It seems the inevitable approaches for the US government and its "supported entities" Fannie Mae and Freddie Mac. Both, moving in tight alignment, have lost over 60% of their market value in the preceding 30 days. Hovering dangerously between $3-$5 a share. Something is certain to break.

So, where does will a Fannie, Freddie meltdown leave mortgage borrowers?

What is Fannie Mae and Freddie Mac?

Understanding Fannie and Freddie is important to sorting out how events may unfold and the direct impact on homeowners.

The Federal National Mortgage Association (FNMA), nicknamed Fannie Mae, was a depression-era institution created under New Deal legislation. Its objective was simple--make homeownership affordable for working-class Americans.

In the face of mounting debt, the US government freed Fannie Mae to the private markets. However, to entice institutional and foreign investors to fund cheap American homeownership they were given a unique implicit guarantee of the US government with the Government Sponsored Enterprise (GSE) label.

In the most simple of explanations, this arrangement was so good they cloned Freddie from Fannie and called it--competition.

Why are Government Sponsored Entities Important?

Where does this convenient collaboration of public and private entities--call GSEs--leave us? Quite frankly, with a very complex mess. A tangled web of interests, nods, and casual winks of assurance.

When asked why this is important to your mortgage rate experts like Dan Green, loan officer and author of, will tell you "mortgage rates are based on the perceived risk of GSE-issued debt so if the government steps in to help, the debt gets an implicit guarantee."

Although this may seem to create a direct taxpayer-funded windfall for shareholders Dan Green reminds us that "the intervention may not trickle down to Wall Street as Fannie and Freddie raise fees, which they have done recently and are likely to do again."

The bottom line is that GSEs, Fannie and Freddie, guarantee or own over half of US mortgages at $12 trillion!

This concentration of mortgage financing leaves us with a couple of significant risks. First, and foremost without it mortgage rates soar without affordable secondary market financing (think pre-1938 when FNMA was created). Second, the implicit government guarantee was banked on by institutional and foreign governments around the world as--"good as gold." Breaking this guarantee becomes global financial crisis.

This is the complex risk map that throws us into the "too big to fail, but perhaps too big to save" debates.

Mike Shedlock, of Sitka Pacific Capital Management, analyzes the GSE's pending need to refinance current expiring debt terms, highlighting the government's looming stabilization role. "$233 billion is an enormous amount of debt to have roll over between now and September 30," states Shedlock while predicting "there is a decent chance the bond market chokes on those rollovers." Shedlock explains this is where Paulson's "blank check to buy unlimited amounts of Fannie and Freddie bonds" come in.

What are Mortgage Professionals Telling Clients?

Where does that leave homeowners and home buyers?

Most mortgage lenders are telling borrowers time is of the essence. Although, we have seen hovering or even slightly declining mortgage rates things will change--probably with a bang, not a trend line.

Mortgage lenders are already seeing it become harder for their clients to get mortgage loans. "Mortgage and refinance qualifications are tightening on a daily basis," says Tom Vanderwell a Michigan mortgage lender, "and a lot of it has to do with Fannie and Freddie already buying less."

The general sentiment is that regardless of how the Fannie, Freddie drama plays out it is going to drive sharp mortgage rate increases. Kept intact, Fannie and Freddie will continue to keep housing affordability within range, but with much higher rates and qualifications.

Published on August 22, 2008