Commentary: Freddie, Fannie fallout touches Main St, too

(Dr. Ann B. Schnare is currently principal of AB Schnare and special consultant to Criterion Economics. Prior to that, Senior VP for Corporate Relations at Freddie Mac, and VP for Housing Economics and Financial Research. The opinions expressed here are her own.)

WASHINGTON (Reuters.com) -- You may not know much about beleaguered mortgage giants Fannie Mae and Freddie Mac -- but without them you might find it much tougher to buy a house, especially in a real estate market like this one.

Fannie Mae and Freddie Mac are not arms of the government, but "government sponsored" private companies set up to help segments of the mortgage market run smoothly. To date, they've performed that task extremely well: homebuyers looking for plain vanilla 30-year mortgages, the kind that Fannie and Freddie deal in, still have a relatively easy time finding loans. In the meantime, markets for larger or more exotic mortgages -- such as those tailored to borrowers with poor credit histories -- have all but dried up.

Still, as you've probably learned, Fannie and Freddie are in trouble. Both have reported significant losses in the past two quarters, and additional losses are anticipated at least through the end of the year. Their stock prices plummeted last week, losing almost 50 percent of their market value due to increasing concerns over a possible government takeover. In response, the Federal Reserve and the Treasury are granting the two GSEs access to additional credit in the event that it proves necessary.

So far, financial difficulties at Freddie and Fannie have not imperiled the important and constructive role that both companies play in the mortgage markets. That's in large part because investors believe that the Federal government will be forced to stand behind the guarantees and debt that these companies issue. Failing to do otherwise would have dire consequences for the housing market and broader economy. The immediate effects would be felt on Wall Street. Fannie Mae and Freddie Mac securities and debt have become an integral part of capital markets, and a loss in confidence in their value would send shock waves throughout the world. The effects would also be felt on Main Street. Among other things, it would mean that Americans would pay significantly higher interest rates when they purchase or refinance their homes, and that fewer Americans would qualify for a mortgage at all. These factors would place additional downward pressure on already-declining housing prices and further undermine an anemic economy.

So far, it is unlikely the government will need to step in. However, this doesn't mean that Fannie and Freddie will come out of this mess without some changes.

THE ROLE OF GSEs

How do Fannie and Freddie work? They provide liquidity to the mortgage markets by buying loans from lenders -- such as mortgage firms like Countrywide and large banks such as Wells Fargo and Bank of America -- and packaging them into securities, which they sell, with a guarantee, to large investors like hedge funds and pension funds. They also purchase mortgages for their own investment portfolios and fund their purchases through the issuance of corporate debt. By providing a secondary market outlet for mortgage loans, the GSEs replenish the funds that are available to lenders, thereby enabling them to make additional mortgages to other borrowers.

Because of their Congressional charters, investors have typically viewed both GSE securities and debt as carrying the implicit guarantee of the federal government. This implied guarantee has enabled the GSEs to raise money at rates that are only marginally above those of comparable US Treasuries, which has translated into lower mortgage rates for borrowers. It has also helped to make the 30-year fixed-rate mortgage the financing vehicle of choice for most Americans.