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Mortgage giants falter

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

By Staff writer of The Christian Science Monitor / July 14, 2008

SOURCE: Fannie Mae, Freddie Mac, Yahoo! Business/© 2008 MCT

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Their odd names hint at something significant: Fannie Mae and Freddie Mac aren't ordinary corporations, and when they're in trouble, the whole US economy takes notice.

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It's not an exaggeration to say that the cost of mortgages, the value of people's homes, and even America's path through the current economic slowdown all hang to some extent on these mammoth conveyors of credit.

And they are in a tough spot.

They have a federal mandate to make sure mortgage loans keep flowing. Yet with the US in the throes of a historic housing downturn, both corporations are losing money.

These are not federal agencies, but suddenly talk of possible taxpayer bailouts is in the air after a big plunge in their share prices last week.

Such a bailout is unlikely, and talk of a crisis is premature, say some experts. But even so, the problems at Fannie and Freddie could well push mortgage costs higher – and make it harder for the housing market to recover.

"They're clearly in deep trouble," says Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pa. "It does highlight the severity of the housing downturn. It's a problem for every homeowner."

In fact, the sudden erosion of investor confidence in these giant enterprises symbolizes one of the economy's great risks – that of a downward spiral in which the housing slump weakens financial institutions and then their problems bounce back and cause still more weakness in the economy and in home prices.

One new sign of the housing market's challenges: On Friday federal regulators seized the faltering mortgage lender Indymac. It will rank among the largest bank or thrift-institution failures in American history.

Throughout the industry, moreover, rising loan losses are impairing the ability of many banks to extend new credit.

Although Fannie and Freddie don't directly make home loans, they are the players who enable a key step in the life cycle of most mortgage loans: resale from the original lender to another institution or to investors. These rival twins either buy loans or guarantee their quality so that other investors will buy them.

Together, the loans they hold or guarantee exceed $5 trillion, or about half the balance of outstanding US mortgages. They're involved in an even greater share of all loans being originated in the current tough market.

When investors or lenders see higher risk – whether at Fannie and Freddie or at mainstream banks – they want something in return. That translates partly into higher mortgage rates, experts say.

And investors do see high risk. Fannie and Freddie each lost about half their stock market value during last week's trading.

"Mortgage rates would be lower now if we didn't have the amount of risk priced into the credit markets that we do," says Michael Darda, an economist at MKM Partners in Greenwich, Conn. "The stock market in general ... is telling us that there are still tremendous strains on the [banking] system. That's going to be a headwind to the economy for the balance of the year."

The typical mortgage rate on a 30-year loan remains relatively low, at about 6.3 percent, according to Freddie Mac. But that's up from about 5.8 percent in January. A range of factors affect mortgage rates - and in this case rising expectations of inflation – have probably played a role as well.

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