Thursday, September 11, 2008

Many will profit from Fannie Freddie failure – Will you?

PRODUCTS:It is unlikely that a government takeover of Fannie Mae and Freddie Mac will bring back those risky products that drove the market over the past several years; however, do we really want them back? We now see what happens when corporate greed wins over sound judgment. Then again, some may ask, what about the stated income products for self employed borrowers with decent credit? After all those people have the money and they pay their bills on time; often times a higher LTV stated income loan is necessary for those borrowers. While this thought process may be correct and these loans may not pose a threat to the marketplace, don’t expect Fannie and Freddie to come back into the stated income loan world anytime soon. Fannie & Freddie are being run by the government, if you are cheating the government on taxes they are not going to then turn around and make it easier for you to get a loan. On the other hand, the government takeover does provide some stability to the market so it is probable that some of the viable products which we have seen disappear will return over the next 12 months, the key word being VIABLE! They will not likely be Fannie/Freddie products, but expect to see some of the truly economically feasible products come back.

RATES:We have seen rates drop in the past two days but why? Well, there are many variables but lets break it down to one of the easiest for you to explain prospective borrowers. If I have a dollar to invest I have thousands of places I can place that money. I can place that money is a low risk vehicle, I can place that money in a high risk vehicle or I can place that money in any level risk investment vehicle in between. As risk increases my expected gain increases and as risk decreases my prospective gain decreases. High risk, high returns potential, low risk, low returns potential. The lowest risk investments are generally US treasuries. These are guaranteed by the government and therefore are a sure bet. Mortgage backed securities, although not tied to treasuries, are a higher risk and therefore a risk premium is placed on them above that premium which can be earned on comparable lower risk vehicles (treasuries). Higher risk means higher risk premium and higher premiums require higher rates to be charged to borrowers. After this weekend’s historical takeover Fannie & Freddie mortgage backed securities are now essentially backed by the government. This backing creates a lower risk, a lower risk means a lower yield and a lower yield means savings to consumers in the form of lower rates. This is a DRASTIC oversimplification but it’s the easiest way to understand what is going on. The government essentially came in and removed layers of risk by taking over the companies. Lower risk equals lower return equals lower rates charged to the consumer.

WHAT DOES THIS MEAN FOR THE MARKET IN GENERAL:Time will tell, but lower rates coupled with the tax incentives for first time buyers should encourage home sales. Also, now that the government has control of Fannie/Freddie they have greater flexibility to deal with defaults and their associated workout arrangements. By helping people buy houses and by keeping houses off the auction block through workout arrangements we should see a reduction in inventories (houses on the market) and a stabilizing of housing prices. In areas where housing prices have already stabilized we may even begin to see some appreciation, a word we have not heard in a while. Am I being too optimistic? Possible, but pessimism never sold a house. J Whether you agree or not we are one step closer to the bottom of the market then we were last week and very possibly in it. Buyers who are waiting out the market for lower prices better jump now because in most regions of the country we are already there.

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