By Shane Quinn
Fannie, Freddie, and You We are in a recession at the best, and a full-blown depression at the worst. Unemployment rates are at their highest levels in more than a quarter-century, major corporations are tanking, which causes massive lay-offs and higher prices on goods and services, and the number of home foreclosures are rapidly increasing as housing values plummet. The Federal Government already took notice of the failing companies in late 2008, and took action to stop the disintegration of the auto industry, banking industry, and even an insurance agency. All of these self-proclaimed "bail-outs" placed the Government as an agitated father awakened in the middle of the night to go downtown to spring his kids from jail. That seems to be the same thing that the government is doing with the bail-out of the mortgage industry. In mid February, the Federal Government went down to the police station again to rescue two more of his children, Fannie Mae and Freddie Mac, from the slammer. Bail for their crimes? $75 Billion. Exactly what did these two juvenile delinquents do that warranted so much money and what is daddy's reaction to the problem? That, along with what we ourselves can learn from their mistakes, as well as how the bail-out affects our own lives is what we are going to look at here. Background on Fannie and Freddie Fannie Mae was established in the late 1930's to buy mortgage loans from banks in order to free up capital in those banks to lend for more mortgages. A bank would lend money to a borrower, then Fannie would buy that loan, giving the bank money to loan to someone else, thus allowing more people to buy houses. 30 years later, in the late '60's, Fannie became privatized to reduce its burden on the Federal Government. Two years later, in 1970, Freddie Mac came into existence to provide competition for Fannie Mae. Shortly after Freddie was born, the two companies began to package the mortgages that they had bought together into Mortgage-Backed Securities that were then sold to investors who were guaranteed a return on that investment. Because mortgages are long-term, structured loans, these securities were fairly low-risk investments, further secured by Fannie and Freddie, who promised to buy back any defaulted mortgages, if such a thing should occur, from the investors. In the early days of these two siblings, the only mortgages that they bought up from the banks were Prime Mortgages- or relatively low-risk mortgages, ones that were at good interest rates, loaned to credit-worthy borrowers, and backed by big down-payments- in other words, loans that would be, barring some freak accident, repaid on time. With this system, Fannie and Freddie were doing very well financially. Beginning in the 80's, other banks began to mimic Fannie and Freddie and get in on the Mortgage-Backed Securities boom. From the 80's through the turn of the millennium, banks competed with Fannie and Freddie, also guaranteeing these securities to investors. However, after a while, the vast majority of Prime Loans had been bought up, and the market on such was very dry. Banks began giving out increasing numbers of Sub-Prime loans- loans that were given as poor interest rates, to people without good credit, and with little to no down-payment- in other words, very high risk loans that barring some freak accident, would probably not be repaid on time. Basically, Fannie and Freddie went from hanging out with the "good kids" to paling around with the kids from the other side of the tracks- the really risky ones. And those kids got into trouble and couldn't pay their mortgages, so Fannie and Freddie had to buy back massive amounts of securities that they had guaranteed, leaving much of their assets tied up in defaulted mortgages, nearly bankrupting the company. When the market collapsed, Fannie and Freddie combined to back roughly 80% of all mortgage-backed securities. The Fed's Reaction Daddy is never happy when his children make mistakes, and sometimes punishments are in order for the larger miscues. When your dad is the Federal Government, those punishments usually mean financial sanctions. In the case of Fannie and Freddie, one punishment was what kids everywhere fear and rebel against- their dad now runs their lives. The Federal government, with this bail-out, effectively has taken control of Fannie and Freddie, to the point of making many of their major decisions, including personnel moves. In many ways this is a good thing, as the Federal Government now can make decisions that are presumably in the best interest of the people, which is what the Bail-out plan is thought
to be, but in other ways it is not so good- such as the thought of the Federal Government reaching its control to private businesses and ultimately into our very homes. But that is not what we are looking at here. The bail-out proposal was presented way back in July of 2008, and Congress agreed that something needed to be done. In September, they passed a funding request for the purpose of bailing out Fannie and Freddie, but it took until mid-February to have that plan outlined and ready to begin implementation. According to the White-house press briefing the day after the plan was approved, that plan had three major parts to it: 1. Allows refinancing for those whose house prices have fallen in an effort to take advantage of the new lower interest rates. Effects an estimated 4-5 million people. 2. $75B program to make mortgage payments more affordable. 3. Giving more money- and more Governmental oversight- to Fannie and Freddie. The first of these three parts is the one that is expected to effect the most people, as it allows homeowners to refinance their current mortgage at a lower rate. This does not apply to all homeowners, as the Government has laid out some specific criteria for this refinancing program (included later in this article). Part two, is an initiative to help people currently upside-down in their mortgage, but who are current in their payments (fewer than 60 days late). The program allows people whose mortgages are current to refinance. This program also subsidizes the payments of the borrower by offering a $1k/yr incentive to pay on time, put towards the mortgage after 5 years. The government also plans to subsidize lenders in a similar manner for successful mortgage modifications. This part of the plan is for owner/occupants only and does not apply to realty speculators or "house flippers." The final assistance provided by part 2 of the plan is to provide an $8k tax credit to first-time home buyers, and is taken on the Federal Tax Return. Part three is the provision that allows the Government to control significant portions of both Fannie and Freddie. So, the Fed reacted to Fannie and Freddie's trouble by giving them money and new rules on how they can or cannot spend it. In effect, Fannie and Freddie got a raise in their allowances (with the stipulation that the money had to be used to make reparations for damages) and, at the same time, got grounded. How the Bail-Out Effects Our Lives As we looked at briefly above, the first part of this program is the call for an allowance of refinancing for current mortgages. The Federal interest rates are at their lowest point in decades, and a way to ensure that more people can pay their mortgages is to allow them to take advantage of these lower rates. This part of the program is for homeowners whose home values have fallen due to the housing market collapse. Working with part 2 of the program, these mortgages will be subsidized to the banks by the government's bail-out money, meaning that banks are more likely to agree to refinance because the disparity in what they would be making at the higher rate is offset by government funds. Also, under this program, the government also offers a subsidy of up to $5,000 towards your mortgage for five years of on-time payments, and an $8,000 tax credit for first-time buyers. Some states are also adding to this credit for the purchase of bank-owned foreclosures. The program's main thrust is towards refinancing homes in order to get mortgage payments down to between 31% and 38% of borrower income, making it much more likely that the mortgages will be paid on time. This will help stabilize the housing market by regaining confidence in the reliability of borrowers to pay their mortgage on time, as well as locking in low interest rates. The governmental subsidization of these loans will ensure that interest rates stay low for some time to come and provide incentive for lenders to refinance borrower mortgages at the new lower rates. The governmental oversight will also help to ensure that interest rates stay low and that new mortgages are being issued. All-in-all, the plan looks okay on paper, but the real success depends on how many people actually qualify for this program, and how many banks and lenders actually participate in the program. There are a few criteria that are in place to see if a person qualifies for this program, and because of these criteria, many people in dire need are left out. People who are too far behind in their mortgages, people who own more than one home, people who are severely underwater in their mortgage, and mortgages that are above the conforming loan levels do not qualify. However, there are other provisions
that could help even some of these borrowers to qualify under different circumstances. In the end, it is up to the banks and lenders to a certain extent, and a borrower will only know for sure after calling their lender. What We Can Learn While much of what we can learn from this familial episode is in the realm of politics and large-scale economics, there are a few things that we can take from this that fall into the real estate category. The major thing is that the Government is actually trying to help in this time of need, even though the plan may or may not be all that helpful in the long-run. We can also learn that the Fed is not against policing the mortgage companies. Finally, we can clearly see that the fault of the collapse of the market came as a result of the greed of the banks and Fannie/Freddie that pushed them to start selling Sub-Prime mortgages as securities, because once the economy had a slight down-turn and some people lost jobs, those securities led to a domino effect in the broader economy. The main problem we can learn from is that in a capitalistic society, we live and die by efforts to make money, and the risks we have to take in that effort, do not always pay off.
The Bottom line: While this plan is designed to make mortgages more affordable to those who have not been foreclosed upon, the bottom line is that not everyone qualifies for this mortgage modification program. You will have to check with your mortgage lender to see if you qualify. There are a few groups of people who are automatically disqualified from this program because of circumstance: • • • • • Mortgages that are severely underwater- at or exceeding 150% of the homes current value Mortgages that are over the conforming loan limit for their area Mortgages on second homes or speculator properties, i.e. homes that are not primary places of residence Mortgages that are severely delinquent or already in foreclosure may not qualify If your mortgage payments are already at or below 31% of your average yearly income
If you do not meet any of the above conditions, you may be eligible for a mortgage modification. Even those borrowers who have taken out a second mortgage on their home can still qualify for a modification. Some banks will contact their borrowers who fit into the modification criteria, however, not all banks will do this, so it is up to the borrower to take the initiative and call their lender.