Government to the rescue

Treasury Secretary Henry Paulson announced last Sunday that the government would take control of mortgage giants Fannie Mae and Freddie Mac, sister companies which together own or guarantee more than half of the mortgages in the U.S. That's over $5 trillion in loans!

The government's move is the latest attempt to shore up the economy and the struggling housing market. Investors have long considered Fannie and Freddie backed by the U.S. government though they are technically private, and, though officially their securities are not guaranteed, it was always generally assumed the government would step in should Fannie and Freddie need the help. Now we no longer need to assume: it’s happened.

Basically, they work like this: Banks loan money to home buyers. The banks then sell those mortgages- assuming they meet certain credit standards- to Fannie Mae and Freddie Mac. Banks then use that money they received for the mortgages to make new loans. Fannie and Freddie, meanwhile, bundle those loans together, attach a payment guarantee to them, and resell them as bonds.

As home prices dropped and mortgage defaults soared, Fannie and Freddie started finding it difficult to sell those bonds to raise money. The government tried to avoid a full takeover in July by explicitly stating that it would provide direct financial support to the mortgage giants if they needed it. This didn’t calm the fears of investors – including the central banks of China and Russia- which continued to sell off bonds.

Economists are struggling to predict the consequences of this unprecedented takeover. Now that the government is in the mortgage-buying business, it’s safe to assume there’ll be both positives and negatives.

It’s good news because the government’s explicit support will calm investors’ fears. It is now inarguable that Fannie’s and Freddie’s securities are guaranteed. This should help stabilize mortgage rates, making buying or refinancing a home a more attractive option. We’ve already seen a drop in the 30 year fixed mortgage rate.

It’s bad news because the $200 million bailout will be financed by tax payers. That’s you and me folks! Not only are we footing the bill to save these so-called private companies, but even with newly stabilized mortgage rates, home prices will probably continue to decline. If the bailout works, though, taxpayers may see that money again. In the future. Sometime. Maybe. I hope.

There’s no doubt that bringing some much needed calm to the housing market is a worthy cause. But in the end the government takeover may just be a band aid on a much, much larger wound.