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Fannie Mae Posts Losses; Mortgage Market Quakes

May 6, 2008 at 6:30 PM EDT
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The mortgage giant Fannie Mae posted $2.2 billion in losses Tuesday in its third consecutive quarter of bad news. A reporter from the New York Times explains this latest bad news and its potential impact on the mortgage market.
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GWEN IFILL: Now, new losses at the nation’s largest buyer of home loans and growing worries about what that might mean. Margaret Warner has the story.

MARGARET WARNER: Today’s posting of a $2.2 billion loss by Fannie Mae was the third straight time the mortgage giant has issued bad quarterly news.

Fannie Mae and its sister, Freddie Mac, were originally created by the government to buy, guarantee and sell home loans. They are now publicly traded companies.

To explain today’s news and its potential impact on the already-troubled housing market, we turn to Charles Duhigg of the New York Times.

And, Charles, thanks for being with us. This huge quarterly loss again for Fannie Mae, in simple terms, why? Did Fannie Mae underwrite loans that went sour, or is it more than that?

CHARLES DUHIGG, New York Times: Fannie Mae bought a lot of loans that two or three years ago people thought were going to perform much better than they did. As almost every other bank has experienced, these loans turn out not to be as good a bet as everyone thought they were.

Homeowners are walking away from homes that they had previously purchased. They’re not making payments on time. And as a result, loans that Fannie Mae both owns in its own portfolio and that it’s guaranteed by selling to other investors and promising to pay if the borrowers don’t pay, they’re now on the hook for.

Fannie, Freddie critical to market

MARGARET WARNER: And to what degree, to what extent does the health of the U.S. housing market depend on the health of Fannie Mae and Freddie Mac?

CHARLES DUHIGG: Enormously. These are enormously important companies.

They basically go to banks and other lenders, and they say, "We'll buy your loans from you. And as a result, we'll give you money that you can use to make more loans with."

If Fannie Mae and Freddie Mac weren't there, the entire housing market could essentially just freeze up. They're the lubricants that provides capital so that everyone can make loans.

And so they're enormously important not just to that market, but because the housing market is so important to the entire economy, they play a tremendous role within the entire U.S. economy.

MARGARET WARNER: Now, you wrote today in your story, your front-page story in the Times that -- you said, "Some financial experts worry that the companies are dangerously close to the edge." In what respect?

CHARLES DUHIGG: Both companies have a small amount of what's called core capital. The regulator says they basically have to keep enough money from shareholders and from their earnings on hand to offset these tremendous, tremendous financial guarantees and debt that they have.

There are some people out there who worry that they just don't have enough money on hand and that, if things got really bad in an unexpected way, that these companies could post losses that would cause their capital levels to fall below regulatory minimums, which would then possibly put the government on the hook for all of the liabilities that Fannie and Freddie have amassed.

MARGARET WARNER: Well, give us an idea of the scale. What's the ratio between the capital they have and the amount of debt they essentially carry in some way?

CHARLES DUHIGG: It's not just debt. It's also guarantees, that they've promised to pay off mortgages if the borrowers don't pay.

Combined, as of the end of 2007, they both had about $83 billion in regulatory core capital that they have on hand. That offsets about $5 trillion worth of guarantees and debts that the companies hold.

And so it's a pretty high leverage rate, much, much higher than you would see at almost any other bank or any other financial institution, which they're allowed to do, because they were created by the government.

And Wall Street believes, whether this is true or not, that if they ever failed, that the government would come in and save them. So they're given a lot more rope.

Pressure from all sides

MARGARET WARNER: Now, today the company announced that it was going to raise $6 billion in new capital. How are they going to raise that money? And what's it going to be used for?

CHARLES DUHIGG: They're going to go to investors and ask them to buy new common share in the company, as well as preferred shares and a convertible type of stock.

It's kind of unclear exactly what it's going to be used for, and it depends on who you're talking to. What the company says is that they're seeing now some of the best business opportunities they've ever seen and so they need new money, because they want to go out and they want to buy a whole bunch of great loans that they essentially have no competition for.

If you talk to other people who say that they are more worried about these companies, they say that they think what this money should be used for or will be used for is to create a larger cushion, so that when there's future losses -- and there will be future losses, and the company has acknowledged that -- that they'll have some money on hand so that nobody really gets overly worried.

MARGARET WARNER: But now, are Fannie Mae and Freddie Mac an important part of the bulwark against -- and you sort of answered this, but just a little more here -- didn't the government turn to them and, in fact, increase their ability to buy loans when this housing crunch hit?

CHARLES DUHIGG: Absolutely. And that's where the tension is that's going on right now.

There are some people within Congress and some lawmakers who say, look, Fannie and Freddie exist so that, when everything gets bad, they can go up and they can go in and soak up all the risk. They can buy all the bad loans. They can save everyone. What those people advocate is that Fannie and Freddie spend and spend and spend.

There's other people in Congress who say, look, these guys are too close to the edge. If they start buying riskier and riskier loans, everyone is going to be walking a tight rope.

And then, in the middle, trying to thread between these two camps, is Fannie and Freddie themselves, who are saying, "We want to buy good loans, but we want to maximize returns for our shareholders." And that means buying great loans, but not necessarily buying a whole bunch of really terrible loans, although they acknowledge that, in order to appease some people in Congress, they have to buy some loans that maybe they wouldn't want otherwise.

And so there's this delicate dance going on of some people who want them to save the housing market, other people who are concerned that if they go too far the housing market will blow up, and Fannie and Freddie, who are trying to do what they can, but are also trying to maximize returns for their shareholders.

Bear Stearns redux unlikely

MARGARET WARNER: And so, briefly, is there a realistic scenario under which Fannie and Freddie could collapse? Or is the taxpayer always there as the bailout of last resort?

CHARLES DUHIGG: The taxpayer is probably always there. I mean, everyone sort of agrees on this. And in the next couple of months, Fannie and Freddie are not going to experience such significant losses.

What everyone is worried about is what happened with Bear Stearns, where everyone said, "It's a great bank," and then literally, in a weekend, it went bankrupt.

If something hugely unexpected happened, the taxpayer could be forced to step in, which would put us, the taxpayers and the government, on the line for trillions of dollars.

MARGARET WARNER: Charles Duhigg of the New York Times, thanks for being with us.

CHARLES DUHIGG: Thank you. I really appreciate it.