Banks loan money to home buyers. The banks then sell those mortgages - assuming they meet certain credit standards - to Fannie Mae or Freddie Mac. Banks then use the money they get from the sale of those mortgages to make new loans. It's a system that provides a continuous supply of relatively low-interest cash so that banks can keep making affordable loans to home buyers.
So where do Fannie and Freddie get the money to keep buying mortgages from banks? They bundle the mortgages they buy from banks and resell them to major investors. They get a good rate of return because, historically, Fannie and Freddie bonds have been considered to be almost as safe as U.S. government bonds.
But as home prices started to drop in many real estate markets, and homeowners started to default on their loans, Fannie and Freddie got caught holding the bag - using their own cash to cover bad loans.
Changes within Fannie and Freddie
Earlier this week, Treasury Secretary Henry Paulson announced that Fannie Mae and Freddie Mac have been placed into conservatorship by the Federal Housing Finance Agency (FHFA). This is the most important event our industry has experienced in the past three years. This is good news for both the mortgage and real estate markets.
This government takeover will be a catalyst for the following changes:
- Immediate reduction in mortgage rates due to the narrowing of Fannie/Freddie yields over Treasuries
- Stabilization of credit markets
- Positive changes in investor psychology
- Positive impact on real estate market due to lower rates. When combined with the first-time buyer tax credit, this will stimulate the first-time home buyer market, which will unlock the trade-up market