by Laura Seddon

Created on: August 20, 2008

Who are Fannie Mae and Freddy Mac and what are they doing to the U.S. economy?
All Americans; not just homeowners, are learning that Fannie Mae (Federal National Mortgage Association) and Freddy Mac (Federal Home Loan Mortgage Corporation) have grown into a potential economic disaster. Together, they own or back about $5.3 trillion in mortgages.

Most of these mortgages were bought between 2005 and 2007. The problem is that the mortgages they hold aren't worth as much anymore. Loans weren't supposed to be more than 80% of a home's value, but through top-up loans and loans purchased from investment dealers, many have broken the 80% rule.

It helps to have a brief understanding of how Fannie Mae and Freddie Mac work to appreciate their potential effect on the U.S. economy. Both were programs introduced by the government to help more American families to own their own homes. When you apply for a mortgage, lenders use guidelines from Fannie Mae and Freddie Mac to decide if they will approve the loan. This initial lender "pools" the mortgages and sells them to Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac, in turn, offer these loans on the stock market as mortgage-backed securities.

The current problem is that it would seem that the mortgages Fannie Mae and Freddie Mac own aren't worth as much as was paid out for them. A $250,000 loan on a home that now is only worth $200,000 isn't a very good investment. So, naturally, the company's stock prices drop and they lose money. Between April and June of this year, Fannie Mae and Freddie Mac lost a combined total of 3.1 billion dollars.

To prevent further losses, Fannie Mae and Freddie Mac are not buying higher risk mortgages anymore. For US home-buyers, this means higher down-payments and closing costs. It also means less Americans qualify for a mortgage; some won't be able to renew their mortgages and will lose their homes. For the US economy in general, it means fewer housing starts and higher unemployment.

Fannie Mae and Freddie Mac were originally government programs but are now largely privatized. However, because of their history, many believe that the federal government will end up bailing out the companies. Fears about Fannie Mae and Freddie Mac's potential insolvency have already resulted in steep declines in stock prices. Americans need to ask what will be the cost of a government bail-out? What would be the cost of not shoring up these programs?

More importantly, people need to consider how to prevent this mortgage crisis from happening again. The people who regulate the mortgage industry have done a poor job of it, but it is the everyday taxpayer, employee or homeowner who will ultimately pay. Americans should demand more of their regulators.

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