What Is the Fannie Mae and Freddie Mac Bailout?

In July, Congress approved a bailout plan for mortgage companies Fannie Mae and Freddie Mac. The plan allows the U.S. Treasury Department to guarantee as much as $25 billion in loans held by the two corporations, who hold or guarantee more than $5 trillion, or half, of the nation's mortgages. Wall Street's recent fears that these loans will default have caused Fannie's and Freddie's shares to tumble, making it more difficult for the private companies to raise additional capital themselves.

The bailout also includes:

• $3.9 billion in CDBG grants to help homeowners in poor neighborhoods.
• Approval for the Treasury Department to buy shares of Fannie 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.

(Source: Associated Press, House OKs rescue for homeowners, Freddie, Fannie, July 23, 2008)

U.S. Treasury Secretary Henry Paulson is 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 warned that the economy may go through months 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." (Source: AP, Paulson braces public for months of tough times, July 21, 2008)

What It Means to You

Fannie Mae and Freddie Mac are two government-sponsored enterprises (GSE) that buy mortgages from banks, a process known as buying on the secondary market. They then package 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 is 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 has 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 will be footing the bill for the bailout. Global concerns about the sustainability of this debt continues to depress the dollar and raise the price of imports. This bailout dwarfs the 1989 Savings and Loan Crisis, which "only" cost the taxpayers $124 billion.