In July, credit woes extended to the strongest participants in housing finance - Fannie Mae & Freddie Mac. Fannie Mae (originally Federal National Mortgage Association) was established as a "government sponsored entities" (GSE's) in 1938 to help Depression era homeowners to obtain mortgages. In 1968, Fannie Mae was partially privatized-shareholder owned, but retained an implicit government guarantee of its obligations and thus can obtain capital at exceptionally low cost. Freddie Mac was established along similar lines in 1970. The two firms own mortgage assets of over $5 trillion, which is about the same amount as the entire US government debt.
Since the credit crisis began last August, FNM and FRE took an increasingly central role in mortgage lending as sub-prime lenders stopped lending or went bankrupt. The range of mortgages acceptable to the GSE's was expanded earlier this spring. Unfortunately, the rescuers were dragged into the quick sand. Defaults on higher quality mortgages are running at twice the rate of 2007. Even a 1% default rate on the $5 trillion portfolio is $50 billion versus combined equity capital of $80 billion at the two companies.
Similar to the Bear Stearns crisis in mid-March, investors bet aggressively against both companies in mid-July by shorting the stock and buying out of the money puts. For a couple of days, it looked like both companies would be forced into receivership (and indeed, bankruptcy does not remain out of the question.) Federal Reserve and Treasury officials announced credit extensions to both companies which keeps them solvent for the time being. Even so, stock prices remain 85% below last August levels.
Housing - how much more pain?
The May Case-Shiller Housing index showed that the national average of house prices fell 15.8% year over year and is now 18.4% below the July 2006 peak. Forecasts for further declines range from 5% to 20%. However the month by month rate of decline is easing from a maximum loss of 2.63% in February to the most recent decline of 0.86% for the month of May. Residential construction activity is down 26.4% compared to June 2007, and overall construction is down 5.9%. Sales of existing homes fell 15.5% over the last year, but the available inventory appears to have leveled off even as new permits and new construction ticked up recently. As we have commented often, we're less shocked by the decline in housing prices over the last two years than the steady surge in prices over the previous 14 years.