Effects On The Subprime Mortgage Crisis
The effects on the subprime mortgage crisis have led the government to support the soundness of the obligations and guarantees on securities issued by Fannie and Freddie to obtain funds. Those funds are in turn used to purchase mortgages from originating banks. The continuing soundness of GSE obligations enhances market liquidity (loanable funds) in the following ways:
- Banks can be assured that Fannie and Freddie have funds to purchase conforming loans, so they can increase such lending. This improves liquidity in the mortgage market, lowering interest rates.
- In 2006, Fannie and Freddie insured 24% of all subprime loans so they needed to keep these loans viable.
- Lower borrowing costs for banks typically increase the "spread" between the rate at which they borrow and which they lend. This increases bank profitability, shoring up bank liquidity and balance sheets further.
- Adjustable rate mortgage (ARM) rates are reduced, which lowers pressure on homeowners and reduces foreclosures. Lower rates also encourage new home purchases.
- The government's role as the primary investor allows a systematic loan refinancing process to be implemented. This should enable rapid loan adjustments or workouts for homeowners, which have been facing bottlenecks due to the requirement to have various investors approve the adjustments. For example, the government could rapidly push-down 45-year mortgage terms and fixed, low interest rates, enabling many more homeowners to stay in their homes. This will reduce foreclosures significantly, helping to stabilize home prices.
- The government can restructure mortgages so that the loan balance is reduced to the current market value, reducing the incentive for homeowners to "walk away" from the property.
- With home prices more stabilized, the value of mortgage-backed securities receives some upward support.
Read more about this topic: Federal Takeover Of Fannie Mae And Freddie Mac
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