Fannie Mae and Freddie Mac: Mortgage Bailout Will Be Expensive

Sept. 8, 2008— -- The federal takeover of mortgage giants Fannie Mae and Freddie Mac will likely lower the cost of a mortgage for buyers with good credit, but it will also likely stick U.S. taxpayers with a bill in the tens of billions of dollars, analysts have concluded.

The mountain of losses by the two huge quasi-governmental agencies threatened the entire mortgage and credit industry since Fannie and Freddie, as they are popularly known on Wall Street, back up nearly half of the country's mortgages.

Both companies were placed on Sunday into a government conservatorship that will be run by the Federal Housing Finance Agency, the new agency created by Congress this summer to regulate Fannie and Freddie.

Their top executives were fired and replaced by Wall Street veterans. Herb Allison, 65, a former president of Merrill Lynch who most recently led the TIAA-CREF pension fund, will take the corner office at Fannie Mae. David Moffett, 56, a former U.S. Bancorp executive who last year joined the politically powerful Carlyle Group private equity firm, will become CEO of Freddie.

The twin takeover, the largest government rescue mission in U.S. history, is packed with global economic repercussions.

But for homeowners with a fixed rate mortgage that is being paid for, nothing changes.

For those looking for a mortgage or looking to refinance, mortgage rates may actually go down if the takeover succeeds in stabilizing the market and restoring investor confidence in the market.

Mark Zandi, chief economist at Moody's Economy.com, predicted that 30-year mortgage rates, currently averaging 6.35 percent nationwide, could dip to close to 5.5 percent.

That's because investors will be more willing to buy the debt issued by Fannie and Freddie -- and at lower rates -- since the federal government is now explicitly standing behind that debt.

"Effectively, the federal government has now become the nation's mortgage lender," Zandi said. "This takes a major financial threat off the table."

There are initial signs that the government's actions are having the hoped-for effect. U.S. stock futures jumped more than 1 percent and pointed to a huge rally today. World markets also soared on the news of the takeover.

Federal Takeover: Refinance and Mortgage Protection

U.S. bond futures, however, tumbled as the plan raised concerns about the additional debt the government might take on.

Analysts are debating how large the taxpayers' bill will be.

"My guess is that it will be in the tens of billions of dollars," Doug Kass, founder of Seabreeze Partners Management Inc., told "Good Morning America."

Kass said the deal puts the U.S. government "on the hook for an additional $4 or $5 trillion dollars of mortgages," although only a small percentage of those loans will likely default.

Treasury Secretary Henry Paulson refused to estimate how much the takeover of the two companies will cost the government, but he insisted that taxpayers will get paid back first.

"We structured this facility to protect the taxpayer," Paulson said today on the "CBS Early Show." "The government will be repaid ... before the shareholders of these companies get a penny."

In a separate appearance on CNBC, Paulson said "we obviously don't know" when asked how much the takeover could end up costing taxpayers. He said that will depend on how quickly the housing market turns around.

Marilyn Cohen, CEO of Envision Capital, called the takeover a "doomsday scenario in the short haul" for investors.

"Clearly, the investors that own the common and preferred [stock] are psychologically and financially devastated," she said. "The question is: Will there be -- over a certain period of time -- recovery that makes it worthwhile to hold on."

Cohen said that at some point the housing market will hit a bottom and recover and eventually Fannie and Freddie could make a profit.

"If the Treasury gets its money back and there are profits, there may be enough then to trickle down to the preferred shareholders, maybe the common, but who knows," she said. "There have been weirder things that have happened in the financial markets. Everybody thought that when Chrysler went under that the government would never get its money back. It not only made its money back, but it made a huge profit. "

The Treasury Department said it was prepared to put up as much as $100 billion over time in each of the companies if needed to keep them from going broke. In exchange for the bailout, the federal government will receive senior preferred stock. If the industry and the companies, the government could actually recoup its massive investment.

The congressionally chartered companies -- the two largest sources of U.S. housing finance -- have suffered combined losses of nearly $14 billion in the last four quarters. Just two months ago, government officials assured the public that Fannie and Freddie had enough cash to weather the storm. But Sunday, the government said the losses on the mortgage giants' books were a lot bigger than they knew.