Stimulus Package Will Hasten Collapse of Fannie and Freddie

Economist Dean Baker reports:

Some folks may have noticed that the stimulus package raises the limit on the size of the mortgages that can be insured by Fannie Mae and Freddie Mac, the two huge government created mortgage agencies, from $417,000 to $730,000. This is supposed to help the housing market in high priced markets, where the current limit may not even be sufficient to purchase the median priced house.

There has been very little analysis of the impact of this measure in the media and all of the commentary has come from economists who somehow managed to miss the housing bubble. If the media had relied on a broader array of sources, they would have told the public that the move is likely to hasten the collapse of Fannie and Freddie.

With house prices dropping at a 16 percent annual rate nationwide, millions of homeowners with prime conformable mortgages (the type that are in Fannie and Freddie's mortgage pools), owe more than the value of their homes. For example, in San Diego, many homeowners may owe $400,000 on a house now worth $300,000.

A high percentage of these homeowners will opt to walk away from such homes, in effect making themselves $100,000 and leading to huge losses for the mortgage holders. This process is already occurring, as the foreclosure rate on prime mortgages is rising rapidly and reaching levels seen in the subprime market just a few years ago.

The capital base of both Fannie and Freddie is very limited compared to the amount of debt that they insure. As the foreclosure rate continues to rise, they will both be forced to take large write-offs and will soon be pressing up against the limit of their capital base. Raising the cap on conformable mortgages will hasten the date when this will occur.

Look for analysis in the media from surprised economists when Congress debates the bailouts of Fannie and Freddie.

[note: Frank Nothaft, Freddie Mac's chief economist, was one of the strong advocates of the view that nationwide house prices never fall.]

Dean Baker was one of the few economists this decade that warned about the housing bubble before the decline.