Explaining What The Government’s Takeover Of Fannie Mae and Freddie Mac Means To Mortgage Rates (In 265 Words)

• Tweet

Sunday, the government announced that it will takeover Fannie Mae and Freddie Mac and assume their respective operations.  Mortgage-backed debt is now government debt.

But for all the front page stories today, there's suprisingly little coverage about how the news impacts homeowners in need of a mortgage.

Mortgage rates are down sharply today, and possibly forever.

See, when Fannie Mae was first created in 1938, it was a federal government entity; a child of the parent government.  Fannie Mae operated that way for 30 years. 

Then, in 1968, Fannie Mae went on its own.

Only saying that Fannie Mae was "on its own" wasn't really true.  Despite the spin-off, the federal government continued to give its mortgage child preferential tax and oversight treatment, plus an unspoken promise to guarantee its debts.

Think of it like when the child of well-known, wealthy parents starts his own business.  There's going to be risks, but there's also going to be that thought in the back of everyone's mind that there's no way the parent is going to let the child fail.

This is how Wall Street looked at Fannie Mae.

For years, Wall Street endured Fannie Mae's accounting issues, leadership scandals, and weak balance sheets, knowing that the mortgage group's parent was just a cab ride away.  Wall Street harbored a deep-seated belief that should things get really bad for Fannie Mae, the government would step and take over.

And, that's exactly what happened.

As of today, mortgage debt is government debt and by the transitive property of risk premiums, mortgage debt is now risk-free.  Therefore, conforming mortgage rates are down.