The Woes of Fannie Mae

The AP posted an article today entitled Mortgage Giants Avert Potential Disaster.

That headline certainly caught my eye!

I have often said that the past decade’s unequalled rise in housing prices has been due to a systemic problem in our nation’s financial structure – specifically, the artificial stimulus to the mortgage market provided by the out-of-control Government-Sponsored-Entities (GSEs), Fannie Mae and Freddie Mac.

Here are the interesting excerpts from the article:

A potential financial disaster that could have shaken the housing market was averted because regulators discovered accounting failures at Fannie Mae and Freddie Mac, the new head of the agency that oversees the mortgage giants said Monday…

...but it still will take years to repair their internal problems…

I’m glad that the problems at Fannie and Freddie were caught early. However, knowing a problem exists does not equal solving the problem…

“The housing market is so important to this country," said Lockhart, who has headed the Office of Federal Housing Enterprise Oversight for about two months. "And to have it built on what turned out to be a shaky foundation could have caused significant financial problems."

Shaky foundation? Significant financial problems?

Problems were averted, he said, because the regulators acted to identify and order corrections at Fannie Mae and Freddie Mac, which together stand behind some 40 percent of the $8 trillion U.S. home-mortgage market.

Fannie Mae and Freddie Mac are behind 40% of outstanding mortgages in the United States? And they were on a “shaky foundation”? Scary stuff.

Fannie Mae, the second-largest U.S. financial institution after Citigroup Inc. and the second-biggest borrower after the federal government, is restating its earnings back to 2001 — a correction expected to reach at least $11 billion.

$11 billion! That’s a chunk of change. But is it just the tip of the iceberg?

And what do exactly do they mean by the "second-biggest borrower after the federal government"?

Most people don't realize that Fannie Mae and Freddie Mac borrow money to buy mortgages in the secondary market, then package those mortgages into Mortgage-Backed-Securities (MBS) to sell on the open market.

Who buys MBSs?

Pension funds, hedge funds, mutual funds, insurance companies…

So, Fannie Mae borrows money to buy mortgages so that money can be loaned out again as mortgages, which Fannie Mae borrows money to buy, so THAT money can be loaned out again...

Does that sound like a sound way to bolster home-ownership?

Congress created Fannie Mae and Freddie Mac to inject money into the home-loan market. They buy mortgages from banks and other lenders and bundle the loans into securities for sale to investors worldwide.

And that’s where they went wrong. The anomalous rise in home prices between 1998 and today are in large part due to the artificial amount of liquidity injected into the mortgage market by Fannie Mae’s irresponsible handling of its duty. According to the article, Fannie Mae was engaged “in a deceptive accounting scheme from 1998 to 2004.”

Hmm…that just about correlates with the explosion in housing prices…

Could there be a connection?