How Fannie, Freddie Bailout Impacts Consumers

THE GOVERNMENT BAILOUT of Fannie Mae (FNM) and Freddie Mac (FRE) should eventually give homeowners firmer footing in the shaky housing market, but it won't be a quick fix.

In an unprecedented rescue effort, the Treasury Department and the Federal Housing Finance Agency seized control of the two mortgage giants Sunday, replacing the firm's chief executives and pledging to provide up to $200 billion in order to stem losses and keep the companies afloat. And, in an effort to inject liquidity into the dried-up housing market, the Treasury said it would invest in Fannie and Freddie's mortgage-backed securities, starting with $5 billion this month.

The move couldn't come soon enough. Fannie and Freddie -- which collectively own or guarantee $5 trillion in mortgages -- were buckling under the pressure of falling home prices and mortgage defaults, explains Dean Baker, co-director of the Center for Economic and Policy Research, a Washington, D.C.-based think tank. "There was no doubt that more was coming," he says.

"The hope is that this is the beginning of the stability the market has been longing for," says Keith Gumbinger, vice president at mortgage-information firm HSH Associates. Among other things, the moves aim to lower mortgage rates and relax lending standards, making it easier for homeowners to buy new homes or hold onto existing ones.

How it will all play out, however, is difficult to determine at this early stage. "This is an unprecedented event, and the market is still shaking all the details out," says Gumbinger. Adds Ed Mierzwinski, consumer program director for the U.S. Public Interest Research Group, a consumer advocate: "We're going to have to figure this out as we go along."

Still, there are a few broad effects Baker, Gumbinger, Mierzwinski and other experts feel confident in predicting. Good and bad, here's what consumers should expect in the coming months:

Once private mortgage investors -- which also secured and backed mortgages -- started pulling their money out of the housing markets, Fannie and Freddie were left holding the bag. In previous years, the two mortgage giants backed about 40% of the market, now they back nearly 80%, says Baker. Because Fannie and Freddie needed more capital to take on all of these abandoned loans, they started charging higher rates to the banks that were selling the mortgages. The banks, in turn, passed those higher rates to consumers. Now that the government will infuse $200 billion in capital into the mortgage giants, they no longer need to charge such high premiums to stay afloat. The result: slightly lower mortgage rates. Based on the firms' past premiums, Baker estimates rates could drop by about 0.25%.

Consumers could pay less in added fees when they secure a mortgage. Treasury Secretary Henry Paulson pledged to reassess the fees Fannie and Freddie charge banks to secure loans. Among them: a recently added "delivery fee" of up to 1% for mortgages originating in troubled markets. Lenders factor such fees into the mortgage rates they offer consumers, says John Courson, chief operating officer of the Mortgage Bankers Association, a trade group, so a reduction or elimination of them could bring rates down further for consumers with good credit. That is, if the banks decide to pass along the savings to consumers.

Now that the government is calling the shots, it has a vested interest in working with homeowners to keep them out of foreclosure, says Baker. And with $200 billion in capital entering the market, lenders have more wiggle room to rework terms and refinance troubled loans while remaining certain that Fannie or Freddie will back the mortgage.

Should all of the above stars align, the rescue plan could help stop the rapid decline in home prices that we've seen since 2007. The hope is that by making it easier to secure mortgages and by offering improved mortgage rates, more consumers will be enticed to buy a home, says Gumbinger. By reducing the inventory of unsold homes, housing values will stabilize.

A similar theory applies to stemming the tide of foreclosures. Those who had unmanageable rates would receive more opportunities to refinance and therefore hold onto their homes. That reduction in the number of defaults would also serve to bolster home prices.

"Taxpayers, good luck," says Mierzwinski. The U.S. consumer is on the hook for funding the government's multibillion-dollar bailout of Fannie and Freddie. But whether it results in higher taxes depends largely on just how successful the rescue plan is over the long term and how much it will ultimately cost. Unfortunately, that sum is extremely difficult to assess. Earlier this summer, the Congressional Budget Office estimated it would cost $25 billion to clear up Freddie and Fannie's part in the housing mess. Meanwhile, William Poole, former president of the Federal Reserve Bank of St. Louis, pegs the total bill at closer to $300 billion.

In the short term, it's likely that the funding will come at the expense of budget cuts to other programs, says Mierzwinski. "What usually happens in our zero-sum game is that something else won't get done," he says.

While the bailout is a big step in the right direction, experts agree that it's not a cure-all for the housing market's woes. "This isn't an antidote for the foreclosures, for the oversupply of houses we have," says Courson. Adds Gumbinger: "Credit quality of existing loans is still quite bad." Plenty of consumers are still in loans they can't afford, and for the market to fully recover, private mortgage investors must be confident enough to step back in, he says. It's going to take awhile before that happens.

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