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Long-term effects of Fannie-Freddie intervention hazy for now

BReaction to the government takeover of mortgage giants Fannie Mae and Freddie Mac has been swift.

Barely 24 hours after Treasury Secretary Henry Paulson made the announcement September 7, rates on a 30-year fixed rate mortgages dropped 0.3%, to 6.04%.

What the long-term effects will be remain clouded.

Fannie and Freddie own or guarantee approximately half of the mortgage loans in the U.S., so one thing is clear: Taxpayers are now on the hook for trillions of dollars in loans. In his announcement, Paulson said the move was necessary to ensure continued availability of mortgages to potential homeowners. The failure of the two companies is yet another result of the nation’s faltering housing economy that has seen the number of foreclosures spike since the subprime mortgage crisis emerged late last summer. Whether government control of Fannie and Freddie will do anything to stem the tide of foreclosures remains to be seen, but government bailouts have been met with mixed results in the past.

Dr. Lance Nail, dean of the school of business at University of Southern Mississippi, says the lowered interest rates marks a good start.

“I haven’t seen anything in the takeover plan that would slow the rate of foreclosures. The bailout basically provides a capital infusion to offset the losses that Freddie and Fannie were continuing to suffer from foreclosures and nonperforming mortgages,” Nail said. “The housing market could be positively impacted by the reduction in interest rates that we have seen since the announcement. The only marginal impact that I see in staving off foreclosures is if the lower level of interest rates lowers adjustable rate mortgages for the marginal borrower on the brink of foreclosure that might be saved by a lower mortgage payment when interest rates adjust downward. But that will be a small effect.

“I think we are seeing a reflection of some risk and uncertainty being taken out the market with the government intervention. The markets were not sure of what would happen if Freddie and Fannie failed as private entities. With the government intervention that uncertainty has been removed, at least in the short run, and so that risk that was priced into interest rates before the Treasury stepped in has been removed for now and rates declined.”

A strong sentiment is that the politicization of the mortgage companies will only encourage the issuing of bad mortgages, which is why the housing economy is in its current condition. Nail is taking the wait-and-see approach.

“(The) Treasury wanted to make a signature statement that they would not let the U.S. housing market collapse due to the capital inadequacy of Fannie and Freddie,” he said. “They accomplished that with this first move, but there are further steps required to establish the infrastructure for Fannie and Freddie going forward. I hope we avoid repeating the same mistake of promising the American dream of home ownership to everyone regardless of financial ability and the loose credit standards that this attitude fostered in recent years. This is the political aspect that worries me. If we promise every American home ownership, then we will find ourselves in the same boat again in the future whether the financial intermediaries are public or private and the taxpayers will again foot the bill.”

To avoid sending a massive invoice to taxpayers, there will have to be additional reforms, starting with more accountability for the two mortgage companies, whose two CEOs were ousted upon the takeover. Politicizing a process like mortgage writing that should be based on sound financial policy is not one of those steps, Nail said.

“Again, it’s too early to make any predictions about whether this will succeed or fail. I believe that it’s the more comprehensive reform that develops beyond this first step that will determine long-term success or failure. The intervention is more about calming the markets and assuring that primary and secondary mortgage markets will continue to function.”

In Oxford, Ken Cyree, interim dean of the School of Business Administration at the University of Mississippi, will offer a lecture on subprime mortgage lending at 6 p.m. September 16 in Holman Hall, Room 30. The free, public lecture is among dozens of campus events planned to help prepare students and local audiences for the first 2008 presidential debate, scheduled September 26 at UM’s Ford Center.

Contact MBJ staff writer Clay Chandler at clay.chandler@ msbusiness.com .

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