A rescue, but not a remedy

Mortgage giants stabilized, underlying problems remain

July 15, 2008|By Paul Adams and Laura Smitherman | Paul Adams and Laura Smitherman,Sun reporters

Consumers still face the prospect of rising mortgage rates, inflation and tighter credit despite the federal government's move to rescue Fannie Mae and Freddie Mac and avert a meltdown in the lending industry, economists and banking experts say.

Most agree that the situation would be much uglier if the Bush administration had not stepped in over the weekend to shore up financial confidence on Wall Street for the two largest mortgage finance companies in the U.S.

More than half the nation's mortgage lending activity is backed by Fannie Mae and Freddie Mac, and disaster for them could have meant soaring mortgage rates and plummeting access to credit for consumers. Consumer spending represents two-thirds of the economy - much of it borrowed.

However, financial experts point out the investments and loans for Fannie and Freddie merely preserve the status quo and do nothing to reverse the underlying problems that are fueling recession concerns and causing consumer confidence to fall precipitously.

Financial markets remain in turmoil, with financial stocks taking another beating yesterday amid worries of more bank failures.

It all adds up to uncertainty for U.S. companies, making them wary of hiring or doing major deals. Unemployment has ticked up in recent months, and many economists say the country is headed for a recession, if it isn't in one already.

"If the Federal Reserve and the Treasury had turned a cold shoulder toward Fannie Mae and Freddie Mac, we would have had a disaster on our hands," said Greg McBride, a senior financial analyst for Bankrate.com. "Now that we've avoided the catastrophe, we'll have to catch our breath and focus on the same things we've been dealing with for the last year."

Markets fell again yesterday as investors grew increasingly worried that the government's moves to support Fannie and Freddie won't be enough to stabilize financial markets. Shares of Freddie Mac fell 64 cents, or 8.3 percent, to close at $7.11; Fannie Mae shares lost 52 cents, or 5.1 percent, to close at $9.73.

Shares of both companies - which started the year above $30 - plunged by double-digit percentages last week as concerns about their finances grew.

Financial shares saw their biggest drop in eight years yesterday as investors grew concerned about the solvency of several regional banks. The Dow Jones industrial average lost 45 points to close at 11,055.19, and the S&P slid 11.19 points to end trading at 1,228.3.

The Treasury Department announced plans over the weekend to extend more credit to Fannie and Freddie and to buy shares in them if needed. In a separate move, the Federal Reserve said it will lend to the firms at the same rate given to commercial banks and Wall Street firms.

The Fed also announced new rules yesterday to crack down on questionable lending practices that contributed to the housing crisis. The rules bar lenders from issuing loans without proof of a buyer's income. They also require lenders to ensure that high-risk buyers set aside enough money to pay for taxes and insurance, among other things.

The series of actions came after federal regulators took control last week of the $32 billion IndyMac Bank, which was failing as a result of its real estate lending problems. Since then, jittery investors have grown increasingly worried that other regional banks could face similar problems, given the housing and credit crunch.

The plan to shore up Fannie and Freddie puts taxpayers on the hook to secure the flagging mortgage industry, which has experienced soaring delinquencies fueled by subprime lending during the real estate boom. Some blame the companies for taking on too much risk.

But many experts say Fannie and Freddie are too important to let fail. Both increased their purchases of mortgages after a number of mortgage companies collapsed last summer, leaving a lending gap in the industry.

Fannie and Freddie play a critical role in the economy by buying mortgages from lenders, freeing the lenders to use those funds to underwrite new loans. The two package the loans into securities, which are sold to Wall Street firms.

If either went bankrupt, it would leave a gaping hole in the industry and send mortgage interest rates soaring. In the past decade, Freddie Mac alone has invested $114.6 billion in Maryland mortgages, serving more than 772,000 homeowners and renters, the company says.

"You almost can't overstate the importance of Fannie and Freddie to the development of mortgages and home ownership to Americans," said Jeff Tjornehoj, a research analyst for mutual fund tracker Lipper Inc.

He said the government rescue will save them from bankruptcy, helping investors in the companies and sending a signal to markets that the government will cover their debt. Treasury and company leaders, however, insist that Freddie and Fannie are in no financial danger but that the moves were designed to restore confidence on Wall Street about the businesses.

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