Fannie and Freddie: Jekyll and Hyde?
The reality is a little more complicated -- but not by much. Fannie and Freddie are better summed up by another horror film cliche: Dr. Jekyll and Mr. Hyde.
Like the dual-personality character in the Robert Louis Stevens thriller, Fannie and Freddie had two sides to their businesses. And, as the beleaguered companies come under increasing attack, it is useful to understand the differences.The good, "Dr. Jekyll" side of the business helped millions of people buy homes. And despite what you've read, the vast majority of those homes have stayed out of foreclosure.
Here's how this part of the business works. Fannie and Freddie act as massive middlemen between banks that make home loans and the bond investors that put up the cash. Fannie and Freddie tell their banks what kind of loans to make, then they pass those loans on to bond investors and guarantee to pay for any losses due to foreclosure.
This side of the business is weathering the housing storm pretty well.
Freddie's delinquency rate is half the rate for the U.S. overall. Across the country, 6.6 percent of all home loans to one-to four-unit residential properties were 90 days or more past due at the end of September, according to the National Delinquency Survey from the Mortgage Bankers Association. But only 3.4 percent the $1.8 trillion in loans guaranteed by Freddie Mac were 90 days or more past due at the end of September. (Since Freddie and Freddie acted almost identically, with almost identical results, let's focus on Freddie Mac.)
You see, most of the loans Freddie helped banks originate, guaranteed, and then sold to bond investors were very conventional, 30-year, fixed-rate mortgages to people with strong credits histories.
Did Freddie engage in irresponsible lending? Not much. Freddie Mac did guarantee home loans to people with credit scores under 620, but those loans are just 4 percent of Freddie's $1.8 trillion loan portfolio. Freddie also made loans that, at the time, covered more than 90 percent of the value of the home, but that's just 8 percent of its portfolio. The story is the same for "interest-only" loans, "Alt-A" loans, and adjustable-rate mortgages. Freddie Mac guaranteed loans in all of these relatively exotic categories, but it totals up to just a fraction of its business.
True, these relatively exotic loans led to credit losses: $2.1 billion in Freddie's $1.8 trillion portfolio in the third quarter alone. But two billion is hardly enough to wreck a trillion-dollar company.
Overall, Freddie's record looks good: it holds 23 percent of single family mortgages in the US, but these loans accounted for just 9 percent of seriously delinquent loans at the end of November. In contrast, "private label" securities account for 12 percent of the nation's mortgages, but a whopping 33 percent of serious delinquencies, Freddie Mac points out on its web site. (Fannie Mae, with 33 percent of all loans, had 19 percent of serious delinquencies for the period).
So what brought Freddie Mac down? And did the company play a leading role in creating the housing crisis that caused the recession? The answers are "yes" and "yes."
Enter Mr. Hyde.
During the housing boom Freddie Mac, once one of the most trusted names in housing finance, also acted like a hedge fund, borrowing hundreds of billions of dollars to effectively speculate in the bond market. (And hedge fund managers conjure up their own horror images -- think "American Psycho")
Back in the boom, hedge funds managers used their reputations on Wall Street to borrow huge sums of money at high rates of leverage and relatively low interest rates. Among other speculations, they used the borrowed cash to buy things that seemed to be relatively stable and even boring at the time... like AAA-rated bonds backed by home loans. The bonds had relatively predictable yields that were only a little higher than the interest rate on the borrowed money. After all, home prices seemed to rise steadily in good times and bad. And if you buy something using mostly borrowed cash and the thing you buy increases even slightly in value, you win a giant jackpot.
Of course, if the value of the asset drops even slightly, you lose everything.
Technically, Freddie Mac is not a hedge fund. But like a hedge fund, it used its government charter to borrow money at low interest rates and high leverage and buy bonds backed by real estate loans -- generating big dividends for Freddie's owners.
Freddie's balance sheet of "mortgage-related investments" grew to more than $800 billion by 2008 - including nearly $200 billion in bonds issued by other companies, some backed by some of the worst subprime home loans. It was these investments in subprime securities that helped the business grow dramatically during the boom -- and created Freddie's problems after the bust.
"Obviously it's been the deterioration of subprime loans that's been the driver of our losses," says Michael Cosgrove, senior director of public relations for Freddie Mac.
Freddie Mac's split personality - part responsible mortgage lender, part rabid hedge fund manager - was built into the company. It was owned by private investors and it had a responsibility to give those investors that best return possible under the law. Freddie also had its Congressional charter that made it possible to borrow huge amounts of money.
Congressmen from both parties now call for Fannie and Freddie to be abolished and replaced - they'll get their chance to act on their killer instinct in hearings starting March 2.
It's a tricky issue. Taxpayers are rightly concerned by the $112 billion and counting that has flowed to Fannie and Freddie. Yet, the companies have played an important role in keeping the housing market going, and any drastic changes could derail the fragile economic recovery. Whatever happens to Fannie and Freddie, the trillions of dollars needed to support home mortgages will have to come from somewhere -- unless we want to go back to the old days, say, a hundred years ago, when most people who bought homes had to pay in cash. Congress will have to find some way to replace the useful part of Fannie and Freddie, the Dr. Jekyll part, while getting rid of Mr. Hyde.
(Artwork by Charles Raymond Macauley for the 1904 edition of ''The Strange Case of Dr. Jekyll and Mr. Hyde'' by Robert Louis Stevenson. Publisher: New York Scott-Thaw)