Treasury Secretary Henry Paulson and Federal Housing Finance Agency Director James Lockhart held a press conference Sunday to announce that the government had placed Fannie Mae and Freddie Mac under conservatorship. After meetings with the boards of directors for both organizations, the Federal Housing Finance Agency took control of these institutions that are vital to home loans.
Fannie Mae and Freddie Mac are government-sponsored enterprises that are involved in more than half of all the real estate financing in the United States. They do that by buying loans from banks and packaging those loans as mortgage-backed securities, then selling those securities. By purchasing the loans from banks, the banks get the capital to make new loans. The sale of mortgage-backed securities by Fannie and Freddie has been hurt by concerns over subprime loans and the higher-than-normal default rates on mortgages.
Fannie and Freddie are involved in $5.4 trillion worth of mortgage debt. To give you an idea of how huge that is, it is more than the amount of the privately held national debt of the entire United States. In the past four months, Fannie Mae and Freddie Mac have been involved in 80 percent of the financing of home purchases. In short, if you want to get financing to buy a home, you need Fannie Mae and Freddie Mac.
What did the government do? They replaced the leadership of these two organizations: Herb Allison, a former vice chairman of Merrill Lynch, was selected to head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp, was picked to head Freddie Mac. The hope is that the rest of the staff will remain in place, and Fannie’s Daniel Mudd and Freddie’s Richard Syron, the former leaders of each organization, have agreed to stay on during the transition.
The government is going to buy $5 billion in mortgage-backed securities held by Fannie and Freddie. This will provide more capital for each organization. The Treasury Department said it will immediately be issued $1 billion in senior preferred stock from each company, but eventually the Treasury could be required to put up as much as $100 billion for each organization over time if the funds are needed to keep the companies afloat. This infusion guarantees that each organization will remain solvent, assuring that financing for real estate purchases will not be thrown into chaos. The government also will receive warrants representing ownership stakes of 79.9 percent in each firm. The existing stockholders will be subordinate to this obligation to pay the federal government, so the $36 billion in outstanding stock for these companies just moved down a notch to be in second position to the federal government. This puts those shares in the position of junk bonds, according to Standard and Poor’s ratings.
In the long run, the government wants to shrink the size of Fannie and Freddie, with their portfolios shrinking by 10 percent per year starting in 2010. All lobbying will cease; all dividends will stop; and other cost-cutting measures will be instituted to make these institutions more efficient.
When I watched GMAC financing close its doors to new loans in the Triangle area of North Carolina, I was concerned about the availability of new loans. Now, I am not, as the government will infuse up to $100 billion into Fannie and Freddie to see them through.
One of the biggest problems in the real estate industry is the availability of financing. This move makes financing more certain, and lets Realtors stop worrying about whether they can get loans for their customers. Just the certainty that loans are available is valuable, and the prospect of getting better interest rates is appealing. The loss to the taxpayers is debatable, as we just got preferred shares in companies that will do well in the long run. My hope is that the projections of a $25 billion loss to the taxpayers is highly inflated, and the taxpayers may even make a profit from the preferred shares that pay 10 percent interest.
In general, this is good news for the real estate industry and benefits the stability of real estate.
Tim Burrell is a Realtor with RE/MAX United in Raleigh, N.C.
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