Friday, September 19, 2008

Freddie, Fannie, and You

What a year! What a week! What a day! Everyone I have spoken with in the finance professions is shocked and awed by the events of the past week. Moreover, they are in various stages of grief or bewilderment as they ponder the future for their clients, as well as themselves. I thought it might be healing (at least for me) to put some thoughts on the screen with regard to what the bailouts mean and what I’m considering to be good advice…

The bailout of Freddie Mac, Fanny Mae, and AIG; as well as the purchase of Merrill Lynch by Bank of America was done, according to Treasury Secretary Paulson, to stabilize financial markets, support mortgage financing, and protect taxpayers. Most of us wonder what is in it for us, as we watch our portfolios shrink as the result of others’ actions. Many also question the government acting in such a way, apparently in contrast to our belief in the free market system. Good medicine sure can taste bad.

First, the Treasury could not let Freddie Mac and Fannie Mae fail. These shareholder-owned companies are actually the creation of the federal government charged with guaranteeing the mortgages issued by private lenders and government agencies. Investors around the world believed these diversified portfolios of mortgage loans to be safe and that the U.S. government guaranteed them, at least that was their perception. These securities were considered to be an almost-as-safe-as-Treasuries investment with a higher return and, together, represented about $6 trillion of the U.S. mortgage market. All this was good. Business in housing boomed for years. Subprime mortgages and speculation began to flourish…until the housing slump. (It does seem to rain on every financial parade.)

As the housing slump wore on, Fannie and Freddie began spending their capital to back these defaulting mortgage loans. In late July, an independent audit revealed that as much as $50 billion was needed to shore-up these firms’ capital accounts. Given the large amount of U.S. debt that is held by other countries, and our ever increasing need to borrow, it was concluded that it is in the best interest of the U.S./world for the U.S. government to intervene. We could not let our credit rating fall. Moreover, without Freddie and Fannie able to participate in the mortgage market, it is estimated that housing prices might fall another 10% to 20%, as it becomes harder to qualify for a mortgage and liquidity is reduced. (Trust me, this is not good news, even if you are a young, first-time homebuyer.)What should you do?· Look at your net-worth statement. If you have debts costing you double digits rates of interest and you’re having trouble sleeping, pay off some debts. Your net-worth will be intact and you’ll be able to sleep.

· Make sure your portfolio is diversified and well balanced among asset classes. Try to resist the urge to look for the “phoenix-investment” rising from the recent carnage. While I do think there are investment bargains in today’s market, do not abandon the discipline of diversification. Do not invest money in a “bargain” that you cannot afford to lose. (In our “in-class” portfolio for my investments class, one of my students “purchased” Fannie Mae, Lehman Brothers, and AIG at the beginning of the semester. Oops.)

· Mortgage rates are beginning to fall. If you’ve an expensive or exotic mortgage that you’d like to abandon, explore your options to refinance. Perhaps, this is time to buy that home. Perhaps, this is a good time to add a real-estate investment to your portfolio.

· Remember that this will pass. Continue to focus on the things that really matter and that define you to be a success. In many cases, real success is much more than financial success.

NEWS FLASH: While I was writing, a report has surfaced that a new entity, similar to the Resolution Trust Corporation, is being considered to handle the nation’s bad debt. As a result the Dow Jones Industrial Average is up 410 points, or 3.86%. What a day! What a week! What a year!

- Robert O. Weagley, Ph.D., CFP(r)

Chair, Personal Financial Planning

University of Missouri

Columbia, MO 65211

1 comment:

Luke said...

I agree with most of what was said, but I don’t totally agree with the assessment that a federal backing of Fannie, Freddie, AIG, or a systematic federal backing of other yet-to-fail banks is necessary. Regardless of a federal backing, the bottom line is that there are trillions of dollars worth of bad debt out there. Either these institutions will fail taking the U.S. and world economies with it, or the federal government will try to intervene with unprecedented deficit spending to buy up worthless securities, at which point, world investors lose faith in the U.S. dollar itself and the dollar loses value. At this point the U.S. economy will be stifled to the point of irreversible recession and other world economies will then follow, not to mention our weakened dollar and government will fail at it's other purposes as well, including national security. In other words, regardless of what Washington does at this point, it’s too late. Now our only choices are to pull the band aid off quickly, or ever so slowly. There’s not going to be an easy way out. But politicians want to be reelected so they’ll try anything to make themselves look like part of any solution, no matter how unfeasible.