What the GSE Bailout Means to Consumers

The Fed's Sunday announcement of the takeover of mortgage giants Fannie Mae and Freddie Mac may possibly become the largest government rescue in U.S. history. The cost is high; up to $200 billion of taxpayer money could be used to fund the rescue.

But the cost of taking no action and letting the two government-sponsored enterprises (GSEs) fail would have been much higher; their failure would result in the inability for many to gain access to mortgage financing, which would send the already-damaged housing market plummeting. A blow that brutal would further damage our sliding economy and be likely turn a recession to a depression.

The GSEs were formed to help more people become homeowners and buy or back almost half of all the U.S. mortgages that traditional mortgage lenders originate. They currently hold about $5 trillion of the nation's $12 trillion worth of mortgage debt.

The GSEs, and their CEOs, made plenty of money through the housing bubble. But the GSEs got in big trouble when declining home values and high numbers of foreclosures threatened to wipe out their financial resources, having too little capital to support all those bad loans.

The GSEs have been put into conservatorship by the newly formed Federal Housing Finance Agency (FHFA). The FHFA will run the GSEs for a non-specified period of time, until the two companies are stabilized. It has not yet been determined what exactly will happen at that point.

Treasury Secretary Henry Paulson said that Fannie Mae and Freddie Mac were so large that "a failure of either of them would cause great turmoil in our financial markets here at home and around the globe."

What does the takeover mean to you?
Mortgage credit will become more available, making it easier to gain access to home loans than it has been throughout the "credit crunch". The government will inject funds to the two companies, as needed, to keep mortgage financing flowing. This means it will also become easier for current homeowners to refinance into a more affordable loan, as long as their home equity hasn't been wiped out by the decline in the housing market.

Interest rates have declined by almost a half a point since the news of the takeover; the national average interest rate for a 30-year fixed rate mortgage is currently 5.78%, according to Bankrate.com. This makes financing a home more affordable for those with stellar credit, which is considered to be a credit score over 700. Some experts believe mortgage rates will continue to fall over the next few weeks.

Attaining a mortgage will still be difficult for those who have less than perfect credit, inadequate documentation of their income, or little cash saved, as credit standards have tightened significantly since the mortgage meltdown. Lenders were lax back then, but now require lower debt-to-income ratios and higher down payments, as well as documentation of income (as reflected by your tax return). Homeowners who currently have Alt-A loans will find it difficult to refinance if they cannot meet today's lending standards.

The further decline of the housing market won't be prevented by the takeover, because there is still a massive over-supply of homes on the market. But, it may decline by less than it would have without the bailout. The rescue of the GSEs means that mortgage lenders will continue to have an outlet for the loans they originate, so they can lend to new home buyers. The housing market still has a long way to recovery, but having the available funding is the first step.

Stock investors and mutual funds that own shares of the companies' stock will suffer losses. Investor's shares of the publicly-traded stock of both companies has plunged from their 52-week highs of about $65 a share to currently under $1 a share. Though the stocks of the GSEs have become nearly worthless, stock markets around the world, including the U.S. stock market, have rallied in response to the news. Common stockholders suffer the biggest losses, and dividends on preferred stock is suspended.


Sources:
biz.yahooCNBC.com