FANNIE MAE, FREDDIE MAC SHARES TAKE BEATING ON FEARS OF RISING LOAN DEFAULTS!
STOCKS FALL AS MUCH AS 17.9% - INVESTORS FEAR LOSS OF CAPITAL, SHARPLY HIGHER INTEREST RATES!
Freddie Mac and Fannie Mae are not candy stores! They are government-sponsored companies whose focus is buying and guaranteeing loans made by banks issuing residential mortgages.
Monday, each company's shares fell dramatically, as their investors feared the continued escalation of loan defaults will force them to raise more capital to keep pace with the high default rate. Billions of dollars of stock will need to be issued, and this will dilute Fannie and Freddie's stock value for investors.
We all know that home buyers are having more and more difficulty obtaining a residential mortgage these days. Across the board, loan underwriting standards have toughened, as the availability of sub-prime loans, for buyers with credit challenges and low down payments, have just about dried up.
On Monday, IndyMac Bank, which specialized in loans to buyers who didn't fully document their income or assets (so-called "stated loans"), declared it will stop making most home loans. Over half of the bank's 7,200 employees will be let go.
If Fannie Mae and Freddie Mac find themselves short on capital, they will have a harder time buying and guaranteeing loans issued by lenders. This could raise mortgage interest rates and fees, thus increasing the cost of the average residential transaction. An already-stressed housing market could encounter reduced demand, and home prices would fall even further than they have in recent months.
Lawmakers in Washington are depending on the two large mortgage guarantors, along with the Federal Housing Administration, to take steps to revitalize the currently-downtrodden residential mortgage market. The pressure is on for them, therefore, to step up their activity, not reduce it.
Fannie and Freddie currently owns or guarantees roughly $5.2 Trillion of residential mortgages - about 50% of all outstanding home loans. During the nine month period that ended March 31, 2008, the two companies suffered combined mortgage write-downs of greater than $11 Billion. Experts predict losses will increase as more home owners default on their loans.
Sharp reductions in the mortgage guarantors' stock prices could send their investors running for the exits - prompting possible goverment intervention - even a bailout, designed at keeping mortgage guarantees flowing at increasing levels. Indeed, any scaling back on the potential volume which the two companies can handle could spike interest rates - predict experts!
See James R. Hagerty and Serena Ng's article in yesterday's Wall Street Journal for more detail.
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