Ted Allrich is the founder of The Online Investor and author of the just released book: Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he'll offer advice to investors who are just getting started.You may not follow the ongoing drama, the one about Freddie Mac (Federal Home Loan Mortgage Corp.: NYSE: FRE) and Fannie Mae (Federal National Mortgage Association: NYSE:FNM).
You probably see the headlines about problems each has, maybe wonder what the fuss is about. Since you don't own the stock or the preferred or any of the debt, you don't really spend too much time on it. You've got your own stocks with problems, or you've just got enough problems without any stocks.
But what happens to Freddie Mac and/or Fannie Mae could have a deep impact on your investments and your life. In a quick summary of their importance: between the two agencies, they own and/or make half of the mortgages in the United States. Currently, it's estimated they're making 70% of mortgages (which have
larger than average profitability because of fewer lenders in the market). If allowed to fail, which many suggest would be the best thing for them, the mortgage market would almost completely dry up, housing values would plummet, and it isn't too far of a stretch to imagine a depression economy.
The chance that these two giants would be allowed to fail is almost zero. Everyone understands their value. The challenge is to figure out how to keep them going without transferring their liabilities to the federal government. That's because every mortgage made by Freddie or Fannie has a guarantee attached, one that gives the buyers of these mortgages the comfort that if the borrower doesn't pay the monthly mortgage, the agency that guarantees the mortgage will. There are trillions of dollars on the line here.
Fannie Mae is by far the larger of the two GSE's (Government Sponsored Enterprise). It is the largest purchaser and guarantor of home mortgages in the country. Its charter is to buy mortgages from lenders such as banks and savings and loans, package them, then resell them in the open market. That creates liquidity for lenders and lowers lenders' risk. With more money flowing into the mortgage market from large investors such as insurance companies, retirement funds, etc., middle-income individuals and families can obtain mortgages to purchase new or existing homes.
These agencies play an important role in the health of the economy. If they don't buy mortgages and guarantee them, many families can't afford homes. The housing market is one of the important cylinders in the engine that drives the U.S. economy. Without an active housing market, many jobs are lost from construction workers to bank lending officers to furniture makers. There's no question of the need for Fannie and Freddie.
Rather, the question is: how do they exist going forward? Currently each is privately owned by shareholders though there is an implied government assurance behind each. Both were created by Congress. Fannie holds over a trillion dollars of mortgages. It was created in 1938, rechartered in 1954, then privatized in 1968.
Freddie currently has $1.5 trillion in its loan portfolio. It was chartered in 1970. There's a minimum of $2.5 trillion in loans guaranteed by these two companies.
If they were to disappear and turn into government agencies, then the federal government would have to back those guarantees. With the added obligations, the ratings for U.S. debt would go down, raising the cost of any future borrowing by the government. That would push up interest rates everywhere along the debt hierarchy, making it more expensive for companies and individuals to borrow money, even pushing some from being able to borrow at all. Of course, the interest rate on a mortgage would go higher as well. The ripples are deep and wide.
The answer isn't to have the government take over these two behemoths, wiping out current shareholders and most likely the preferred holders as well. The answer lies in a compromise, one that allows both to continue operating until there is a "normal" real estate market. Most likely that takes the form of debt or at least the ability to borrow from the Treasury without restrictions, posting mortgages as collateral for the money.
These are loans, not equity, that must be repaid from profits by Fannie and Freddie, much like the Chrysler loans that saved the company years ago. There would be some risk to taxpayers but not as much as if the government bought an equity position since there would be mortgages pledged against the borrowings. And another stipulation: new government oversight and new management are a must.
Fannie and Freddie are more than mortgage facilitators. They're part of a vibrant economy that is stalled. To allow them to fail has significant negative implications, far more than just the housing market. Some experts believe the companies don't need real attention until early next year since they have more than adequate capital at the moment. But if losses are greater than expected, that capital will disappear quickly. An announcement from Treasury stating the borrowing window is open and will stay open would go a long way to help the stock, the preferreds and the outstanding debt holders. And it would make borrowing costs go down for both agencies which in turn would lower the cost of mortgage money which in turn would spur more home buying.
Taxpayers should be worried about the government getting into private business. That's not its role. But these two GSE's have grown to such a vital role in the housing market that the government may need to see them more as they do the highways and defense of the country. There are some things too big for the government not to be involved.
larger than average profitability because of fewer lenders in the market). If allowed to fail, which many suggest would be the best thing for them, the mortgage market would almost completely dry up, housing values would plummet, and it isn't too far of a stretch to imagine a depression economy.
The chance that these two giants would be allowed to fail is almost zero. Everyone understands their value. The challenge is to figure out how to keep them going without transferring their liabilities to the federal government. That's because every mortgage made by Freddie or Fannie has a guarantee attached, one that gives the buyers of these mortgages the comfort that if the borrower doesn't pay the monthly mortgage, the agency that guarantees the mortgage will. There are trillions of dollars on the line here.
Fannie Mae is by far the larger of the two GSE's (Government Sponsored Enterprise). It is the largest purchaser and guarantor of home mortgages in the country. Its charter is to buy mortgages from lenders such as banks and savings and loans, package them, then resell them in the open market. That creates liquidity for lenders and lowers lenders' risk. With more money flowing into the mortgage market from large investors such as insurance companies, retirement funds, etc., middle-income individuals and families can obtain mortgages to purchase new or existing homes.
These agencies play an important role in the health of the economy. If they don't buy mortgages and guarantee them, many families can't afford homes. The housing market is one of the important cylinders in the engine that drives the U.S. economy. Without an active housing market, many jobs are lost from construction workers to bank lending officers to furniture makers. There's no question of the need for Fannie and Freddie.
Rather, the question is: how do they exist going forward? Currently each is privately owned by shareholders though there is an implied government assurance behind each. Both were created by Congress. Fannie holds over a trillion dollars of mortgages. It was created in 1938, rechartered in 1954, then privatized in 1968.
Freddie currently has $1.5 trillion in its loan portfolio. It was chartered in 1970. There's a minimum of $2.5 trillion in loans guaranteed by these two companies.
If they were to disappear and turn into government agencies, then the federal government would have to back those guarantees. With the added obligations, the ratings for U.S. debt would go down, raising the cost of any future borrowing by the government. That would push up interest rates everywhere along the debt hierarchy, making it more expensive for companies and individuals to borrow money, even pushing some from being able to borrow at all. Of course, the interest rate on a mortgage would go higher as well. The ripples are deep and wide.
The answer isn't to have the government take over these two behemoths, wiping out current shareholders and most likely the preferred holders as well. The answer lies in a compromise, one that allows both to continue operating until there is a "normal" real estate market. Most likely that takes the form of debt or at least the ability to borrow from the Treasury without restrictions, posting mortgages as collateral for the money.
These are loans, not equity, that must be repaid from profits by Fannie and Freddie, much like the Chrysler loans that saved the company years ago. There would be some risk to taxpayers but not as much as if the government bought an equity position since there would be mortgages pledged against the borrowings. And another stipulation: new government oversight and new management are a must.
Fannie and Freddie are more than mortgage facilitators. They're part of a vibrant economy that is stalled. To allow them to fail has significant negative implications, far more than just the housing market. Some experts believe the companies don't need real attention until early next year since they have more than adequate capital at the moment. But if losses are greater than expected, that capital will disappear quickly. An announcement from Treasury stating the borrowing window is open and will stay open would go a long way to help the stock, the preferreds and the outstanding debt holders. And it would make borrowing costs go down for both agencies which in turn would lower the cost of mortgage money which in turn would spur more home buying.
Taxpayers should be worried about the government getting into private business. That's not its role. But these two GSE's have grown to such a vital role in the housing market that the government may need to see them more as they do the highways and defense of the country. There are some things too big for the government not to be involved.
Comfort Zone Investing: Survival of the fittest -- letting some banks fail
Three All-American stocks for portfolio fireworks
Michael Jackson fireworks, the workaholic
Reader Comments (Page 1 of 1)
8-30-2008 @ 4:49PM
HardMoneyMi said...
This is what happens when a lender get's into loosening guidelines just for the sake of increasing business (money). When I started in hard money money lending in 1984 you were either "A" paper or you were hard money, black and white. Fannie and freddie quickly drifted into the grey area and just plain got carried away with the potential profits. It looks like we may be back to black and white lending.
8-30-2008 @ 7:21PM
gumbo koontz said...
Some people are good at studying and preparing for their own futures by reading textbooks or periodicals. Others will never be good at that and they need to sort of get the feelings or experiences to be able to understand how things work. If we reject the latter due to credit risks or similiar things, they will never be able to understand or improve themselves. What is the best way to really educate the latter other than giving them subprime loans and watch them messing them up . Now we have millions of people who really understand the in and outs of money in this case. They will be able to share their experiences with their families and friends. That is one of the great ways America invest in the future of all Americans.
8-30-2008 @ 7:38PM
Peter said...
This sets a bad precedent ! Should GM be bought out next? ......and then who after that ? As Kenny Rogers said ...."Ya gotta know whem to hold then , and know when to fold them" I think the time is now to let Freddie and Fannie fold and let the free market takes it course .
8-31-2008 @ 6:45AM
Pearl HD said...
What is the difference between "tax payers and Government" ? We the people are the government. We the people are the taxpayers who pay people in government who are suppose to be looking out for us. So while some are lining their pockets, they have insurance. "The Government/Taxpayer won't let me drown, if my decision is wrong. It is a win-win situation.
9-01-2008 @ 7:30AM
john said...
bad predecent....we all know whats coming its just a matter of time.
I think as things to down a bit, there will be hell to pay and people wont want to keep paying their levels of tax anymore. Probably like a tax revolton the cards.
twitter.com/crashof2008
9-01-2008 @ 9:38AM
al coholic said...
I wonder what would really happen if both of these companies went away?
Well, for a lot of people, not much. That's assuming they aren't selling or buying a house. I guess if the housing market really dried up a lot more folks' equity lines would be reduced because, as is happening already, lenders would be lowering their exposure to reduced real estate values. Of course on the other hand this reduction of the money supply might reduce inflation, since there would be fewer dollars chasing more goods.
And I guess the result of less equity money being used for consumer spending the recession would be prolonged. But at least when it finally did recover it would be a much healthier situation.
The numbers of workers who transfer for their employers along with people who move for other reasons might diminish because of the difficulty in selling and purchasing new housing.
Rental property would probably benefit though as people who would have ordinarily jumped into housing they knew they only planned to keep for a couple of years and flip for a profit would lose big dollars following that strategy.
Interest rates might go lower as the demand for corporate and mortgage money would be less. In addition if the government didn't spend a wad bailing out these companies our national debt would be smaller resulting in cheaper rates for the government to borrow, further reducing the national debt.
The worst thing would be that a lot of houses would be lost to forclosure because they couldn't be refinanced. But in the end even that might strengthen our morgage industry. Maybe local banks who made loans and kept them would become the norm again. That would certainly be the best way to prevent the sub-prime mess from continuing.
I don't claim to know, I'm just musing.
9-02-2008 @ 8:13AM
J. Schottenstein said...
HOW DOES ONE OHIO HOMEBUILDER MAKE ONE BILLION DISAPPEAR? LEGAL?
Updated:2006-07-11 09:51:06
M/I Homes Reports New Contracts and Homes Delivered; Backlog Exceeds $1 Billion
PR NEWSWIRE
COLUMBUS, Ohio, July 11 /PRNewswire-FirstCall/ --" M/I Homes, Inc. (NYSE: MHO) announces homes delivered and new contracts for the three- and six-month periods ended June 30, 2006 and backlog as of the end of the period."
"M/I Homes, Inc. Announces the Resignation of Steven Schottenstein
PR NEWSWIRE
COLUMBUS, Ohio, June 15 /PRNewswire-FirstCall/ -- In a joint statement issued today, M/I Homes, Inc. (NYSE: MHO) and Steven Schottenstein announced that, after 27 years with the Company, Steven Schottenstein, Chief Operating Officer of M/I Homes, has resigned to pursue other interests. He will remain on the Company's Board of Directors and continue to serve as Vice Chair of the Board.
Robert H. Schottenstein, Chairman of the Board, Chief Executive Officer and President stated, "Steven has been a key member of senior management of M/I Homes for more than 27 years. He was instrumental in the opening of our Tampa and Orlando operations in the early 1980's and helped launch our Washington D.C. operation in the early 1990's. He has provided strong leadership and played a significant role in the growth and success of M/I Homes. "
MOST FIRMS AVOID TAXES
Reuters with AP
"August 13, 2008 --
"Most corporations doing business in the United States avoid paying
any federal income taxes, according to a government study released
yesterday."
The Government Accountability Office said 72 percent of all foreign
corporations and about 57 percent of US companies paid no federal
income taxes for at least one year between 1998 and 2005.
The study said 68 percent of the foreign companies avoided corporate
taxes in the same period. "
EX-10.1 2 agreement.htm EXHIBIT 10.1 SECURED CREDIT AGREEMENT
"Section 10.1 Taxes.
"(a) Payments Free of Taxes
"Section 11.3 CHOICE OF LAW; VENUE. THIS AGREEMENT SHALL BE GOVERNED
BY THE LAWS OF THE STATE OF TEXAS"
IN WITNESS WHEREOF, the parties hereto have caused this instrument to
be duly executed as of the date first above written."
LENDER:
GUARANTY BANK,
a Federal savings bank,
Address
as a Lender
BORROWER:
M/I FINANCIAL CORP.,
an Ohio corporation
"
Wells Fargo Home Mortgage
3601 Minnesota Drive, Suite 200
Bloomington, MN 55435
Huntington Mortgage Company
7575 Huntington Park Drive
Columbus, Ohio 43235
Freddie Mac (FHLMC)
8200 Jones Branch Drive
McLean, Virginia 22102
Universal Mortgage Corp.
12080 N. Corporate Parkway
Mequon, WI 53092
CitiMortgage, Inc.
13736 Riverport Dr
Maryland Heights, MO 63043
US Bank
3501 Del Prado Blvd.
Cape Coral, FL 33904
Flagstar Bank
5151 Corporate Drive
Troy, MI 48098
Countrywide Funding Corp.
8511 Fallbrook Ave.
West Hills, CA 91304
Chase Manhattan Mortgage Corp.
6867 Southpoint Drive North
Jacksonville, FL 32216
Fannie Mae (FNMA)
One South Wacker Drive
Suite 1300
Chicago, Illinois 60606
Home Savings
3690 Orange Place
Beachwood, OH 44122
Taylor, Bean & Whitaker
3201 SW 34th Ave.
Ocala, FL 34474
"GMAC Bank
100 Witmer Road
Horsham, PA 19044"
Should a CEO have recall of valuation and tax returns?
SHOULD THIS PUBLIC OHIO BUILDER STILL BE ON THE NYSE EXCHANGE WITHOUT
EVER AUDITING ANY OF THEIR 19 BANKS? (CONFIRMED LETTERS FROM
DELOITTE)
"DEPOSITION OF ROBERT H. SCHOTTENSTEIN"
Taken at Kemp, Schaeffer, Rowe & Lardiere
88 West Mound Street
Columbus, Ohio 43215
March 20, 2000, 12:57 p.m.
12 Q. "Did you ever fill out and complete"
13 "personal property tax returns in the early '70s"
14 "where you would have had to have disclosed the"
15 "value of any securities held, whether it be by"
16 "public companies or privately-owned shares? "
17 MR. WOLINETZ: "I'm going to object."
18 "Even if he did, it would be hearsay, and his "
19 "valuation as to his stock would be irrelevant to"
20 "the stock of any of the other shareholders."
21 "Having said that, you can answer the question."
22 A. "First of all, when did the -- when was"
23 " the gift made? I do not recall the date. Because "
24 "I thought it was in early '80s, but maybe I'm"
1 "wrong. Was it in the late '70s?"
2 Q. "Late '70s."
3 A. "Late '70s? "
4 Q. " Yeah."
5 A. 'Okay. All I know is that from around "
6 "that time, the late '70s -- '79, '80, '81, "
7 "somewhere in there, Harold, from that point until"
8 "now, my tax returns have been consistently"
9 " prepared by Deloitte & Touche. And if a valuation "
10 "was directly or indirectly performed in connection"
11 " with any of those returns, then the answer to your"
12 "question would be yes. I have no idea."