Prior to that, in July 2008, Congress approved a bailout plan for the two mortgage companies. The plan allowed the Treasury Department to guarantee $25 billion in loans. This was more of a vote of confidence than an actual bailout because, together, they held or guaranteed more than $5 trillion, or half, of the nation's mortgages. Wall Street's fears that the loans would default sent Fannie's and Freddie's shares plummeting. This made it impossible for the private companies to raise the additional capital needed to cover the mortgages.
Most people don't realize that the July bailout also included:
- $3.9 billion in CDBG grants to help homeowners in poor neighborhoods.
- Approval for the Treasury Department to buy shares of Fannie's and Freddie's stock to support stock price levels and allow the two to continue to raise capital on the private market.
- Approval for the Federal Housing Administration (FHA) to guarantee $300 billion in new loans to keep 400,000 homeowners out of foreclosure.
- About $15 billion in housing tax breaks, including a credit of up to $7,500 for first-time buyers.
- An increase in the statutory limit on the national debt by $800 billion, to $10.6 trillion.
- A new regulatory agency to oversee Fannie and Freddie, including executive pay levels.
Former U.S. Treasury Secretary Henry Paulson was the major force behind the bailout, which was introduced to reassure financial markets that the banking system is solid soon after the failure of IndyMac Bank.
Paulson appeared on television throughout the weekend, warning that the economy would go through months of challenging times. As it turns out, its been years of challenging times.
He admitted, "The three big issues we're facing right now are, first, the housing correction which is at the heart of the slowdown; secondly, turmoil of the capital markets; and thirdly, the high oil prices, which are going to prolong the slowdown." However, he added "...our economy has got very strong long-term fundamentals, solid fundamentals. And you know, your policy-makers here, regulators, we're being very vigilant." Unfortunately, they should have been more vigilant years earlier, when the subprime derivatives were being bought and sold in an unregulated market. (Source: AP, "Paulson Braces Public for Months of Tough Times", July 21, 2008)
Fannie Mae and Freddie Mac were two government-sponsored enterprises (GSE) that bought mortgages from banks, a process known as buying on the secondary market. They packaged these into mortgage-backed securities, and resell them to investors on Wall Street. The entire financial system is built on trust. That trust was shaken by the Subprime Mortgage Crisis.
The Federal government stepping in to restore that trust by promising to bail out bad loans. It was meant to keep the housing slump from getting worse. Unfortunately, it is all being funded by the U.S. Government, which already had a $9 trillion national debt. In fact, the provision to allow the debt level to be raised to over $10 trillion is acknowledgment of who exactly has been footing the bill for the bailout. Global concerns about the sustainability of this debt keeps downward pressure on the dollar, which increases the price of imports. However, the greater threat from the eurozone debt crisis has created a flight to safety. When the world is in turmoil, the dollar looks strong, despite the high debt-to-GDP ratio of the U.S.
The Fannie and Freddie bailout was greater than the 1989 Savings and Loan Crisis, which "only" cost the taxpayers $124 billion. It was on par with the subsequent bailout of AIG, which started at $85 billion but grew to $150 billion. Both were small potatoes compared to the $700 billion bailout of the U.S. banking system -- even though only $350 billion of that was ever spent.