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As expected, Freddie Mac (NYSE: FRE) announced a $6 billion preferred stock sale on Tuesday and told its investors that their dividends will be cut in half to just 25 cents so that it can hold on to enough cash to satisfy federal regulators. The dividend cut is Freddie's first cut since the government-chartered enterprise became a public company in 1989.
Freddie hopes that the preferred stock sale will be enough of a cash infusion to offset losses from the subprime mortgage mess, or it could be forced to curtail future lending and sell off some of its portfolio of mortgages. If that happens the mortgage cash crunch already seen in the housing industry could get much worse. Private investors already have fled the market. If Freddie can't play, then that puts the burden on Fannie Mae (NYSE: FNM), which also reported loses in the past quarter.
What will it mean to the market if Freddie has to cut back on lending? Less money will be available than there is now to buy mortgages on the secondary market. If banks that initially make the mortgage can't sell it on the secondary market, then they will have to hold the mortgages in their own portfolios. By selling mortgages to the secondary market, which includes Freddie Mac, Fannie Mae, and whatever private investors or international banks are left to play in this volatile market, banks that initially loaned the money can then loan more money.
If Freddie can't meet its government-mandated minimums, it will only have three choices: limit is mortgage portfolio growth (buy no more mortgages), reduce its mortgage investment holdings, or issue more stock. Congress could also ease the crisis by raising the government-mandated minimums. While some in Congress are suggesting those minimums for Fannie and Freddie be raised, there isn't a groundswell of support for the plan because it then means that taxpayers take on more risk if Freddie or Fannie defaults.
Freddie and Fannie's government mandated mission is to keep money flowing to lenders in the mortgage market. If that money isn't flowing, lenders won't have the cash to lend and mortgages will become even harder to get than they are now.
Lita Epstein has written more than 20 books including "The 250 Questions You Should Ask to Avoid Foreclosure" and "Complete Idiot's Guide to Improving Your Credit Score."
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