The Economist's Reports on the Credit Crunch
caused by the Subprime Mortgage Meltdown
Analysis of Fannie Mae & Freddie Mac's Impact on the Credit Crisis
July 12, 2008
Overview of Fannie Mae and Freddie Mac
Founded in 1938, the Federal National Mortgage Association (FNMA) (NYSE: FNM), more commonly known as
Fannie Mae, is a government sponsored enterprise (GSE) of the United States federal government.  It is a publicly
traded company authorized to make loans and loan guarantees. It is not backed or funded by the U.S. government,
nor do the securities it issues benefit from any statutory government guarantee or protection.  

In 1970, the Federal Home Loan Mortgage Corporation (FHLMC) (NYSE: FRE), also known as Freddie Mac, was the
second GSE of the United States federal government to purchase mortgages on the secondary market.  Like Fannie
Mae, Freddie Mac is publicly traded and authorized to make loans and loan guarantees. The creation of Freddie Mac
was to expand the secondary market for mortgages in the US. Along with other GSEs, Freddie Mac buys mortgages
on the secondary market, pools them, and sells them as mortgage-backed securities to investors on the open market.

Fannie Mae and Freddie Mac are the two leading market-maker in the U.S. secondary mortgage market, which helps
to replenish the supply money for mortgages and enables money to be available for housing purchases.

The name "Fannie Mae" and "Freddie Mac" is a creative pronunciation of the company's initialism that has been
adopted officially for ease of identification.  
On October 20, 2007,
The Economist
published an article
titled
Lessons From
the Credit Crunch
,
"Central banks have
worked miracles for 30
years. Don't count on
that continuing."
 

They compared the
current credit crisis to
the Black Monday stock
market crash of
October 1987.  

According to the
Economist, this credit
crisis was caused by
"loose monetary policy
is partly responsible for the mess the central bankers are now
trying to clear up.  Other factors contributed to the crunch,
including rash lending, securitisation and globalisation."

The full print article can be found at this link;
The Economist,
October 20, 2007, Lessons From the Credit Crunch.  
The Economist
followed up its
Lessons from the
Credit Crunch
article
with a April 5, 2008
articled titled
Fixing
Finance
, "Crises are
endemic to financial
systems. Attempts to
regulate them away
may do more harm
than good."

This article focuses on
the current state of the
banks and financial
service companies
that are publicly traded.
It then goes on to predict an inevitable crash.  This article was
written before the serious crisis at Fannie Mae and Freddie Mac.  
Fannie Mae and Freddie Mac can be the companies that cause a
major crash in the US markets.  The US federal government just
bailed out Bear Sterns, and may have to bail out these two
companies also.  But how many financial service companies can
the US federal government bailout?  

The full print article can be found at this link;
The Economist, April
5, 2008, Fixing Finance.  
Analysis of the Fannie Mae & Freddie Mac Fallout
Investors were not supposed to watch their financial
stocks plummet more than 70 percent in the last three
quarters.  American taxpayers were not supposed to be
left holding defaulted mortgages and abandoned homes
while executives who presided over balance sheet
implosions walked away with millions.  Taxpayers are also
given the bill to bailout poorly managed Bear Sterns.  

Over the course of this 18-month financial crisis, we have
lurched from land mine to land mine. The latest crisis
comes from the fallout of Fannie Mae and Freddie Mac,
the giant government-sponsored enterprises set up to
provide affordable housing across the nation.  By issuing
debt, these shareholder-owned companies guarantee or
own more than $5 trillion in home mortgages.  The
majority of them are good, but because of the recent
subprime mortgage mess, the percent that default have
been increasing over the past 18-months.  

Investing in Fannie Mae and Freddie Mac seemed like
conservative investments.  These were government
established companies.  The implied guarantee is what
drove Fannie and Freddie’s business models.  However,
investors were foolish to think they were still government
backed and therefor were guaranteed.  

The reason why there is a crisis at these two companies
is because they are not required to keep as much cash
on their books as banks.  But now because so many
mortgages are defaulting, there low cash supply is now in
a dangerous state.  To raise the necessary capital to stay
afloat, these companies will call on the American
taxpayers to bail them out.  

Speculation that mounting losses at Fannie Mae and
Freddie Mac would require billions of dollars in additional
capital have fueled a firestorm of criticism this week,
sending stock investors fleeing. Fear spread across
financial markets after the government offered no hint
that it would step in to help the companies.

The companies combined have about $1.6 trillion in debt
outstanding, much of which is held by central banks
around the world. They use the money to fund the
portfolios and securities that lawmakers have increasingly
relied on to support the ailing housing market.

Mortgage-backed securities issued by the companies
also gained relative to Treasuries. But MBS issued by
Ginnie Mae sharply lagged in price since their relative
advantage of full government support over Fannie Mae
and Freddie Mac issues would be diminished in a
takeover.
The stock performance of these two companies has been terrible in 2008.  Fannie Mae's stock has plummeted to
$10.25, down over 74 percent in 2008.  Freddie Mac's shares also crashed, they closed at $7.75 on July 10th, a loss
of 77 percent in 2008.

This problem may have been long overdue.  It was not as if this problem came out of no where. Fears that Fannie
and Freddie were getting too big have been a recurring theme in recent years. And Congress has had ample
opportunity to create a new regulator that would be vigilant about ensuring the safety and soundness of both
companies.

But even after both companies were found to have accounted for their results improperly, Freddie Mac in 2003 and
Fannie Mae in 2004, Congress failed to act. As a result, Fannie and Freddie were allowed to become high-growth
companies and stock market darlings.

Bear Sterns may not have deserved a taxpayer bailout, but Fannie Mae and Freddie Mac must have one if they run
low of capital.  Without Fannie Mae and Freddie Mac, banks will not be able to raise new capital to sell new
mortgages.  If they are not able to sell new mortgages, the housing crisis will never end.  New mortgages are
necessary to reduce the supply of houses on the market.  We will have to brace for higher taxes by the new
administration, and budget cuts in other areas.