November 21, 2007 - Freddie Mac and Fannie Mae, the two federally backed companies that are largely responsible for purchasing home loans from lenders, have both announced large financial losses for the third quarter of 2007. The announcement is likely to make it much harder for homeowners to refinance and could lead to further reductions in home values nationwide. It may also stop several proposals that Congress is considering to prop up ailing mortgage markets.

Freddie Mac, a company that was created by an act of Congress in 1970 to purchase home loans from lenders and then resell them as securities, stunned the financial world with the announcement that it lost $2 billion in the third quarter. Its sister company, Fannie Mae, has also announced a loss of $1.4 billion for the same period.

The news is extremely bad for both borrowers and lenders. 95% of the loans owned by Freddie Mac are considered prime. This means that the borrowers who took out these loans had good credit and could prove it with documentation. Freddie Mac's loss is proof that the problems with subprime mortgages and a slowing economy are now spilling over to the prime market.

As a part of its announcement, Freddie Mac said that the loss could force the company to reduce the number of mortgages that it purchases until it can raise additional capital. This means that many lenders who rely on Freddie Mac to purchase loans from them may be facing some real trouble.

The problem is especially bad for Countrywide, the nation's largest lender. Two months ago, because of losses on subprime loans, the company announced that it would change its lending strategy and focus on loans that could be purchased by Freddie Mac and Fannie Mae. Freddie Mac's announcement caused Countrywide's stock to drop to $8.21 in mid day trading. Although it did recover some by the end of the session, the stock is down 25% in the last five trading sessions and as much as 76% for the year. This has led some analysts to speculate that the company might be headed for bankruptcy.

While Countrywide may be the largest example of troubled mortgage markets, it is far from the only one. Many other lenders also rely on Freddie Mac and Fannie Mae. If lenders are unable to sell their mortgages to these companies, then they will have to significantly limit the number of loans they make. This would lead to several things.

First, it will make it much more difficult for homeowners to refinance existing loans or take out new home equity loans. Secondly, it will make it much more difficult for anyone who needs to borrow money to purchase a new home. In turn, this will lead to further reductions in housing prices specifically, and slow economic growth in general.

In order to help homeowners who are currently in adjustable rate subprime mortgages, Congress has been considering several pieces of legislation that would allow both Freddie Mac and Fannie Mae to expand their portfolios. Some of these proposals also include lifting the cap on the loan sizes that they can buy (currently set at $417,000 for most of the country). This would allow both companies to purchase more loans in higher priced areas of the country like New York and California. News of these losses will almost certainly stop debate on most of the proposals floating around.

by Jim Malmberg

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