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Lost in Translation: What Does the Fannie and Freddie News Mean for You?

Sep 10, 2008 - Fannie Mae and Freddie Mac have been at the forefront of business discussions for months as the housing market has imploded. But the two organizations' fates were sealed this weekend when Treasury Secretary Henry Paulson announced plans to take over the beleaguered companies.

The bailout has people talking, markets roiling, and presidential campaigns chomping at the bit. But what does it mean for you? Here we analyze what happened, why, and what the future holds for consumers and borrowers.

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How did we get here?

Fannie Mae and Freddie Mac was extremely hard hit by the downturn of the housing market and the general economy. Operating as private, shareholder-owned corporations for almost 40 years, these government sponsored entities worked to boost the availability of home loans and provide market stability. But since the subprime collapse and ensuing housing slump, the companies have been hit with more than $500 billion in losses.

This year alone, the companies have lost $14.9 billion, forcing them to increase their borrowing costs and causing major anxiety and confusion for the entire economy. The integral role of the companies in the mortgage market and greater economy, represented by their ownership and/or guarantee of almost half of the $12 trillion in U.S. home loans, caused stocks to plummet and added to talks of recession.

The Treasury stepped in after accounting analysis by Morgan Stanley, revealing that the two companies relied on accounting “maneuvers” to meet their capital requirements. The companies were overstating the value of their actual reserves. The government decided it was time to act to preserve economic stability.

What are the Feds going to do?

The Treasury plans to put the two organizations into a conservatorship and inject capital into both. In the process, the chief executive officers will be forced out. The government will continue to make periodic deposits of funds into the companies by buying convertible preferred shares or warrants. The idea is that this method will avoid large upfront taxpayer costs.

The method is also designed to keep other financial institutions, which are the biggest holders of the companies' preferred shares, safe. The companies' assets will be preserved rather than disposed of, goes the plan.

Does anything else change?

Only the entire organization of the companies. Since their inception, Fannie and Freddie have been government-sponsored entities. With the takeover by the Federal Housing Finance Agency and leadership change, the change is being called one of the most radical in global economic and financial arenas in years.

I'm looking to get a mortgage. What's this mean for me?

The takeover could mean a slight reduction in interest rates (30 year mortgage rates), as well as a boost in the availability of credit. Fannie and Freddie will now have the capital to do more of what they were created to do: buy mortgages from other banks, create mortgage-backed securities to sell, and as a result pump more money into bank reserves. This means more funds for more mortgages. And it means the credit crunch could ease up.

I'm a homeowner. What does this mean for me?

Home prices are falling, and many homeowners find themselves in a position where their mortgage is worth more than their home. This bailout could help towards stabilization of prices, with more funds available for borrowing and less anxiety in the economy. That means things could be looking up for many homeowners lamenting their eroding home value.

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Now the big question. What does this mean for my taxes?

That's the rub. Taxes will not be raised in order to finance this takeover and provide funds for the companies. But in effect, the companies will have an unlimited taxpayer-funded credit line, which could bode poorly for the future. In addition, this plan plunges the country into even further debt, creating an even more precarious national economic situation.

For Further Reading:
Paulson to Take Over and Restructure Fannie, Freddie: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aehgn34fooGc

Mortgage Rates May Fall After Fannie, Freddie Rescue: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ag65X0mdQ_r0

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