Fannie and Freddie to allow principal reductions

In a reversal of a long-held stance against principal reductions, both Fannie Mae and Freddie Mac have agreed to allow principal reductions for underwater homeowners under certain conditions. From an L.A. Times story:

In a rare victory for proponents of principal reduction,Fannie Mae and Freddie Mac said they will immediately allow their borrowers to participate in Keep Your Home California and other states' Hardest Hit Fund programs that shrink the mortgages of troubled borrowers using taxpayer funds...

Where do they stand? Obama vs. Romney on housing policy

After several years of false starts, there finally appear to be more green shoots appearing in the nation’s housing market which indicate a slow yet actual rebound.  Sales of both new and existing homes are on the mend, affordability is at generational highs, and the dreaded tsunami of foreclosures expected to lower prices even further have largely been bought up by investors to re-purpose as rental properties.  Even better, according to Moody’s housing analyst Celia Chen, homeowners will begin to favor newly built homes versus distressed homes which are damaged.

Nonetheless, because the economy remains the top concern of most voters in the 2012 Presidential election, how President Barack Obama and the GOP’s presumptive nominee Mitt Romney influence housing policy is of critical importance to homebuilders and homeowners alike.  As a political Independent for well over a decade, I may have no abiding loyalty towards either major party, but I do certainly want what’s best for the industry and, by extension, the country.

According to the NAHB, the housing sector normally accounts for 15% of the nation’s GDP, and is one of the few sectors which cannot be out-sourced to other countries across the globe.  Based on population growth and demographics, the nation will have to build 17 million new residences just to keep up with demand over the next decade, and yet for now the industry remains largely hamstrung by deferred household formations, limited construction financing, and a flawed appraisal system in which new homes erroneously get compared against deeply discounted distressed and foreclosed units.

So can market forces alone help guide this all-important sector of the U.S. economy to health, or will it continue to need more help?  The answer to that question depends on whom you ask.

For Mitt Romney, while there is nothing on his campaign Web site which specifically addresses housing, he seems to rely more on the private market to sort things out.  According to Glenn Hubbard, an economic adviser to Romney, the domination of housing finance by government entities such as the FHA, Freddie Mac and Fannie Mae is simply not sustainable and must be phased out in favor of private lenders.

At a recent campaign event in Florida, Romney also reportedly mused about getting rid of agencies such as the Department of Housing and Urban Development (HUD) as part of his plans to simplify the federal government.  As for foreclosures, he prefers to let the free market let prices hit ‘rock bottom’ as opposed to government policies which would seek to make such declines more orderly.

President Obama, on the other hand, seems to believe that continued intervention by the federal government – at least in the short to medium run -- is essential to providing adequate mortgage capital and even to help underwater borrowers refinance, with restrictions, to today’s historically low rates.  He probably doesn’t have much choice:  given that his previous attempts to bolster the housing market haven’t worked at even close to the scale that is necessary – with less than 20% of homeowners eligible for loan modifications -- if government intervention is to work at all, the policies must be more aggressive.

More recently, Obama seems to have absorbed this criticism, unveiling more than a half dozen plans to encourage refinancing, to reduce the overhang of debts owed by underwater homeowners, and to expand existing aid programs even to borrowers who were speculators or simply took on too much debt.  These latest moves seem as much practical as they are political, since the previous obsession with refusing to help those who made financial mistakes has really acted as a structural brake on the economic rebound.  Schadenfreude may feel good to the individual, but it does nothing to fix the housing market.

Since the Obama Administration has put the housing market back on its front burner, I’d expect the Romney campaign to do the same.  But given that the federal government continues to guarantee or insure more than 90% of all home mortgage activity through FHA, Fannie Mae and Freddie Mac, candidate Romney will have to offer specifics on just what, when and how the private sector will successfully step up to the plate.

Changes to home mortgages seem inevitable

As I sit here and write this post, the U.S. national debt is climbing past $14.25 trillion, or an average of nearly $46,000 for each citizen. Each day, that national debt rises by about $4.1 billion, as 40% of the 2011 federal budget is made up of borrowed money. Of the Obama Administration’s proposed $3.7 trillion budget for 2012, 30% will go to Medicare and Medicaid, 22% will pay for Social Security benefits, 19% will go for defense-related programs and nearly 13%, or $474 billion, will be used to service the existing debt. So just what does that have to do with mortgage finance? Everything.

For starters, in order to reclaim up to $131 billion in annual foregone tax revenue, the National Commission on Fiscal Responsibility and Reform has the long-standing mortgage deduction in its crosshairs, to be replaced by a 12% tax credit that would help those who don’t itemize their deductions but punish many who do. Not surprisingly, trade groups representing real estate agents and home builders have strongly opposed the idea for a number of very solid reasons.

Meanwhile, however, the leaders over at AARP are also fighting against any changes to Medicare or Social Security that would anger their 40 million-plus members, while lobbyists for defense firms visit Capitol Hill to offer dire consequences resulting from defense cuts. But if no one budges at all and simply throws up walls of discontent at the mere mention of changing the status quo, how do we ever fix this huge – and escalating – problem?

It’s in times like this that true leadership is required, and for the building industry that may require some compromises on not just the tax deduction, but also the nature and duration of home mortgages. Instead of being purely re-active, what if the leaders of NAHB and NAR were pro-active enough to discuss some type of gradual and reasonable changes to the tax code – such as grandfathering in existing owners and leaving it in place under certain conditions to promote homeownership -- but only if commensurate changes are also made to entitlement programs and the defense budget?

Those who want to see the deduction disappear argue that other countries such as the United Kingdom and Italy have phased out their own tax deductions for homeownership and survived – and Canada’s housing market has done quite well without one at all – but those countries’ mortgage markets remain largely the domain of banks, and not of investors buying securities. In the U.S., it’s a different story. That’s also why the fate of the mortgage tax deduction and the market itself – including the phasing out of Fannie Mae and Freddie Mac -- are so closely intertwined.

For a fully private investor such as Bill Gross of Pimco in Newport Beach, CA to buy mortgage bonds, he’s been quoted as demanding a 3% premium to compensate him for his risk. But Moody’s Analytics economist Mark Zandi and a colleague have instead offered up a sort of public-private hybrid solution that would have government insurers act as market intermediaries for mortgage securities but maintain a large bail-out fund and ensure reserve capitals can withstand steep price declines. They claim their plan would keep interest rates competitive while boosting sales, prices and homeownership.

Whatever the outcome, it seems highly unlikely that the system which led to the unraveling of the housing market – and the global economy – will ever return in the same form it was before. Into that vacuum, builders and agents will have no choice but to support eventual reforms that support not just their own businesses, but also the country in which they live. The clock is ticking.

Notes from the May 21st edition of The Kiplinger Letter

For some time now, I've been subscribing to The Kiplinger Letter, which is a weekly newsletter summarizing trends in politics and economics for managers and other decision-makers.

The May 21st edition was chock full of interesting remarks on housing and economics that I wanted to share here:

• The red ink hemorrhage at Fannie Mae and Freddie Mac is far from finished.

The tally of losses since Uncle Sam took the two over will likely double
before all the bad loans made during the housing bubble years are washed out.

So far, the feds have funneled about $146 billion to the two mortgage giants,
and Obama has pledged to cover the duo’s losses, no matter how deep, through 2012.

There’s little chance Congress will undertake an overhaul this year,
and it probably won’t finish up next, either. Republicans want to tackle the issue now,
while there’s a sense of urgency, so they can wind down Fannie and Freddie’s role
over five years or so.

But Democrats won’t agree. They fear that would deal a blow
to the housing market. The two quasi-governmental agencies, along with the FHA,
the Federal Housing Admin., now make or buy nine out of 10 new mortgages.

Delay has an indirect upside. Odds are Fannie and Freddie will be cut back,
but not eliminated, when lawmakers finally hash out what to do with them.
In the interval…more time for banks to repair their balance sheets and beef up lending
and for a private secondary market to revive. Otherwise, lending would be constrained.

• The slowdown in mortgage foreclosures isn’t necessarily good news.

Though the pace is decelerating, it isn’t because fewer homeowners are falling behind.
Lenders are simply taking longer to pull the trigger…12 months instead of about six.

Banks hope that by holding loans and letting delinquent borrowers stay put for now,
they’ll stave off a tidal wave of foreclosures and help to stabilize housing prices.
Short term, it’s good news for hard-hit areas such as Las Vegas and Miami.
But it will drag out the adjustment process. Now the number of foreclosures
isn’t likely to peak until sometime next year. One in eight mortgages is in distress...

• Europe’s woes spell a break for mortgage seekers, purchasing or refinancing.

For the time being, investors are loading up on U.S. Treasuries, pushing yields down
to about 3.2%. That’s translating into a dip in the 30-year fixed rate for mortgages.

The effects won’t last much longer, though. If Greece, Portugal and Spain
get a better grip on their budgets, following through in the coming weeks on promises
to rein in spending, investors’ worries will shift to the mounting pile of U.S. debt
and resulting inflationary pressures. Look for Treasury yields to bounce back up...

To read the entire letter or subscribe, visit www.kiplinger.com.

Can Fannie and Freddie ever exit life support?

A year after the government takeover of Fannie Mae and Freddie Mac, it seems that both mortgage entities would likely fail without the implied guarantee of U.S. taxpayers. First from an AP story via MSNBC Money:

A year after the near-collapse of Fannie Mae and Freddie Mac, the U.S. mortgage giants remain dependent on the government for survival and there is no end in sight.

The companies, created by the government to ensure the availability of home loans, have tapped about US$96 billion in government aid since they were seized a year ago this weekend. Without that money, the firms could have gone broke, leaving millions of people unable to get a mortgage.

Many questions remain about Fannie and Freddie's future, but several things are clear: The companies are unlikely to return to their former power and influence, the bailout is sure to cost taxpayers even more money and the government will have a big role in the U.S. mortgage market for years to come...

A year later, the government controls nearly 80 per cent of each company, and their problems are growing as defaults and foreclosures continue to skyrocket.

The percentage of homeowners who have missed at least three months of payments is normally under one per cent for both companies. Now it's nearly four per cent for Fannie and three per cent for Freddie...

It could be another year before the final taxpayer tab for Fannie and Freddie is known, and that outcome will depend on when delinquencies and foreclosures finally crest.

Barclays Capital predicts the companies will need anywhere from $160 billion to $200 billion out of a potential $400 billion lifeline, which the Obama administration expanded from the original $200 billion set last fall. Most analysts don't expect the money to be returned any time soon, if at all...

For its part, the Mortgage Bankers Association is hoping for an overhaul of both GSEs into smaller, more manageable pieces. Can anyone say "turf war?" From a Reuters story via MSNBC:

The U.S. Mortgage Bankers Association said on Wednesday it will ask Congress to transform mortgage lenders Fannie Mae and Freddie Mac into several smaller, privately held companies that would issue mortgage securities with a government guarantee.

The proposed framework from the industry group would give successor entities to Fannie Mae and Freddie Mac the authority to create securities backed by certain types of mortgage...

"The government has an important, limited role to play to ensure a stable flow of funds for mortgages," said Michael Berman, MBA's vice chairman and chairman of the Council on Ensuring Mortgage Liquidity.

The MBA plan calls for government agencies, rather than the new companies, to assume the "mission" of promoting affordable housing that Congress has long assigned to Fannie and Freddie.

The number of new companies would be initially limited to two or three, the MBA said.

Fannie Mae and Freddie Mac were not immediately available for comment.

Fannie and Freddie reportedly in critical condition

Remember those wild childs Fannie Mae and Freddie Mac, taken over the federal government (i.e., all of us) last fall? Apparently they're still beset by multiple problems and are still not able to operate without government assistance. From a CNN story:

Fannie Mae and Freddie Mac, charged with helping lead the nation out of its housing crisis, are facing "critical" financial problems, federal regulators said Monday.

The companies suffer from severe financial, operational and compliance weaknesses, the Federal Housing Finance Agency said a report to Congress detailing its annual examinations of the firms. Taken over by the government in September, Fannie and Freddie are not able to operate without federal assistance.

"With new senior management teams, each enterprise has made strides in remediating problems," the agency said. "But they still face numerous significant challenges including building and retaining staff and correcting operational and credit management weaknesses that led to conservatorship."...

To continue functioning, the firms have drawn down about $60 billion of their combined $400 billion lifeline from the federal government. Fannie reported a $23.2 billion quarterly loss and Freddie a $9.9 billion quarterly loss earlier this month.

One hurdle to putting Fannie and Freddie back on firm financial footing is the many vacancies in their executive ranks. Hiring has been slowed by compensation concerns, the agency said.

While the housing meltdown prompted the companies' near collapse in 2008, this year will also be difficult. Fannie Mae will face challenges as it works with servicers to help troubled borrowers and to manage and sell a growing inventory of foreclosed properties, the agency said. Freddie Mac, meanwhile, needs to improve its internal controls and find a chief executive officer.

Mortgage industry throws more hurdles onto borrowers

Although home prices continue to fall and mortgage rates are historically low, nervous lenders continue to pile on new fees and requirements for borrowers hoping to jump back into the market. From the "Nation's Housing" column in the L.A. Times:

Take Fannie Mae's and Freddie Mac's add-on fees for loans purchased after April 1. In some cases, applicants are being hit with extra fees of 3% to 5% because of the type of property they want to buy or refinance, their credit scores or the size of their down payment.

Some major lenders who sell loans to Fannie and Freddie are going further -- tightening underwriting rules beyond what either corporation requires...

Fannie Mae now has a mandatory fee of three-quarters of a percentage point on all condominium loans, no matter how high the applicant's credit score...

On top of these extra fees, borrowers are now starting to get hit with two sets of cost-raising appraisal rule changes. Fannie and Freddie have begun requiring all appraisers to complete an extra "market condition" report that includes detailed statistical analyses of local sales and pricing trends -- above and beyond the regular appraisal data. Many appraisers are charging an extra $45 to $50 for the time required to complete the form. Home buyers and refinancers can expect to pay the higher fees.

On top of that, beginning May 1, Fannie and Freddie are refusing to fund loans with appraisals that do not follow a set of new rules known as the Home Valuation Code of Conduct. Among the procedural changes: Mortgage brokers no longer can order appraisals directly, but instead must allow lenders or investors to use third-party "appraisal management companies" to assign the job to appraisers in their networks.

How does that affect the consumer? Consider the notification one Connecticut brokerage firm recently received from a major lending partner: Starting April 15, all good faith estimates provided to applicants must indicate a flat $455 charge for appraisals arranged through the appraisal management company. The broker previously charged $325. Consumers will now have to pay the appraisal fee upfront -- before any inspection or valuation is completed -- using a credit card, debit card or electronic fund transfer.

What happens if the appraisal comes in low and the applicants can't qualify for the refi or purchase program they sought? Tough luck: They'll have just two choices: Pay another $455 for a second appraisal -- with no assurance that it will solve the problem -- or cancel the application...

Click here for entire column.

Fannie Mae tightens rules on mortgages for new condos

As if the demand for new condominiums units hasn't tanked enough, Fannie Mae is throwing an additional wrench into the system by toughening up lending requirements. From a Wall Street Journal story:

Just as a flood of new condominiums are scheduled to hit the housing market this year, Fannie Mae has added restrictions making it more difficult for developers to sell their units.

The government-backed mortgage-finance company stopped guaranteeing mortgages in condo buildings where fewer than 70% of the units have been sold, up from 51%. In addition, the company won't back loans for sales in buildings where 15% of current owners are delinquent on association fees or where more than 10% of units are owned by a single-entity.

The new policy became effective March 1, and most lenders have started to implement Fannie's guidelines. Freddie Mac, Fannie's chief rival, hasn't yet followed Fannie's lead.

Fannie says the new rules protect borrowers from buying units in buildings that have a high risk of failure while also preventing the companies -- and taxpayers, given that Fannie and Freddie are operating under government conservatorship -- from throwing good money into troubled developments. Developers can petition Fannie for an exemption from the rule, and so far more than 50 exceptions have been made...

Moreover, Fannie and Freddie are both set to increase fees on condo buyers next month. Buyers without at least a 25% down payment will have to pay closing-cost fees equal to 0.75% of their loan, regardless of the borrower's credit score. The companies say these fees are necessary to protect against higher default rates...

The new rules have left developers in limbo. Some are turning their buildings into rental apartments -- at least in the near term -- on the expectation that they won't be able to sell the units anytime soon. Others are selling units in auctions, often at prices discounted steeply enough to entice cash buyers.

Some developers are seeking creative ways to finance units. Asset-management firm New Oak Capital, based in New York, has begun working with developers to offer seller-financing by recycling existing capital from investors and lenders to fund loans that can be sold to investors or lenders once secondary markets recover...

In extreme cases, developers also are beginning to use Chapter 11 bankruptcy protection to restructure and use their remaining capital to provide seller financing. "It's not that there's not demand for the condo; you just can't get the financing," says Craig Rankin, a bankruptcy lawyer representing the principals of West Millennium Group, which has 12 condo projects in Southern California including the Brockman, an 80-unit condo conversion of a historic building in downtown Los Angeles.

Some are turning to their construction lenders to provide seller financing. Projects with multiple buildings are "re-phasing" their development plans to treat each structure as its own condo. Others are offering rent-to-own purchase plans...

Click here for full story.

Obama announces detailed housing rescue plan

This morning President Obama announced details of his plans to help 9 million homeowners avoid foreclosure. First, a summary from the L.A. Times:

• Remove restrictions on Fannie Mae and Freddie Mac that prohibit the institutions, both taken over by the government last year, from refinancing mortgages they own or have guaranteed when more is owed on a home than it is worth. The White House says this could reduce monthly payments for up to 5 million homeowners.

• Create incentives for lenders to modify subprime loans at risk of default or foreclosure. For lenders that agree to reduce rates to levels borrowers can afford, the government will make up part of the difference between the old monthly payment and the new payment. Participating lenders also will be required to cut payments to no more than 31 percent of a borrower's income. Up to 4 million homeowners could benefit.

• Keep mortgage rates low for millions of middle-class families seeking new mortgages. Using money already approved by Congress for this purpose, the Treasury Department and the Federal Reserve will continue to buy Fannie and Freddie mortgage-backed securities to maintain stability and liquidity in the marketplace. The department, through its existing authority, will provide up to $200 billion in capital for this purpose.

• Pursue reforms to help families avoid foreclosure. The administration will continue to support changing bankruptcy rules so judges can reduce mortgages on primary homes to their fair market value, as long as the borrower sticks to a court-ordered repayment plan. As part of the $787 billion stimulus package that Obama signed into law on Tuesday, the administration will award $2 billion in competitive grants to communities experimenting with innovative ways to prevent foreclosures.

If you missed the press conference, you can watch it below:

Are Fannie and Freddie deliberately sending borrowers to FHA?

With both Fannie Mae and Freddie Mac adding tough new restrictions for the loans they're willing to buy -- including larger down payments, higher credit scores and extra fees for buyers of condominiums and duplexes -- it almost seems as if regulators are trying to steer more buyers into the arms of the FHA, which offers down payments as low as 3.5% and looks more at debt levels than credit scores. Of course in order to sell a condo unit, it has to be located in a building approved by FHA. So is this just more government stupidity or is there actually a plan here? From the Nation's Housing column the L.A. Times:

Under Fannie's and Freddie's new guidelines, even applicants who assumed that their FICO scores would get them favorable rates will be charged more unless they can come up with down payments of 30% or higher...

Applicants who seek to buy a condominium and cannot come up with a 25% down payment will be hit with a three-quarter point add-on penalty, no matter how high their credit score, simply because they are not buying a traditional detached, stand-alone home.

Buyers of duplexes, in which one unit is owner-occupied and the other is rented, will be charged a flat 1% add-on from Fannie, even if they've got FICO scores above 800 and make 50% down payments. Refinancers who take cash out at settlement also will be forced to pay extra -- as much as three points if they've got low credit scores and modest equity stakes...

Charles McMillan, president of the National Assn. of Realtors, complained in a letter to the Federal Housing Finance Agency, the regulator of Fannie and Freddie, that individual fee increases were not only unjustified but in combination they could also seriously deter home purchases. McMillan said "a borrower with a credit score of 670 making a 20% down payment for a condominium would have the fee raised from 150 basis points [1.5%] to 350 basis points [3.5%] -- more than double" under Fannie Mae's new schedule...

Where's all this headed? Absent congressional intervention or new marching orders from the companies' regulator, the add-on fees are here to stay. But there's an alternative readily available for just about anyone who wants to avoid the fees: FHA mortgages, where down payments go as low as 3.5% and credit scores are not an issue for most applicants.

Loan work-outs now available before missing mortgage payments

Up until this point in the mortgage crisis, borrowers had to be behind on their payments before lenders would even consider re-working a loan. Now, however, more lenders are allowing 'early workouts' when a wage earner loses a job, thus imperiling a mortgage soon down the road. From Kenneth Harney's column via the L.A. Times:

Here's some good news for homeowners facing tough financial times: You no longer have to miss two to three months of payments before your mortgage firm can modify your unaffordable loan terms.

Fannie Mae, the mortgage giant with an estimated 18 million home loans in its portfolio or in mortgage bond pools it guarantees, now will allow borrowers who face financial difficulties to request "early workout" loan alterations, even if they've never been late.

Fannie's policy change has the potential to help thousands of people who are losing jobs or facing layoffs as the recession crunches onward. Most lenders and loan servicers traditionally have declined to intervene in mortgage problems until borrowers are 60 to 90 days late. So-called loss mitigation staffs may then try to work out solutions through techniques such as rescheduling back payments or extending the loan term.

Under Fannie Mae's revised approach, servicers of the company's loans will be required to inform borrowers that if they are "reasonably" certain that changes in their income will cause them to miss mortgage payments, they might qualify for an advance loan modification -- before they fall behind.

Borrowers who qualify will enter into a trial period of reduced payments, usually for four months. If they make payments on time during the trial, the modified mortgage terms could be made permanent.

Click here for full story.

Would the last honest person in the U.S. please turn out the lights?

I remember last week my reaction to a report that students who cheat still consider themselves "good people" -- a complete and total lack of surprise. I'm sure the heads of Fannie Mae and Freddie Mac also thought the same thing. At least drug dealers and armed robbers know what they're doing is illegal; in some twisted way, that actually makes them more honest than the so-called professionals who've been running the housing industry over the last decade. From an AP story via MSNBC:

Top executives at mortgage finance companies Fannie Mae and Freddie Mac ignored warnings that they were taking on too many risky loans years before the housing market plunged, according to documents released Tuesday by a House committee.

E-mails and other internal documents released by the House Oversight and Government Reform Committee show that former Fannie Mae CEO Daniel Mudd and former Freddie Mac CEO Richard Syron disregarded recommendations that they stay away from riskier types of loans.

Click here for full story.

New mortgage rescue plan falls short

Although a new plan announced by the White House to streamline loan modifications for mortgages held by Fannie Mae and Freddie Mac, critics contend that it will only help a small portion of homeowners and ignores those with sub-prime and Option ARM loans. From a CNNMoney.com story:

The federal government's plan to streamline modifications of troubled loans held by Fannie Mae and Freddie Mac won't help the majority of people threatened with foreclosure, experts said.

Under a plan unveiled Tuesday, homeowners whose loans are owned or backed by the mortgage finance companies and who are at least 90 days behind can enter a streamlined modification program. Their payments would be adjusted through lower interest rates or longer repayment terms that would total no more than 38% of their monthly household income. In some cases, payment on part of the loans' principal may be deferred, though not reduced.

The interest rate could be lowered to as little as 3% for five years. After that, it would increase by 1 percentage point a year until it hits either the market rate or the original interest rate, whichever is lower, officials said.

Unlike previous federal efforts, participation by servicers is not voluntary. They will now work with eligible borrowers to reach more affordable mortgage payments, using the guidelines laid out Tuesday.

Click here for full story.

What now for Fannie & Freddie?

With Fannie Mae and Freddie Mac now firmly under federal control, what might the future look hold for the mortgage giants? Barron's has an idea (hat tip: Brian McDonald):

FANNIE MAE AND FREDDIE MAC , THOSE two wild and crazy kids who partied on Uncle Sam's dime, finally have been sent to the "time out" corner. In the near term, the federal bailout of the heretofore quasi-governmental mortgage giants, which occurred last week amid doubts about their continued solvency, will improve conditions in the secondary mortgage market, and already has begun to lower mortgage rates.

Longer-term, some in government and the financial markets think Fan and Fred should remain under federal control, while others favor privatization or the outright elimination of the agencies -- an outcome that, by some estimates, could boost mortgage rates to as high as 9%-10%. Whatever Congress decides, the seizure of Fannie (ticker: FNM) and Freddie (FRE) closes an especially ugly chapter in U.S. financial history, when greed trashed fear, and opens the door to a rethinking of mortgage finance generally, perhaps along the European model that more responsibly ties lenders to credit risk...

In the government takeover, engineered by Treasury Secretary Henry Paulson, the top managers and directors of both Fannie and Freddie have been shown the door. The Treasury has agreed to invest up to $100 billion in each of the agencies to ensure that they maintain a positive net worth on a GAAP basis...

By placing Fan and Fred in "conservatorship," not receivership, the government has created what Paulson calls a time out to recapitalize and rehabilitate the companies, not liquidate them. Both now will be under the thumb of their new regulator, the Federal Housing Finance Agency, with Treasury looking over the FHFA's shoulder...

Some proponents of continued government control argue not only that the size of their balance-sheet investment portfolios, or the mortgages on their books, should be reduced, but that the two should lose their privileged debt status, thus evening the playing field with their private competitors in the Wall Street securitization business and the mortgage-insurance game.

As for Fannie's and Freddie's shared social mission of providing cheap mortgages and extending home ownership to the less affluent, that might best be assumed by other government-owned and financed agencies, such as the Federal Housing Administration, or FHA...

Many observers, no matter their political stripe, have high hopes the U.S. will copy Europe in using "covered bonds" to finance most home mortgages. In this case, banks and other lenders retain the credit risk on home mortgages they have made, but sell bonds backed by those mortgages to outside investors, thus off-loading interest-rate risk. Such a system is cheaper and more efficient than the multi-level government-sponsored-enterprise financing system that has flourished in the U.S. for years...

THE BIGGEST POSITIVE to emerge from the Fran and Fred bailout to date is the increased amount of money that will flow into the secondary mortgage market, and at lower interest rates, to make up for the agencies' recent neglect of their mission. Under the rescue plan, the Treasury Department will create a new, unlimited borrowing line for both companies, permitting them to borrow directly from the government, using existing mortgage paper the U.S. owns to collateralize the loans.

Scary Times

Just how bad is the Fannie/Freddie situation? Back in July, according to a CNN.com article, Ben Bernanke assured us that these two GSEs were just fine:

U.S. Federal Reserve Chairman Ben Bernanke told the U.S. Congress on Wednesday that troubled mortgage giants Fannie Mae and Freddie Mac are in "no danger of failing."

The two mortgage giants are "adequately capitalized," Bernanke said. However, "weakness of market confidence is having an effect" on the companies, making it difficult for them to raise capital.

How could he have been so wrong just a few months ago? Did he know and was just spinning the truth on some misguided hope that this fiasco could be avoided? Or was he that clueless? Either through corruption or incompetence, that does not bode well for the decision making process at the Federal Reserve.

And what of the bafoons running Freddie and Fanny? According to the WSJ, they are facing the humiliation of being removed from their jobs:

Mr. Lockhart appointed a new chief executive officer for each company but said he hopes to keep most other employees in place. At Fannie, Herb Allison, who has served for the past eight years as chairman of the investment company TIAA-CREF, succeeds Daniel Mudd. Freddie's chief executive, Richard Syron, was replaced by David Moffett, who has been vice chairman and chief financial officer of US Bancorp.

It appears Mssrs. Syon and Mr. Mudd (how apropos is that name?) were brought in to clean up the place in 2003. They did a heck of a job, Brownie.

……But then the companies' efforts to disguise the normal fluctuations in their earnings led to regulatory findings that they had violated accounting rules. The scandals flushed out top executives at both firms.

In late 2003, Freddie drafted in as its chairman and CEO Mr. Syron, a former president of the Federal Reserve Bank of Boston and chief executive of the American Stock Exchange. A year later, Fannie gave a battlefield promotion to its chief operating officer, Daniel Mudd, giving its CEO job to the decorated ex-Marine, a son of TV newsman Roger Mudd.

But the humiliation of being booted is somewhat tempered by the obscene amount of money both are carting away:

Mr. Syron may walk away with an exit package that could total as much as $15 million, says David Schmidt, a senior consultant at James F. Reda & Associates LLC, a compensation consulting concern in New York. That includes a pension and deferred compensation, about $3.7 million in severance pay, and a possible payment of $8.8 million to compensate for forfeiting certain equity grants.

Mr. Mudd's exit package, including stock he already owns, could total $14 million, Mr. Schmidt estimates. That includes $5 million in pension and deferred compensation, $4.2 million in severance pay and $3.4 million of restricted stock, based on Friday's closing price. That value of that stock could fall sharply, however.

Of all the blogs, I think Mr. Mortgage’s blog http://mrmortgage.ml-implode.com/ hits the key factors the best. He is clearly outraged at what’s happening, as we all should be.

He points out that Freddie/Fannie’s toxic loans were made due to corruption/incompetence all the way to the top ( his entry 'Enron on Steroids').

He says these loans should not be bailed out by us taxpayers, and in fact at the time they were made, were explicitly not backed by the government. He and another blogger, Karl Denninger, extract the important points to focus on in this mess. Whether anybody is listening is debatable.

What will happen to Fannie Mae and Freddie Mac?

Want to get a good (and opinionated, but I like opinionated) summary of how Fannie and Freddie got into their current mess and what's likely to happen? First, be sure to check out Lou Barnes' latest edition of Mortgage Credit News:

The Fannie-Freddie story will be widely mis-reported, especially in those journals hostile to housing or to any intervention by government into markets.
The real story is a tale of public policy mangled by everybody connected to the two Agencies in the last 15 years -- both parties, two Administrations, eight Congresses, and real estate- and mortgage-industry lobbying...

The real story is very good news. Fannie and Freddie have high-quality portfolios, the only trash the “affordables” forced on them by Congress. A government takeover would wipe out stockholders, but might not cost a dime. Then the original charters will be restored: upon return of good times, both outfits will gradually sell their portfolios....

I have believed since August that a nouveau Resolution Trust Corp would be required to extract the worst of the assets, take stock in the institutions, and work out the trash over a long time. That extraction will work (we’ve done it many times), but I’m a tad nervous that we waited too long, damage from credit starvation now may be hard to stop, especially in housing.
Some good news: the same Congresspersons who insisted all fall and winter, “No bailouts! Punish the lenders!”, by this weekend began a different chorus. “Necessary evil... Regrettable but unavoidable.” About time, guys; and I hope in time.

To me, the knee-jerk 'no bail-out' crowd never seemed the grasp how intertwined the mortgage crisis is to the overall economy. After all, why learn about how the world works when you can simply shout out platitudes instead (you know, like the politicians!).

So where are we at now with the two mortgage giants? The Wall Street Journal summarizes in this article:

The government headed into the weekend deliberating the state of struggling mortgage giants Fannie Mae and Freddie Mac, with Treasury Secretary Henry Paulson insisting that any potential rescue plan not benefit the companies' shareholders, according to people familiar with the matter...

The discussions at Treasury highlight the dilemma created by the financial crisis gripping the U.S: Some institutions are considered too big to fail, but propping them up could erode the market's incentive to properly judge risk by offering investors a false sense of security.

After a week of near panic among shareholders of the two companies -- and a stomach-churning day on Wall Street Friday -- the next big test will come Monday when Freddie Mac is due to sell $3 billion of short-term debt. An unsuccessful sale could be a major blow to investor confidence. If the administration were to intervene, it could do so before markets opened that day, according to a person familiar with the deliberations...

How any rescue might be orchestrated remains unclear. The administration doesn't expect the firms to fail and it is "not talking about nationalizing" the struggling mortgage giants, according to a person familiar with its thinking. Mr. Paulson issued a written statement Friday saying that the administration's "primary focus is supporting Fannie Mae and Freddie Mac in their current form."

One possible option would have the government buy a chunk of Fannie and Freddie's preferred stock with terms that dilute the equity of common shareholders. The Federal Reserve could support Fannie Mae or Freddie Mac in a short-term funding crisis through its lending operations, which were extended to investment banks in March with the downfall of Bear Stearns Cos. A spokeswoman said Friday the Fed hasn't discussed that possibility with either company...

Investors are worried the firms will suffer more losses as mortgage defaults rise. Stock-market investors are also worried the companies will need to raise significant amounts of capital to cover those losses. For investors, that means the value of their ownership stakes in the company will be cut. Bond investors continue to lend to both companies, though they are also demanding slightly higher interest rates.

If a rescue becomes necessary, Mr. Paulson does not want to help the shareholders because of the "moral hazard" it would create -- desensitizing investors to risk because they believe the government will bail them out. It's a similar position he took during the government-orchestrated rescue of Bear Stearns by J.P. Morgan Chase & Co...

The crisis has been exacerbated by the strange hybrid nature of the two companies, which have prospered because they are seen as having the implicit backing of the U.S. government. Chartered by Congress to ensure a steady flow of money into housing finance, they can borrow cheaply because investors believe the government probably would rescue them in a crisis. Yet they are owned by private shareholders who want profit growth and dividends.

The implicit guarantee has allowed the companies to borrow at lower rates and buy more mortgages, providing a benefit to shareholders. There's a belief among many politicians and officials that it is the shareholders -- not taxpayers -- who should bear those risks because they benefited greatly in the past from the implied government backing.

The government has increasingly leaned on the so-called government-sponsored enterprises to provide stability to a housing market crippled by falling home prices and banks too nervous to lend...

"Do a little examination and ask yourself, 'What do you think the housing market in the U.S. would look like without the GSEs now?"' Richard Syron, Freddie's chairman and chief executive, said earlier this year.

The Bush administration has long worried about the systemic risk posed by the companies. The administration has pushed for a regulatory revamp, including a new, more powerful regulator to oversee them. Long-awaited legislation that would do that passed the Senate on Friday.

So how exactly do these two mortgage giants work and what would be the consequences of a bailout? A slideshow from the New York Times helps explain.

S&P warns of risks to Fannie and Freddie

S&P is issuing a warning that financial pressure on GSEs Fannie Mae and Freddie Mac could require a government bailout far larger than the $29 billion in mortgage assets assumed by the Federal Reserve from Bear Stearns. From a CNNMoney article:

A deep recession could force mortgage-finance titans Fannie Mae and Freddie Mac to require a federal bailout large enough to hurt the U.S. government's top-grade credit rating, Standard & Poor's warned Monday...

The financial stress Fannie (FNM) and Freddie (FRE, Fortune 500) face poses a far larger risk to the government than the $29 billion in mortgage assets taken on by the Federal Reserve to avoid the bankruptcy of investment bank Bear Stearns Cos, the credit rating agency said.

Still, S&P analysts see a bailout of Fannie and Freddie as unlikely and point out that U.S. officials "are focused on avoiding a deep and prolonged recession."...

While the government isn't obligated to assist Fannie or Freddie in a financial emergency, many on Wall Street believe it would bail them out if there is a collapse. The idea that they are "too big to fail" enables the two companies to borrow relatively cheaply by issuing top-rated securities backed by mortgages.

Aiding Fannie and Freddie, plus the government agencies that back home loans and student loans could add up to 10% of gross domestic product, the total value of all goods and services produced within the United States, S&P said...

Encouraged by regulators and politicians intent on keeping more homeowners from defaulting, Fannie Mae and its smaller government-sponsored sibling Freddie Mac have expanded their roles in the stricken housing market. The companies together must provide as much as $200 billion in new funding for home loans in exchange for getting their risk cash cushions reduced. The government requires them to keep a certain amount on reserve to guard against risk.

Over the past year, Fannie and Freddie's share of new mortgages has been soaring, as Wall Street investors have backed away from all but the safest mortgage-related securities. Their market share of new mortgages rose from 46% in the second quarter of 2007 to 80% in January, S&P said.

New & stricter Fannie Mae loan guidelines issued

For those homeowners facing foreclosure walking away from homes thinking they'll just jump back in with no consequences in a couple of years, FannieMae has some news: no problem, as long as it's been 5 years since a foreclosure (the rule used to be 4) and a minimum FICO score of 580. From a story in the Wall Street Journal:

Fannie Mae announced a new round of tightening in its standards for home mortgages it buys or guarantees.

The government-sponsored provider of funding for home loans told lenders Monday it will require a minimum credit score of 580 for most loans it buys on an individual basis. Credit scores, which range from 300 to 850, are designed to measure borrowers' likelihood of repaying loans. In the past, Fannie had no minimum score. The company said it will still acquire loans with lower credit scores in certain circumstances.

Among other changes announced to lenders, Fannie also said it will increase the period needed for borrowers to "re-establish" their credit history after a foreclosure to five years from four years. Fannie said it would allow shorter recovery periods for borrowers with "documented extenuating circumstances" that caused the foreclosure.

Separately, Fannie last week told loan servicers -- companies that collect loan payments -- that they can increase their forbearance period on delinquent borrowers to as much as six months from four months to allow more time to seek alternatives to foreclosure. Fannie hopes that move will reduce the number of loans on which it needs to recognize losses, though it may be only delaying the pain in some cases.