The sad state of Fannie and Freddie

Think the banking bailout was bad? Check out the funds going to these two companies.

By Kim Peterson Jun 21, 2010 2:08PM
Home financing © CorbisWe've spent a lot of time talking about the federal bailout of the banking industry, but guess what: The government's takeover of Fannie Mae (FNM) and Freddie Mac (FRE) will cost taxpayers even more money.

That's according to The New York Times, which had an excellent report Sunday on the sad state of Fannie and Freddie. The tab to take care of the companies is up to $146 billion, and the Congressional Budget Office predicts it could climb as high as $389 billion.

What happened here? Fannie and Freddie have been getting investors to fund mortgage loans for decades, promising to repay if borrowers defaulted, Binyamin Appelbaum writes. The companies used the money to buy loans already made by banks.

And it was a brisk business -- until a giant chunk of homeowners did in fact default. Fannie and Freddie had to make good on their promises to repay investors, who had become skittish about having anything to do with the two companies.

That's when the federal government took over, hoping that investors would continue to buy in. That would in turn provide more money for continued home loans. Post continues after video:
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These days, Fannie and Freddie are busy seizing foreclosed homes, sprucing them up and reselling them at a huge loss, Appelbaum writes. The companies took over a foreclosed home every 90 seconds in the first three months of the year, he reports.

What to do with Fannie and Freddie now? Congressional Republicans want to be done with the companies, cutting all ties once the current economic crisis fades, Appelbaum writes. Democrats don't want to talk about it until after the elections this fall.

But there are larger issues that must be discussed at the same time -- namely, how involved should the government be in the housing market. Banks and other private lenders don't want to give loans to anyone without a 20% down payment. If the government didn't step in to help, a large percentage of the population would never be able to own a home.
The government extended itself too much to prop up the housing market over the past two years, keeping prices artificially inflated. Advocates argued that allowing the housing market to fall any further would obliterate an already reeling economy.

But there's something to be said for letting the chips fall where they may in the housing market. A correction in prices is badly needed.

One prominent government official -- Sheila Bair, chair of the Federal Deposit Insurance Corporation -- says a revamp of Fannie and Freddie should be the government's next financial priority after financial reform passes.

She's right. The government has slowly been removing its emergency support mechanisms in the housing market, and it must overhaul Fannie and Freddie soon.
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