Here are some answers to what the plan does and how it affects American homeowners.
Question: How do Fannie and Freddie affect mortgage finance?
Answer: They buy mortgages from commercial banks and other home lenders, then package these pooled mortgages and sell them into a secondary mortgage market as bonds, called mortgage-backed securities. This process is called securitization, and it allows a bank to pass on the loan and not keep it on its own books, freeing up its balance sheet for more lending.
Q: Are Fannie and Freddie going bust?
A: No. But investors who purchase mortgage-backed securities — banks, investment funds and even foreign central banks — were concerned that, as more Americans fall behind on their home payments, especially those with good credit, Fannie and Freddie might have insufficient capital to withstand losses.
Q: How does this help homeowners?
A: It helps in a broader sense. Since Fannie Mae and Freddie Mac own or back more than half of U.S. mortgage debt, anything to stabilize them helps the broader financial markets. In recent months, investors have demanded higher returns in exchange for buying Fannies and Freddies. That led to a widening spread, or gap, between these bonds and, say, a 10-year Treasury bond. Mortgage rates take their cues from long-term U.S. government bonds, so it has had the effect of driving up mortgage rates. Because a Fannie or Freddie will now effectively be government-issued debt, the gap should narrow and rates fall. A drop of 1 percentage point in rates equals about 15 percent savings on the costs of a mortgage over its life.
Q: So will the housing slump end because of the Treasury secretary's plan?
A: No. The half of the secondary mortgage market that doesn't involve Fannie and Freddie is run by the private sector — termed private-label mortgage-backed securities. And that part of the market is frozen over.
Q: Then what's the significance of the Treasury action?
A: It assures that the functioning part of mortgage finance, while facing challenges, continues to operate smoothly.