Fannie, Freddie, Foreclosures, and the Federal Funds

Freddie Mac and Fannie Mae are largely invisible entities to the general public. They could even be mistaken as a Mom and Pop grocery store or male and female dolls sold as a couple. But these two highly influential institutions own or guarantee about half of the US mortgage market, with combined holdings amounting to $5.3 trillion. The sub-prime mortgage crisis that wreaks havoc on the US economy and affects the global financial system, hastened the decline of the prevailing economic structure, and exposed the malady of unscrupulous practices and malignancy of loosely organized models and methods. The untold misery and ruined lives of millions of Americans as a result of this crisis, rooted in the deception and greed that accompanied the rise of sub-prime mortgage lending, is the tragedy that will see no alleviation nor bailout.

Traditionally, banks financed their own mortgage lending and dealt directly with the home buyer, using their deposit funds for the purpose. The concern of the bank in safeguarding depositor funds was evident in its meticulous home evaluation and income capacity checks on the borrower. This process limited the amount of funds for home mortgage lending and was considered a slow process that would not meet demand. A new model was adopted where banks sold mortgages to bond markets and used the funds generated to grant mortgage loans without taking from their customer deposits. This increased the volume of homes sold that required the creation of 3 layers independent of the banks; the home appraisers, mortgage brokers (both dealing with the bank and the home buyer), and the rating agencies ( those who evaluate a bank's operations and provide reports to the mortgage bond market).

Freddie Mac (a nickname for the acronym FHLMC or Federal Home Loan Mortgage Corporation) and Fannie Mae (a nickname for for the acronym FNMA or Federal National Mortgage Association) are both GSE's (Government sponsored enterprises) but both privately owned and run entities authorized to make loans and loan guarantees on behalf of the Federal Government. Freddie and Fannie buy and pool these mortgages from the bond markets and sells them in the open market worldwide, as mortgage backed securities. Because of the millions of homes involved, the possibility of defaults from a home buyer or a bank can easily be covered by the discounted rate at which Freddie and Fannie pay for the mortgages and the spread they add when sold in the open market. All these layers above the home buyer are profit centers which are added on to the cost of the mortgage the home buyer will pay for the duration of the loan.

Fannie and Freddie thus protected banks from default losses by guaranteeing the mortgages they sold to the bond markets which they possessed, provided, the mortgages followed their guidelines. But many of these loans, a little more than half of $12 trillion were outside these guidelines due to the fast and fat profit potential of selling more in the shortest possible time. Connivance between the home appraiser, mortgage brokers, bank personnel and other parties enticed unsuspecting home buyers with deceptive schemes to sign up for a home - taking advantage of their desire for a better life, and pounding in their heads the fulfillment of the American Dream - owning a home. It would provide quality living and show them to be upwardly mobile, without stating that they will suffer the fate of Icarus.

Home buyers were offered a low fixed interest rate for two years, to lure them into accepting the mortgage offered. They were told that after 2 years, interest will be on market rates which may be lower or a little higher, but that they had the first 2 years to increase their incomes. These were actually "balloon" mortgages where the interest rates were deliberately lowered at the outset and the difference added to prevailing rates plus additional interest on year 3. The interest rates after 2 years were at times more than double while incomes remained flat and cost of living rose. Last year, 1.7 million families lost their homes and up to 2 million more are expected to be foreclosed in 2008. While some home buyers may be part of the conspiracy to defraud, these are minimal at best. Misrepresentation and deception, in the type of mortgage offered, the re-financing promise before the 2 years expire, value of the property, and even the reporting of the buyers income to the bank, were the standard practice to sell more and pocket huge commissions.

There is a glut of 4 million properties on top of continuing foreclosures that brought home prices down. This has resulted in losses to the banks for loans without the GSE guarantee; losses to Freddie and Fannie, who hold mortgages whose values have crashed; and pension funds, foreign banks, and many other small investors worldwide who included these mortgages in their portfolios. The crisis has affected the global financial markets and has created a credit crunch that suffocates the flow of funds.

On September 7, The Federal government announced a conservatorship of Freddie and Fannie, a huge takeover of both financial institutions with the Treasury department contracting billions of shares paying at the rate of 10% a year. The total amount could go into hundreds of billions of dollars. Analysts praised the move after the stock market rose the next day which is a profitable event for stock brokers. But this is a knee jerk market reaction as evidenced by the sudden tapering and decline later in the same day. It is possible that bond markets holding these mortgages rushed in to buy, hoping others would follow - then resold when the prices were up.

The takeover and bailout of Freddie and Fannie will save their stockholders and some of their investors who purchased their repackaged mortgages. Federal funds from taxpayers have been used to rescue the big corporations, but it will not be used to save the homes of these same taxpayers. The ambiguity of the Federal government's relationship with GSE's raises many ethical questions which are dismissed as mere conspiracy theories. Yet the taxpayers will be required to shoulder the cost of this bailout without clear indications of how much and how long - just like the balloon interest rates of the mortgages.

The automotive and Airline industries also suffered heavy losses, shouldn't they be entitled to a bailout too being big taxpayers? Has the United States become the bailout capital of the world for its decrepit business models, loosely structured operating systems, cross-eyed management vision, and unscrupulous business practices? Not if you are a home owner, a mere citizen who doesn't have the ear of the powers that be. One who cannot make significant contributions to their political coffers, and who cannot influence a bloc of voters whether these are bought, coerced, or convinced. Home owners, or former home owners, who need to wake up from this worst nightmare of their lives after being led to a mirage of their American Dream, will be voiceless, powerless individuals who have to bear the consequence of being duped for their ignorance.

Their loss is beyond money. It encompasses self-respect, dignity, self-worth, and crushes their spirit with a devastating blow to their belief in America and what it stands for. Their thoughts will be joined by billions of people all over the world, where no one understands what America really stands for.

Haaarrrwwwwk...Twoooooooph...Ting!