I am always inspired and enriched by the quality of email I receive from readers here. There are so many knowledgeable sources among us, from so many industries, and each one has a valuable insight. I firmly believe that if we can pool our ideas and research, from each of our areas of expertise, we can come up with some real solutions to a lot of the issues concerning us. OK, not all of our ideas have been reasonable. (To the man whose suggestion for a retirement plan includes scheduled euthanasia, I am worried about you my friend) But at the very least the discussions have been thought-provoking. And that is exciting.
One of the topics that many have written to me about recently has been Government Sponsored Enterprises, specifically Fannie Mae (FNM:NYSE), and its cohort Freddie Mac. They have played very large roles in keeping the housing markets strong, but as many of you have passionately pointed out, there are inherent risks in the relationship between these companies and taxpayers.
Let me first point out that I have traded FNM, and even wrote an article last December about FNM, recommending it. I love the idea of this company. Their intentions are as American as apple pie, and their earnings are solid. They have been growing at 15% for as long as I can remember. For the first six months of this year revenues increased 5%, and all indications say that trend is continuing. The stock yields 1.9% too. They are even on Fortune’s list of 50 best workplaces for minorities.
The establishment of Fannie Mae has also helped our country to an immeasurable extent. They have allowed millions of families at or below median income to realize the American Dream. The average Fannie Mae mortgage is around $100,000, and 74 percent of those borrowers earn between $20,000 and $80,000 a year. And they have pledged to provide $2 trillion to 18 million underserved families by the end of the decade. These are all good things, so what has you all in an uproar?
Well, here’s the problem.
Fannie Mae has never actually loaned anyone money to buy a house. Their purpose is to make sure that mortgage money is readily available for existing and potential homeowners. They do this by buying loans made by banks, savings and loans, credit unions, etc. This allows those primary lenders to replenish their funds, and go out to find more customers.
Once Fannie buys the loan, they can either A. hold onto it, profiting from the interest the homeowner is paying Or, B. they can bundle several mortgage loans together, into an investment product called a Mortgage-Backed Security. After they guarantee this product for a fee, they can sell it to a third party, like a mutual fund, pension fund, or an insurance company. It gets even more complicated too, when they bundle the MBS’ in yet another product called a Real Estate Mortgage Investment Conduit. But if anything goes wrong, such as defaulting on the loans, Fannie Mae is responsible. Fannie bought or guaranteed $600 billion in mortgages last year. This is what is known as the secondary-mortgage market.
To pay for these loans it is buying, Fannie issues bonds. Fannie Mae's bonds make up over $700 billion of its outstanding debt. They pay the bond-holders with the interest and principal they collect on the mortgages they own. So this all comes down to homeowners being able to pay their mortgages. If these mortgages go into default, Fannie Mae will not have sufficient cash to pay the holders of its bonds. Fannie and Freddie, which account for nearly ¾ of all housing loans, have gotten so big, that their failure would endanger our entire system. And being a Government Sponsored Enterprise, we taxpayers would be responsible for bailing them out. We have reason for concern.
And we aren’t alone in our concern. In late 2000, Warren Buffett commented, after selling most of his stock in Fannie and Freddie because he felt uncomfortable with the risk, "We're never sure if there is an iceberg situation or not. We figured we'd never see it until it's too late." Even Alan Greenspan, who has made it clear he does not see a housing bubble, still has encouraged congressional review of the government-granted advantages of Fannie and Freddie, which he feels funnel a disproportionate amount of investment money to housing.
Charles P. Kindleberger, author of the economics classic "Manias, Panics, and Crashes: A History of Financial Crises.", was one of those to warn about the technology bubble in the forward of his book released in 1996. In a recent interview with the Wall Street Journal, the 91 year old said, "If I was 30 years younger, I'd write a small book on Fannie Mae and Freddie Mac."
If we can keep up the demand, jobs improve, and the economy recovers, we should be fine. But signs of weakening has many of us worried. The Mortgage Banker’s Association of America just reported that home loan applications soared to new heights for the period ended Sept. 6. Unfortunately, foreclosures also reached a 30-year high of 1.23 percent of all loans from April to June, up from less than 1 percent last year. That increase is being attributed to a change in lending, including more frequent use of interest-only, low-downpayment loans.
The Financial Times also recently reported that insider selling this year has been at record pace in the US home-building industry, amounting to the largest net sale of stock in the industry since 1996. In many cases officers have sold more than 50% of their holdings over the past year. Subtle signs are out there. But I believe that if we keep our heads out of the sand, and pool our knowledge, we will be better able to maneuver these troubled waters. Thank you to everyone who provided input for this article, and have a nice week!