The Fannie Mae, Freddie Mac Factor

Fannie Mae and Freddie Mac gain strength via federal support.

September 1, 2008

The stock prices of mortgage giants Fannie Mae and Freddie Mac have dropped dramatically this summer, prompting the federal government to take the unusual step of making its support of the government-sponsored enterprises explicit.

Why are the companies’ share prices falling? Investors fear they will collapse because of rising mortgage defaults driven by home price declines.

What are the default rates on loans held by the companies? For Fannie, 1.22 percent for single-family loans delinquent 90 days or more, up from 0.62 percent; for Freddie, 0.81 percent, up from 0.49 percent. The figures are for April and were reported in The Wall Street Journal.

What happens if they collapse? Mortgage rates will rise much higher.

Will they collapse? Not likely. The Office of Federal Housing Enterprise Oversight, the companies’ regulator, says Fannie and Freddie have enough capital to withstand extreme conditions.

What if the extreme conditions are realized and their capital runs out? Then they’ll need to raise capital by issuing more stock. Given the belief—made explicit in July by federal regulators—that Fannie and Freddie will be backed by the government, the process of raising capital should be easy.

What happens if home prices fall much further than anticipated and the newly raised capital runs out or stock prices fall to zero? The federal government will take over the companies (without a doubt) and assume the mortgage debt default risk.

Does this mean that taxpayers will lose $5 trillion? No, the U.S. government might lose some money or even possibly make money if defaults slow down.

But, I keep hearing that $5 trillion in taxpayer money is at risk. The $5 trillion would be lost only if all mortgages are written off. This assumes everyone no longer pays mortgages.

Lawrence Yun
Chief Economist and Senior Vice President of Research at the National Association of REALTORS®

Yun oversees and is responsible for a wide range of research activity for the association including NAR’s Existing Home Sales statistics, Affordability Index, and Home Buyers and Sellers Profile Report. He regularly provides commentary on real estate market trends for its 1.3 million REALTOR® members.

Dr. Yun creates NAR’s forecasts and participates in many economic forecasting panels, among them the Blue Chip Council and the Wall Street Journal Forecasting Survey. He also participates in the Industrial Economists Discussion Group at the Joint Center for Housing Studies of Harvard University. He appears regularly on financial news outlets, is a frequent speaker at real estate conferences throughout the United States, and has testified before Congress. Dr. Yun has appeared as a guest on CSPAN’s Washington Journal and is a regular guest columnist on the Forbes website and The Hill, an “inside the beltway” publication on public affairs.

Dr. Yun received his undergraduate degree from Purdue University and earned his Ph.D. from the University of Maryland at College Park.