Huge news in the credit markets came this past weekend, as the US government took over failing mortgage finance companies, Fannie Mae and Freddie Mac. The government takeover ended months of speculation amid concerns that failure of the two mortgage giants could have a catastrophic impact on already struggling credit and housing markets.

With the pending elections, both Democratic and Republican leaders agreed that a takeover was necessary in order to cut mortgage costs and protect the credit markets from even greater doom and gloom. There are several factors that played into the decision, and while ideally the government would not have to become the country’s largest mortgage owner, most economists saw the move as unavoidable.

Ironically, as the government is backed by taxpayer dollars, it is essentially US taxpayers who now are fully invested in the mortgage enterprise that is set to become a huge undertaking for the next president and his administration. Cheaper home loans and more available mortgage opportunities is a prime goal of the move. Administration leaders hope to offer low cost mortgages to encourage more Americans to buy into a dark housing market to spark some life into it. Already the effects of the move have been witnessed. According to bankrate.com, 30-year fixed mortgage rates averaged 5.88 per cent Tuesday, compared with 6.26 per cent one week ago.

Other goals of the move include putting an end to the ongoing trend of record home foreclosures and falling home prices. Home prices have been widely expected to fall for the second straight year in 2008, after 2007 saw the first median home price drop in forty years, on an annual basis. Foreclosures have created a huge surplus of homes in many markets and buyers have been too concerned about the economy to buy in, even with many real estate markets operating at rock bottom prices.

The takeover is certainly not without risk. Early estimates suggest the move could cost US taxpayers tens of billions of dollars. Some have even suggested this mortgage takeover could be more impacting than the failure of 700 savings and loans during the 1980s and early 1990s that cost American taxpayers $125 billion.

Because Fannie Mae and Freddie Mac own over $5 trillion in mortgage debt, the national debt could potentially rise from a current high of $10 trillion, to $15 trillion. This would create a huge financial burden for taxpayers and dramatic increase the already high liabilities maintained by the US government.

It will be interesting to see whether Americans and investors are motivated by a significant drop in mortgage prices. Some analysts have predicted a quick drop to around 5.5 per cent for a 30-year fixed loan. This would bring mortgage rates near historic lows. Earlier this year, following several quick and emphatic Fed fund rate cuts, mortgage rates fell fast to the mid 5 per cent range. However, rates just as quickly climbed back up over six per cent, where they have rested for several weeks.

The Bush administration hopes that Americans that have avoided home buying because of concerns about the economy and credit and housing markets will find peace of mind in the takeover of the mortgage giants. Some economists have started talking recession again as retail sales have stalled again as of late. The government has seemingly exhausted all reasonable maneuvers to try to jump start the major sectors of the economy.

Market Recap

Big news hit the markets Monday as it was announced that the US government was taking over Fannie Mac and Freddie Mac. This is expected to cause an immediate drop in mortgage rates as the news is a relief to a struggling credit market. The Dow jumped 290 points as investors soaked up the news in good spirits. The NASDAQ and S&P climbed 13 and 25 points. The Dow quickly gave back most of its gains Tuesday with a drop of 280 points. The NASDAQ and S&P both fell hard, down 59 and 43. Credit concerns over Lehman were at the forefront. OPEC mentioned a plan to reduce oil output to slow falling oil prices.

Neil Kokemuller
Tuesday, September 9, 2008
11:43 PM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University.

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