressure on the government-linked enterprises to steady the market.

The House of Representatives appeared poised to vote Wednesday on a bill designed to stem a record tide of foreclosures.

Among other things, the bill would call for the Federal Housing Administration, a government agency, to let cash-strapped homeowners refinance into more affordable, fixed-rate mortgages. Before the FHA agreed to refinance the loans, the current lenders would have to agree to take substantial losses. That means the federal agency would insure a loan that’s smaller than the original one, for about 85 percent of the current value of the home.

The approach might help half a million borrowers keep their homes, according to the Congressional Budget Office. That would help at a time when foreclosures are running at a pace of more than a million a year.

But it would leave the government vulnerable if a high number of borrowers later default on their new, FHA-insured loans. Traditionally, FHA borrowers pay premiums that cover this default risk. Taxpayers might be on the hook in a scenario of high defaults and collateral (property) that falls another 15 percent or more in value after the refinancing.

Fannie and its sibling, Freddie Mac, don’t carry official backstopping by US taxpayers. But they are widely seen as institutions too large and important to be allowed to fail if they ever faced bankruptcy.

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