Mortgage Rates and Kissing Fannie and Freddie Goodbye

Lately for work I've been writing about the fiscal announcements Obama's been making, like the plan to wind down Fannie Mae and Freddie Mac and the budget announcement. And maybe it's just from being in Washington, but I think it's kind of interesting to talk about, so I thought maybe this Conversation Topic Tuesday could cover what the president and Congress are doing with tax dollars. (I really don't mean for this to be taking political sides; really just a discussion of what happens to be going on.)

Fannie Mae and Freddie Mac:

• These are names we hear a lot. In case you're looking for a little background on what they do, here's how it goes: Banks give people loans to buy houses. However, these loans are usually very long term (say, 30 years) and in the U.S. the way it works is you lock in an interest rate when you sign up for a mortgage loan. If the rates go down, you can refinance to get the lower rate. But if rates go up, there's not much banks can do to charge you more. So this makes banks not like these loans because it creates risk for them. However, the U.S. government steps in to encourage banks to make 30-year fixed-rate mortgage loans by having Fannie Mae and Freddie Mac come in and buy loans off of the banks. Fannie and Freddie then repackage those loans and sell them to investors, who make money on them when people pay off their mortgage and lose money if people don't. The thing about Fannie and Freddie is, they've been kind of guaranteed by the government, so when too many people were not paying their mortgages a couple years ago and Fannie and Freddie were about to go bankrupt, the government steeped in with a whole lot of money and kept them afloat.
• The fact that Fannie and Freddie currently back more than 90% of the mortgages that are being made right now makes it pretty obvious why the government stepped in; if they hadn't, the housing market would have come to a complete and utter standstill and no one would be able to get a loan and people would have lost even more money on their homes, which would have caused the economy to tank further and more people would have lost their jobs.
• However, the fact that Fannie and Freddie are backing more than 90% of mortgages also makes it really clear that the government needs to find a way out of this, because mortgage making is not the government's job. For once, both Democrats and Republicans have decided they can agree on this, but since if the president were to put out one plan for how to solve the problem, Republicans would just shoot it down, he proposed three plans and now people can talk about them until they find a consensus.
• No matter what happens, Fannie and Freddie are going to be history in ten years or less. The president's plan is to sell off their assets over the next ten years. Tim Geithner was saying five to seven years. The point is, they won't be around a decade from now.
• Obama has put forward three possibilities for what could replace them
• Under the first plan, the government would pretty much pull out of home financing, but would retain some presence, focusing only on low- to moderate-income level and very credit worthy borrowers. This sounds really great. The only trouble is that we would pretty much have to kiss the 30-year fixed-rate mortgage goodbye and mortgages would be more expensive. However, taxpayers wouldn't be on the hook if things headed south again.
• Under the second plan, the government would focus mostly on low- to moderate-income, credit worthy borrowers, but would also include a government backstop that could "scale up" (as the report to Congress put it) to provide more financing when the economy tanks and banks don't want to lend. However, 30-year fixed rates will still get more expensive.
• Under the third plan, the government would again offer mortgage-backed securities just fewer of them and there would be very tight oversight. Thirty-year fixed rates will be more expensive, but less so. However, tax payers will be more on the hook.
• The thing is, as much as people talk about getting the government out of financing mortgages, if push comes to shove, if the economy tanks as bad as it has recently, the government will step in. So realistic lawmakers kind of have to add that into the mix, too.
• To sort of sum things up, the government is going to be withdrawing from home financing. How dramatic that withdraw will be remains to be seen. Loan prices will go up, which may sound like a bad thing, but there are positives, too: As we've seen, when anyone and everyone can get a home loan, prices go up like crazy. So even though financing is going to get harder and a bit more expensive to come by, that will also mean that builders and home sellers won't be able to charge as much for their homes because people won't be able to get approved for as much, and that will hopefully help keep home prices tethered to earth. So there are pros and cons both ways.

Ok, it's bed time. I think this will have to be a two-part series and we'll cover Obama's budget tomorrow.