The Feds Takeover Fannie and Freddie

The immediate impact of the Federal Government’s takeover of Fannie Mae and Freddie Mac is a drop in the conforming (under $417,000) 30-Year Mortgage rate. The Feds have indicated that they will not only inject capital as needed into Fannie and Freddie, but they will give a guarantee to the mortgage-backed securities issued by these firms as well as committing to buy up to $6 Billion in securities. This gives stability and liquidity to a troubled market that has been limping along in search of good news.

While it has been reported that the potential rate drop is one point, that actually translates into a rate drop between .25% and .375%. Consequently, the 30-Year Fixed rate today is around 5.75%. To put this into perspective, the last time we saw this rate was January 2008. The difference between the 10-year government bond yield and the average U.S. fixed mortgage rate has averaged 2.3 percent this year through last week, compared with 1.6 percent during the prior four years, as lenders and investors demanded higher rewards for owning mortgage bonds. Now that the Federal government is backing Fannie Mae and Freddie Mac, that “risk spread” will move closer to the historical average. Rates could drop by as much as much as three-quarters of a percentage point.

Fannie and Freddie have always had a tacit government guarantee; it was not codified by law, but we all thought that, in need, the Federal government would step in; and they have. The primary reason for the move is to give a sense of confidence to investors (such as foreign governments and large pension funds) in mortgage-backed securities. The weekend move was met by a rebound in the stock market and a sense that things might be getting better. However, “This euphoria might fade, because Fannie and Freddie are not the problem,” said Christopher Low, chief economist at FTN Financial. “Their woes are a symptom of a worldwide contraction in credit that may not be cured by the decision.”

One of the major drivers for the Fed takeover has been to calm the disquiet of major purchasers of Fannie and Freddie debt. The Chinese government is the largest holder with some $365 billion, followed by Japan and Russia. Presumably, now, they and others may be willing to buy more bonds. The losers in this deal are the shareholders and the holders of preferred debt who will lose most of their investment; these are hedge funds and banks.

How will this move affect home prices? Stability on the financing side may ultimately provide a benefit, but there remains a huge inventory of unsold homes which will continue to weigh on prices. It continues to be more difficult to qualify borrowers today because there is less competition; in the last year, almost 80% of the lenders in New Mexico have gone out of business, and there are fewer loan products. Nevertheless, large national lenders are still pursuing new loans and there is money for purchases and refinancing for those who qualify. As a counter to this, though, is the idea that the Federal caretakers may ultimately tighten guidelines and make it even harder to borrow. Lenders are looking for good credit and full documentation; however, in certain situations, there are still loans which will allow stated income and loans up to 100% of the purchase price.

Jumbo loans (in New Mexico, over $417,000) still are a struggle, with rates easily 2% above conforming. A 30-Year Jumbo is 8.25% this morning.

While the Fed takeover is probably good news, we still live in a global marketplace which is affected by events beyond the scope of our government. Huge inventory and present and future foreclosures weigh heavily on the health of the market, and this move has done nothing for larger loans. Nevertheless, with rates this low and prices substantially lower in most price ranges, it is still a very good time to buy or refinance.