Fannie and Freddie

In 1938 and 1970, respectively, the US government created Federal National Mortgage Association or Fannie Mae and Federal Home Loan Mortgage Corp. or Freddie Mac, with the idea of providing home to people. It however, went a little too far when these mortgage houses started to buy from borrowers with poor credit rating. To make matters worse, the Congress directed these houses to lower their standards further for prospective borrowers, in order to compete with the emerging private sector, which was pushing hard into subprime loans. By 2008, $500 billion of the total $5.7 trillion of the loans Fannie and Freddie guaranteed or held were in subprime mortgages.

Now since the housing bubble has burst, the government is struggling to estimate the scale of losses. Even after extensive measures, the government is still left with a huge number of unsettled bad loans. The sum required to set the books in order is dependent upon the market situation. As Treasury Secretary Timothy F. Geithner puts it, “It’s very hard to judge what the scale of losses is.” An optimistic turn of events may require $160 billion. A further slump of 20 percent in the housing sector may however, pose a need of as much as $1 trillion.

The Obama administration is considering the idea of dividing all the loans among good banks with all the performing assets and bad banks with ill ones. Credit Suisse estimates the cleanup cost to the bad bank at around $290 billion, which will ensue from the taxpayers. The other alternative in sight is to let these companies default on their terms. Though, this can lead to a global turmoil and investors around the world may see US markets as the precarious ones for times to come.

The Republicans tried to push for amendment to slowly phase out the mortgage houses. A New Jersey Republican and a co-sponsor of the phase-out amendment Scott Garrett held the view that phasing out these houses will make it imperative for the government and market to deal with the issue directly, which currently is not the case. He asserted that without doing so, it would not be possible to judge the extent of damage.

There are divergent views on the issue however. It is said that keeping the houses would help the economy eventually. The National Association of Home Builders reported that the real estate market contributed 17 percent to the GDP in 2009. In addition, hoping for the private sector to fill up the huge gap is not seen as realistic. Whatever the way to deal with it is, purging the markets off the bad loans is going to cost the taxpayers a lot of money over several years to come.