Freddie Mae and Fannie Mac: How did we get here?

To understand where you are you must first know where you started. So with the big announcement yesterday that the government will take over struggling Fannie Mae and Freddie Mac let’s review what these entities are and why they were created.

But first a statement from Treasury Secretary Henry Paulson: “Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance."

The Federal National Mortgage Association, nicknamed Fannie Mae, was created in 1938 as part of President Roosevelt's New Deal when private lenders were reluctant to invest in loans for homes. To encourage home ownership, Fannie Mae provided local banks with federal money to finance mortgages. Fannie Mae operated a lot like a national savings and loan, allowing local banks to charge low interest rates on mortgages. Because of the financial support that Fannie Mae received from the U.S. Government it was able to borrow money from foreign investors at low interest rates. This allowed Fannie Mae to provide fixed interest rate mortgages with low down payments to home buyers. Thus Fannie Mae profited from the difference between the interest rates homeowners paid and what foreign lenders charged. Fannie Mae also quickly became queen of the secondary mortgage market.

For thirty years Fannie Mae held a monopoly over the secondary mortgage market. Then 1968 changed things. Fiscal pressures created by the Vietnam War caused President Johnson to privatize Fannie Mae and remove it from the national budget. That’s when Fannie Mae became a GSE. A GSE, or government sponsored enterprise, is privately owned and operated by shareholders, but protected financially by the support of the Federal Government. These government protections include access to a line of credit through the U.S. Treasury, exemption from state and local income taxes and exemption from SEC oversight. To further squelch Fannie Mae’s hold on the market, the Federal Home Mortgage Corporation, nicknamed Freddie Mac—another GSE was created in 1970.

The decades that followed were amazingly fruitful for Fannie and Freddie and it appeared that they would live happily ever after. Together they enjoyed total assets 45 percent greater than that of the nation's largest bank. But their debt also climbed to 46 percent of the current national debt. It is this combination of rapid growth and over leveraging that has lead to the current concerns of Congress, the Justice Department and the SEC with regards to the financial practices of these GSEs. Additionally accounting scandals have plagued Freddie Mac.
Fannie Mae and Freddie Mac are the only two Fortune 500 companies that are not required to inform the public of financial difficulties. If either should collapse, U.S. taxpayers could be held responsible for hundreds of billions of dollars in outstanding debts.

And that, friends, is how we got to the government takeover announced on Sunday. What will be the next piece of the story?

The Millionaire Party Could Be Ending

If you've read one "how to be a millionaire" book you've read them all. And if you haven't read the book maybe you caught some of the infomercial. Nearly everyone who brags about being a millionaire wants to sell you their secret formula for purchasing real estate at ridiculously low prices and reselling for profit.

Meanwhile, the foreclosure rate for the Denver metro area is up 9% over last year's all time high. For some people this misfortune has been a gold mine. Previously it wasn't that easy to find investment properties for less than $100,000. But with foreclosures more ordinary people have been able to add "investor" to their resume for less than half that.

photo by Martin Deutsch

But the new housing relief bill may be closing the window of millionaire opportunity. The measure includes $300 billion in new loan authority for the federal government to back cheaper mortgages for troubled homeowners. The goal of this funding is to help more home owners avoid losing their homes. And that means fewer deals for investors.

Now maybe that also means there will be less books published that try to trick us into buying them with promises of becoming a fast millionaire.

Why Your Money is Still Safer at a Credit Union

No sector of the economy is immune to the effects of the mortgage market woes--not even credit unions. The recent Wall Street Journal article Mortgage-Market Trouble Reaches Big Credit Unions Mortgage-Market Trouble Reaches Big Credit Unions highlights the paper losses of 5 corporate credit unions. Corporate credit unions do not serve the individuals they provide investments and financing to credit unions.

It's important to understand "paper losses". These are not actual losses, instead they represent investments that have lost value but are not expected to be sold. General belief is that these investments will eventually rebound and credit unions won't reach the point when they'll need to sell them off at a loss.

Brian Resch, CEO/President of Coors Credit Union had this to say, "I’d like to reiterate Mr. Buckham's comment (director of the office of corporate credit unions for the National Credit Union Administration) 'the possibility that a corporate credit union might fail now is "so remote" that "I can't even imagine that happening.'

The article also accurately points out that credit union corporates are the most conservative, risk-averse institutions in the country. That is a clear difference between the credit union sector vs. the likes of Indy Mac. How all of this with Freddi Mac and Fannie Mae plays out in the end should make for some interesting financial history. Meanwhile know that your assets deposited in credit unions are safe.

Understanding the Housing Bill-Part 2

Thinking about taking advantage of the sad real estate market to purchase a new home? Here's what the soon-to-be Housing Relief Law has in mind for you...

No More Help with Downpayments

Once upon a time first-time homebuyers, low-income and moderate-income could get a little help with home ownership through down payment grants. It was a nice idea, but now the feeling is that this may have caused more trouble than good including contributing toward inflated housing prices. That's because while the FHA insured mortgage required the buyer to put down 3%, it didn't stipulate where that 3% came from. In fact if you follow the link above you'll quickly see that FHA encouraged down payment grants. It worked like this:

The seller wants to unload the house, but the buyer doesn't have the 3% down payment. Technically the seller cannot provide the buyer's down payment. They can, however, give the money to one of the granting agencies such as AmeriDream or Nehemiah who then gives it to the buyer.

And so the Housing Relief law will ban such programs as of Oct. 1.

Extended Loan Limits

Earlier this year the maximum loan amount that FHA would insure was temporarily raised. The new law makes that raise permanent. The limit will be 115% of the local median home price up to $625,500.

FHA for Doublewides

Manufactured homes have been limited to FHA-insured loans of $48,000. The new law will increase the amount to $70,000. But the insured loan only covers the home and not the land. The upside of the increase is two-fold: 1) the previous limit was set in 1992, the new limit will index with inflation, 2) the increased limit will allow for the purchase of bigger and better manufactured homes, i.e., doublewides.

In Other Cases

For the Troops

Currently if a service member has a mortgage before entering duty and then defaults on the loan the lender can begin foreclosure proceedings just 90 days after they return home. The new law will extend protection to 9 months after they return from duty. In addition, active service members who hold a mortgage will have the interest rate on all existing debt capped at 6% until 1 year after they return.

When You're 62

Reverse mortgages, which are typically sold to people over the age of 62 will have a tighter watch. The new law bars insurance salesmen from originating reverse mortgages. And originators cannot require homeowners to buy annuities or insurance products. Origination fees will be limited and indexed with inflation.

The Grand Finale

The new law will create an Office of Housing Counseling. It will also require licensing and registration of all mortgage brokers.

Understanding the Housing Bill-Part 1

We've been hearing about Capitol Hill's plans to rescue the mortgage crises through the "Housing Relief Bill" for some time. After passing the House last week the outlook is strong that the Bill will be soon become the law of the land. And whether your a home owner or a home buyer it's got something in it for you...like it or not.



First if you already own a home here's what the Housing Bill means to you.

ARM Relief
If you're adjustable rate mortgage shot up to an unaffordable new rate and you can't refinance into fixed-rate loans because your home has lost value, and you owe more than your house is worth the soon-to-be law may help you. Here's the scenario:

You bought a house (before Jan. 1, 2008) for say $125,000 (it's just an example, I know it's rare to find a house that cheap). You took an ARM for $110,000 after making a $15,000 down payment. But the house lost value. Now it's worth $100,000, based on an appraisal. Meanwhile, the ARM's rate went up and you can't afford the loan payment.

Under the new law, the lender would forgive everything you owe above 90% of the home's current appraised value--or in this example $90,000. The lender would not be allowed to seek any of that $15,000 later.

That allows you to find another lender who would underwrite a $90,000 mortgage to be insured by the FHA. That loan amount would include the upfront FHA insurance premium of roughly $2,700. However....If you sell the house (or refinance the loan) the FHA gets a cut.

The equity-sharing arrangement goes like this: If you refinance or sell less than a year after getting the FHA loan, the government gets 100 percent of the home price appreciation. So if you sell that house in the example above for $120,000 the FHA would take a cut of the extra $20,000. If it's more than a year but less than two years, the FHA gets a 90 percent cut. The FHA's cut decreases by 10 percent until the five-year mark. Anytime after that, the FHA gets half of the appreciation, no matter how long you have the loan or own the house.

The idea is to encourage homeowners to keep their FHA-insured mortgages for at least five years, but to refinance before home prices zoom upward again.

Property tax deductions
Currently you can deduct your property taxes from federal income tax if you itemize deductions on Schedule A. But if you don't have enough deductions to file Schedule A then you take the standard deduction without the property tax deduction. The proposed law does away with the need to meet Schedule A requirements and sets a standard deduction. It looks like this:

For homeowners who pay property taxes, the standard deduction is increased by $500 for single filers and $1,000 for couples filing jointly. But, you can't increase the standard deduction by more than your the property-tax bill. So if you're married filing jointly and you pay $800 in property taxes, you get an $800 deduction, not a $1,000 deduction.

More on the Housing Relief Bill and what this means for new buyers tomorrow....

Don’t like the Housing Outlook? Move Over a Few Miles.

USA Today reports that Green Ranch near DIA is looking like ghost town as for the foreclosure plague moves in. But while the tumble weed may be blowing in the prairie it’s not indicative of the rest of the metropolis. We all know that Colorado, particularly the Front Range, is comprised of a multitude of micro-climates. Well, same goes for the housing market. And so, we seem to fit right into whatever media headline needs to be written.

Need a doom and gloom story? Just last week Forbes included Denver among the “riskiest housing markets”, but with a caveat…

Other spots, Denver, for example, exhibit negative characteristics like foreclosures, lending problems and vacancies, but are adding jobs, a sign that the local economy can better handle these difficulties.

And for a good time…Earlier this year Forbes nominated Douglas County as No. 5 in America’s Richest Counties.

And my point is? Denver seems to reflect what’s happening through the country. While some pockets continue to prosper others fail.

Let's hope that like most storms in Colorado this one passes quickly with beautiful times ahead. It’s a sweet time for investors and new buyers and sad for those who bought into bad loans.

photo by artbabee