Fannie Mae, Freddie Mac and you

The financial crisis that has been sweeping the United States and much of the capitalist world since last summer reached a new phase when mortgage giants Fannie Mae and Freddie Mac moved near insolvency. This unfolding crisis may be the worst threat to the U.S. economy since the Great Depression. More important, it threatens the jobs, homes, economic security and future of all working- class families.

Fannie and Freddie Federal National Mortgage Association (Fannie Mae) was a government agency created during the Great Depression to stabilize the housing market. It was privatized in 1968 and, along with the similar company, the Federal Home Loan Mortgage Corporation (Freddie Mac), operates as a for-profit corporation. While enjoying favorable tax and regulatory treatment worth many billions of dollars, through their status as government sponsored enterprises (GSEs), these corporations have provided secure dividends for stockholders and executive compensation in the millions.

Local banks sell their mortgage loans to Fannie and Freddie, this provides the local banks with cash to make additional loans, and then the process is repeated. Fannie and Freddie hold the mortgages, or package and sell them to investors. In either case, the GSEs take the hit if the homeowner fails to make payments. In normal times, the default rate is low, and they make profits from the fees they charge for buying and selling mortgages.

Financial crisis In the absence of an adequate national, federally-sponsored housing, this mechanism has made it possible for a huge expansion in homeownership. Investors and financial institutions (including GSEs) financed vast new construction at inflated prices, as well as home equity loans. These loans were in excess of any realistic ability of the borrowers to repay. Inevitably, delinquency rates rose above the level sustainable by the lenders.

Fannie and Freddie own or guarantee about half of the $12 trillion in U.S. mortgages. Now even these prime mortgages have a high delinquency rate. Like other financial institutions, GSEs borrowed the money they needed to buy these mortgages, and have to make payments on the borrowed money. With homeowners not making loan payments, GSEs are having trouble finding the cash to meet their own commitments.

Fannie and Freddie are so large that their failure could paralyze much of the financial system. Finance is the lubricant of capitalist economy. Already, it is difficult to get a mortgage even with good credit. The U.S. economy runs on credit to an unprecedented degree, both at consumer and business levels. Failure of GSEs, added to what has gone before, would tend to freeze credit and threaten a deep depression.

Government response Since last summer, the U.S. treasury has bought up $500 billion in bad loans from some of the failing banks. It is likely that the U.S. taxpayer will end up stuck with the bill for most of that. A recent Senate bill, if it becomes law, may help a small percentage of homeowners in trouble, but will mainly shield investors from their biggest losses.

Now, it appears that Treasury Secretary Henry Paulson and congressional leaders will agree on a scheme to provide low-interest loans to “save” Freddie and Fannie. Economist Dean Baker describes the rescue as telling “truck drivers, school teachers, and fire fighters that they will have to pay more in taxes to help some of the richest people in the country escape the consequences of their own stupidity.”

Alternatives It was refreshing to read the New York Times' report on Sen. Obama's response: “any government action to rescue the two mortgage companies should be done from the perspective of the homeowners, not just shareholders and investors and CEOs of companies.”

According to Baker, “We had to keep Fannie and Freddie in business, but we could have done this by putting conditions on the bailout. The government uses conditions all the time. Unemployment insurance, TANF, food stamps, and even student loans come with all sorts of conditions.”

These conditions, according to Baker, could include limiting executive compensation and cutting off stockholders. Both good ideas, but I would go further. Legislation should include a national moratorium on foreclosures. Vacant housing should be turned over to local authorities for low-cost ownership and rental. And Congress should pass H.R. 6116, introduced by Congressman Raul Grijalva (D-AZ), to allow families who cannot pay their mortgages to remain in their home as renters at fair market rates.

Local actions As the crisis spreads, local governments are taking action in the face of the administration's inaction.

Last year, Massachusetts responded to public protests by declaring a 60-90 day moratorium on foreclosures that stem from predatory lending practices.

This May, the New York State Assembly passed a 1-year moratorium on foreclosures. Although it failed to become law, it paved the way for compromise legislation that improves protections for homeowners in court. The New York Times concludes 'the failed effort produced at least one benefit: It made every other proposal look moderate in comparison.'

On the local level, from Chula Vista, Calif., to Cleveland, Ohio, cities are levying fines and penalties on banks who fail to maintain foreclosed properties. These measures slow neighborhood decay, and also encourage banks to find an alternative to foreclosure. In Buffalo, N.Y., a judge uses a state law to force lenders to maintain properties.

A West Virginia county has voted to purchase foreclosed McMansions at a discount, and remodel them into affordable apartments.

And around the country, the community organization ACORN has organized protests and have achieved some success in negotiating with lenders.

So far, these efforts have been only a few sandbags in the path of the flood of foreclosures. But local actions like these, combined with a massive mandate for change in the November election, can create the environment for the national legislation that is needed.