Since the last time we wrote about Fannie and Freddie, quite a bit has happened. Last time we wrote about how Fannie and Freddie might help the mortgage crisis, this time we are writing about how they are causing a crisis of their own.

First off we must understand the position that Fannie and Freddie are in right now. The Angry Bear wrote an article about how they have hit rock bottom. However, it seems like they can still go lower. This year Fannie Mae stock has dropped a massive 76%. Just today it has dropped 5.95% (it’s still dropping as I’m writing this).

The extent of how low Fannie and Freddie have sunk is evident in Freddie Mac’s sale of $3 billion of short term debt this morning. Despite the sale going well, Freddie is still down 16.39% and dropping.

So what happens when they fail? We’ll quote the same source that Angry Bear did:

If either company stumbled, the mortgage business could lose its only lubricant, potentially causing the housing market to plummet and the credit markets to freeze up completely.

And if Fannie or Freddie fail, taxpayers would probably have to bail them out at a staggering cost.

Both Obama and McCain have ties to Fannie Mae and Freddie Mac. And Obama recently said that his focus is stabilizing the housing market and Fannie and Freddie are key components in accomplishing that. So it seems relatively safe to assume that either candidate would work towards stabilizing Fannie and Freddie, and probably even bail them out should they fail.

Many lawmakers, such as Chris Dodd, are working to rein in these companies in order to force them to raise more capital. Forcing the companies to raise more capital would give them a larger cushion should they begin to fail. The NYT article we linked to earlier has a nice graph illustrating this (click for full size):

Calculated Risk has a nice post about some possible solutions to the crisis. They include conservatorship (placing the companies under full government control) and guaranteeing the companies debt. He believes that guaranteeing the debt would be the best option and that conservatorship would only hurt.

Unfortunately neither of the candidates seems to grasp the extent of the problem. Take a look at Obama’s recent comment regarding the situation:

“I am absolutely committed — both as a senator and should I have the good fortune to be elected president, as president — to make sure that we [have] liquidity in the housing markets. Freddie Mac and Fannie Mae play critical roles in that process,” he said. “There are a lot of different definitions of what a bailout would look like. There are issues related to the short term liquidity. Can they borrow money — versus issues related to whether the underlying assets of the two corporations are really unsound? And I think we need to watch carefully to see how it plays out before we make a decision about which steps need to be taken if any.”

In this excerpt Obama mentions a bailout, but weasles his way out of committing to anything. In regards to the recent plan announced by the Fed (which includes backing 2.25% of any borrowed fund):

John McCain believes the measures announced Sunday “are consistent with the goal of providing support for a path through the current duress toward steps that include regulatory reform, market discipline and mission focus,” said Douglas Holtz-Eakin, senior policy adviser.

So it seems like a McCain administration would be better for Fannie and Freddie, but both candidates appear supportive.

Last 5 posts by Jeffrey Miller

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