11 September 2008
Government Rescues Two Biggest Mortgage Companies
Help meant to stem further problems in housing market
Washington — The decision of the U.S. government to seize control of America's two largest mortgage companies, known as Fannie Mae and Freddie Mac, could cost taxpayers many billions of dollars. But the move was made to prevent what many feared could be an even costlier scenario: a possible collapse of the two companies, with disastrous consequences for the housing and financial markets.
President Bush said in a written statement that the government had to act because the companies' problems posed “an unacceptable risk” to the American economy.
The companies are an unusual type of enterprise: private corporations owned by their shareholders but created at the initiative of the U.S. Congress and mandated to provide funding to keep housing affordable. Fannie Mae, short for Federal National Mortgage Association, was established during the Great Depression of the 1930s. Freddie Mac, short for Federal Home Loan Mortgage Corporation, was created in 1970 to provide competition. Together they employ 11,000 people and own or guarantee about half of the $12 trillion in housing loans in the United States.
The Census Bureau reports that 68 percent of U.S. households own the home in which they live. The United States economy is bolstered by home ownership, and owning a home is considered an important part of the “American Dream” that immigrants and young people strive for. These mortgage companies play an important role in expanding the rate of homeownership.
The companies do not issue mortgages themselves, but they provide capital to make sure home buyers can get low-cost loans. They do this by buying mortgages that approved lenders have made. They sell some to investors as mortgage-backed securities and keep some themselves for their own investment portfolios.
The two companies profited from the housing boom of recent years. But they were done in by the so-called “subprime” housing crisis, in which banks and other lenders made a growing number of home loans with variable interest rates to people who could barely afford them. When interest rates rose, more and more borrowers defaulted.
This set off a vicious cycle: Mortgage defaults have left banks and other lenders with big losses. The losses forced them to tighten restrictions on loans. Even though house prices have fallen substantially, fewer would-be home buyers have been able to get loans. This has hurt lenders’ business even more and contributed to a weak housing market.
The growing number of mortgage defaults has caused Freddie and Fannie together to lose nearly $14 billion over the last year.
Ordinary people are suffering too. More than 1 million American families lost their homes over the last year. A further 9 percent of U.S. home mortgage holders are behind in their payments or face repossession of their houses.
Many feel the situation would get far worse if Freddie and Fannie were allowed to collapse. So the government appointed new managers to reorganize and run the companies, and pledged to provide the companies with huge sums of money if they are unable to repay their debts — up to $100 billion for each company.
U.S. Treasury Secretary Henry M. Paulson Jr. announced the administration’s rescue plan Sunday, September 7. It was the government's most ambitious move so far to end the recent crisis in the housing market.
Under the plan, the government places the two companies in conservatorship, which is similar to what a court does when it appoints new directors to reorganize a bankrupt business. The administration immediately named new managers to head the two companies.
Paulson would not say how much money the government might end up putting into the companies to keep them afloat. Two months ago the Congressional Budget Office said such a move could cost U.S. taxpayers $25 billion. Some observers say it could be much more.
“Our economy and our markets will not recover until the bulk of this housing correction is behind us,” the Treasury secretary said. “Fannie Mae and Freddie Mac are critical to turning the corner on housing.”
Paulson said the rescue plan was designed with three main objectives: stabilize financial markets, ensure the continued availability of mortgages for home buyers, and protect taxpayers.
Under the plan the two companies will modestly increase the amount of money they make available for home loans until the end of 2009 to stabilize the troubled housing market. Starting in 2010, the companies will gradually reduce the volume of their business.
The government will pay an initial $5 billion to purchase mortgage-backed securities from the two companies. Observers say this injection of government money should help lower interest rates on the home loans that Americans obtain.
The plan, which quickly won support from both main political parties, guarantees repayment of the companies’ debt, much of it held by Asian central banks and municipal pension funds in the United States.
Freddie’s and Fannie’s shareholders do not benefit from such a guarantee.
A statement by Treasury Secretary Paulson and a fact sheet on the conservatorship are on the Treasury Department’s Web site.
The text of the statement by President Bush is available on America.gov.
