CreditBloggers: The Outlook for Fannie Mae and Freddie Mac

Federal Housing Finance Agency chief James Lockhart’s testimony before the House Financial Services Committee deserves analysis. Ever since the federal government took over Fannie and Freddie, the FHFA has acted as the conservator of the two enterprises.

Bottom line: Fannie and Freddie continue to roll up losses, as previously reported. But the good news is that the government is ready to keep supporting them. The Federal Reserve Board and the Treasury Department have already bought $804 billion in mortgage-backed securities from them.

I do not see how that could be allowed to change. To put it bluntly, economic recovery depends on restoring the housing market. Home equity has always been a significant ingredient, if not the greatest component, of a family's personal wealth. Eroding values have left some 10 million families with no equity in their homes. A couple of million more families have lost their homes to foreclosure.

Therefore, as I see it, recovery depends upon the continued operation and health of Fannie and Freddie, which account for more than 70 percent of the mortgage market today. FHA probably accounts for another 20 percent with the small remaining fraction composed of what remains of the "pure capitalist component" of the mortgage market.

We are starting also to get some idea of what went wrong in these markets. Here’s a quick summary here: In 2002, we started the first refinance boom of the decade. Mortgage originations swelled as rates dropped. Rates were in the 6 percent range and that allowed millions of homeowners with 7- 9 percent rates to refinance. In 2003 and into 2004, rates fell into the 5 percent range, further stimulating the boom.

But in 2005 the boom was beginning to subside. And it was at this point that the subprime industry that had been building on the sidelines took center stage. Subprime originations mushroomed as the industry started doing loans for borrowers with impaired credit and no down payment, or both.

It now appears that Fannie and Freddie started looking at "market share." Now I understand Proctor & Gamble being vitally concerned about the market share of Tide, but it seems wholly out of place for Fannie and Freddie to do so. I suppose they recognized that there was a market segment in which they were not participants.

Helllloooo! That was never what they were supposed to be doing! But in an effort to maintain volume after the drop in volume from the prior few years, they jumped into the market. As the FHFA report says:

"Ultimately, the Enterprises eroded their own credit standards in an effort to keep pace with the rapid growth of subprime and other non-traditional mortgages funded with PLS," (private label securities issued by subprime lenders).

As a loan originator myself, it was never apparent in our market that Fannie and Freddie would do subprime loans. But they certainly did allow "piggyback loans" where borrowers did not make down payments. The borrower would get an 80 percent 1st loan from Fannie or Freddie and get a 20 percent 2nd loan, the piggyback loan. But at least those were to creditworthy borrowers.

Finally, I will take Mr. Lockhart to task. He stated:

"The enhanced regulatory authorities provided by that legislation [the Housing and Economic Recovery Act of 2008] came too late to allow FHFA to prevent excessive leveraging and to address serious safety and soundness issues at Fannie Mae and Freddie Mac."

Mr. Lockhart seems to be acting like he just came on the scene. He overlooks the fact that the FHFA is nothing more than a new name for the Office of Federal Housing Enterprise Oversight that was responsible for supervising Fannie and Freddie since 1992. Obviously, he and they failed in that regulatory mission and must bear some responsibility for the current mess.

Read the full 23-page report of his testimony.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles, Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.