|
|
Blog #3
IS THE FANNIE MAE/ FREDDIE MAC BAILOUT BAD NEWS?
By Tom McAllister, CFP™
All the news you've been hearing about Fannie and Freddie is not about spouses or siblings. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are two giant mortgage businesses. Both fall into a category all their own, because they are federally government-chartered. They're BIG - between the two of them, Fannie and Freddie guarantee just about half of all US mortgages, to the tune of six trillion (with a T) dollars!
Both FNMA and FHLMC are shareholder-owned corporations that make loan guarantees, and sell investments in packages of mortgages to investors. Fannie and Freddie buy mortgages from lenders and then hold the mortgages in their own portfolios until maturity. Or they can, and do, sell these mortgages in the form of securities called collateralized mortgage obligations. That puts cash back into the two companies that can then be loaned out..
Fannie was founded as a government agency in l938 as part of FDR's New Deal. Freddie came along in l970 to expand the secondary market for mortgages in the U.S. They make money by charging a guarantee fee on loans in exchange for taking on the credit risk. In other words, Fannie and Freddie guarantee that the principal and interest on any of their mortgages will be paid back to the investors who buy the collateralized mortgage obligation investments regardless of whether the homeowner actually pays the mortgage.
For the forty-six years that I've been doing financial planning there has been an "implicit" guarantee behind the securities of Fannie or Freddie; both federally chartered shareholder-owned companies. However, the understanding was that the US government would stand behind both organizations if the need arose. Because of this implicit guarantee FNMA and FHLMC securities have been rated AAA and have therefore been able to borrow money at lower interest rates.
Well, as of July 13, the implicit guarantee went explicit! First, the United States Treasury announced it stands ready to provide whatever amounts are necessary to keep Fannie and Freddie in healthy financial condition, and Congress then went on to pass a bill authorizing these changes. Included in the bill was permission to make direct equity investments in the companies in the highly unlikely case it became necessary.
I realize that government action was necessary. In fact I believe this particular action will be a big positive towards the eventual recovery of the U.S. housing market. The fact that our government stood behind its implied guarantee will help renew trust and confidence in the entire system.
How can financial planning clients "make cents out of the news"? Don't purchase the common stock of either Fannie or Freddie (the possible government investment would dilute the value). Their preferred stock, on the other hand, is worth a look. Both Fannie Mae and Freddie Mac recently issued high yielding preferred shares, which have been "hammered" in the marketplace and are now selling at bargain rates. Dividends from these preferred securities, by the way, are federally taxable at a maximum rate of 15%.
It's unrealistic to expect an overnight housing market recovery, even given the new "explicit guarantees".
Any potential bailout creates additional hefty debt on our government, which is not to be taken lightly. As for a bailout itself, which has created so much press, I'm taking it as a plus. In fact, as such a long-time financial planner, I'm reminded of the words in a show tune: "This could be the start of something good."
|
| |
| |
______________________________________________
| |
Click To Print This BLOG
