Latest News

Mortgage backers ignored threat of falling home prices

WASHINGTON — Mortgage giants Fannie Mae and Freddie Mac — despite their robust cadre of economists and mortgage experts — failed to heed warnings that the most dramatic housing bubble in U.S. history would burst.

The companies — particularly Freddie Mac — didn't raise enough cash to reassure Wall Street that it would be able to withstand a severe downturn in U.S. home prices.

As losses started rising at alarming rates, investors lost confidence, forcing the government's historic takeover of the two companies, which could be announced as soon as Sunday.

Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, said in an interview Saturday that the companies' financial picture was better than investors assumed, but "it just plainly became clear that elements of the market wouldn't accept that."

Investors have reason to be jittery.

On Friday, the Mortgage Bankers Association said more than 4 million American homeowners, a record 9 percent, were behind on their mortgage payments or in foreclosure at the end of June.

Also on Friday, Nevada regulators shut down Silver State Bank, the 11th failure this year of a federally insured bank.

Treasury Secretary Henry Paulson has been in contact in recent weeks with foreign governments that hold billions of dollars of Fannie and Freddie debt to reassure them that the United States recognizes the importance of the two companies.

Nevertheless, the Bank of China said in late August that it cut back its portfolio of the Fannie and Freddie's debt by about one quarter since the end of June.

Fannie and Freddie are the engines behind a complex process of buying, bundling and selling mortgages that remains a mystery to millions of Americans whose home loans pass through this system. Together Fannie and Freddie hold or guarantee $5 trillion in mortgage debt — about half of the nation's total.

They traditionally backed the safest loans, 30-year fixed rate mortgages that required a down payment of at least 20 percent. But in recent years, they lowered their standards dramatically, matching a decline fueled by Wall Street banks that backed the now-defunct subprime lending industry.

Armando Falcon, who clashed frequently with the companies during his six years as Fannie and Freddie's chief government regulator, said in an interview last month that their woes are similar to the downfall of other major corporate titans like Enron and WorldCom earlier this decade. "It boils down to a whole lot of greed and arrogance," he said.

Plummeting home prices are the key to Fannie and Freddie's troubles. As prices fall — as much as 25 percent during the past 12 months in Las Vegas, Miami, Phoenix and Los Angeles — the value of mortgages the companies hold on their books drops. That means Fannie and Freddie are recovering far less money through foreclosure sales.

While a government intervention had been expected for weeks, its timing came as a surprise.

The companies had been able to raise money through regular debt sales, but analysts say the Treasury Department probably grew concerned that foreign investors were pulling back.

In addition, an investigation by investment bank Morgan Stanley into the two companies' financial positions might have turned up new problems.

Freddie Mac in particular has had investors and analysts fearful for months. The company, led by CEO Richard Syron, promised to raise $5.5 billion earlier this year to shore up its finances, but failed to do so, and its sinking share price has since made it all but impossible for the company to raise that money from private investors.

Fannie Mae executives are likely to have resisted the proposed takeover because the company's financial condition isn't as dire as its sibling company, said Bert Ely, a banking industry consultant based in n Alexandria, Va.

But the government would still have to take over both companies, he said, to allow them to borrow money at the same rates.

"In order to level the playing field between the two companies, you've got to take over both of them," said Ely, a longtime critic of the two companies.

Fannie Mae, based in Washington, was created by the government in 1938, and was turned into a shareholder-owned company 30 years later. Freddie Mac, based in McLean, Va., was established in 1970 to provide competition for Fannie.