Inside Scoop on Fannie Mae and Freddie Mac - Research Paper Example

Inside scoop on Fannie Mae and Freddie Mac Contents Inside scoop on Fannie Mae and Freddie Mac 1 Contents 1 Introduction 2 Background 2 History and Current Condition 2 Budgetary Issues 4 Alternatives 4 Recommendation 7 Conclusion 8 Reference 9 Introduction Freddie Mac and Fannie Mae are the two federal government owned organizations but they were listed. It means they were also owned by the private owners. The main objectives of the organizations were to extend the secondary mortgage market. They used to purchase the mortgage from the lenders who originate them and traded them in the secondary markets. In the year 2007 due to the housing bubble of United States the debt of the organizations has raised, as a result the federal government took the decision to acquire these two companies. As the organizations are the main cause of the higher debt of the federal government the federal budget also get affected for the liabilities of the two organizations. In the era of globalization, whole world is the stakeholder of the debt. The borrowers of home loans are mainly behind the periodic payments. But in the current policy they are unable to pay the amount of mortgages. If the liabilities of the organization and in turn the government’s are persistent then it would be a problem for the economic scenario of the whole world. SO there need some policies to be implemented by the federal government so that the borrowers can repay the mortgage amount and the debt burden of the organizations and the government comes down. The report is an attempt to recommend the ways so that the borrowers can make their payments and liabilities o the organizations as well as the federal government’s come down. Background History and Current Condition Fannie Mac, which was the national mortgage association of United States, was founded in the year 1938, when there was the great depression. The company was traded publicly from 1968, though it was a government sponsored organization. The purpose of the company was to extend the mortgage market in the secondary market. In the year 1999 a leading newspaper of United States, New York Times reported that Fannie Mae was taking more risk than the normal, which can create pressure for the company in the time of financial turbulence, though it would be not problematic in time of good economic condition (Holmes, 1999). Freddie Mac is also a company which was working on expending the secondary mortgage market in United States. The company was founded in the year 1970. In the secondary market the company buys the mortgages, pools them and sells them to the investors in an open market as the mortgage backed security. The goal of the companies like Freddie Mac and Fannie Mae was to improve the living condition of the middle and lower class people by improving their home ownership policy. Through the companies they were able to obtain a fixed rate mortgage for more years like 30 years. The families have to pay lower down payment (Executive Office of the President, 2005, pp. 1-2). But in the year 2003-04 the subprime mortgage crisis began. Subprime mortgage means loans provided to the people who have difficulties to maintain the repayment schedule (Levitin and Wachter, 2011, pp. 4-6). The subprime mortgage amount has increased, which was the main cause of global economic downturn. In that scenario the U.S. government planned to take over both organizations as the financial situation has worsen of both the companies. These two companies have guaranteed a massive proportion of the housing loan or have owned the loans. As the subprime mortgage amount has increased the financial condition of the companies has worsen. In the year 2008 Freddie Mac and Fannie Mae owned or guaranteed half of the mortgage market of United States (Duhigg, 2008). The effect of the two companies in the economy was heavy as he bonds of the two companies were owned by the money market funds as well as the governments of different countries. The banks of U.S.A. like Lehmann Brothers were also under trouble in that situation. As the economic condition of United States was continuously deteriorating, the government has decided to seize Freddie Mac and Fannie Mae. The board of directors and the chief executives of the two organizations were dismissed by the government. In the year 2008, the U.S. law which enables the expanded authority of regulation over Freddie Mac and Fannie Mae, increased the debt ceiling of U.S.A. from US$ 800 Billion, to US$ 10.7 trillion for the potential need of the treasury for supporting the home loan banks of U.S.A (Herszenhorn, 2008). In the year 2010 the stocks of both the two companies have been delisted from the New York Stock Exchange as the value of the share was below $1 over 30 days. Federal Housing Finance Agency (FHFA) estimated in the year 2010 that the bailout of the two companies i.e. Freddie Mac and Fannie Mae would cost $154 billion cost for the taxpayers of United States (Davidson, 2010). Budgetary Issues In December, 2011, the budget and accounting transparency act was introduced by the vice chairman of house budget committee Rep. Scott Garrett. As a part of the reform process it has been implemented that Freddie Mac and Fannie Mae, the government sponsored enterprises require on-budget and for federal credit programs they need to follow the fair value of accounting (Garrett, 2012). The aim was to balance the budget and pay their debt, as the two organizations are both under heavy debt. They need to disclose their liabilities for correcting the debt crisis. For make a secure future they need to disclose their liabilities which in turn help the American people to know about their country’s actual liabilities. The budget and transparency act of federal government needs to conduct the study to extend the fair value methodology by office of management and budget and congressional budget office to federal insurance program, currently which is accounted on a cash flow basis. For federal credit programs it is required to follow the fair value accounting by the two organizations as per the budget and transparency act. The organizations i.e. Freddie Mac and Fannie Mae are the part of government, so the budgetary reforms would reflect in the federal budget. It is also required as per the law that the office of management and budget and the congressional budget office to study about the budgetary terms related to the collected money by the federal government which was not structured at all and inconsistent over the decades. Alternatives In this situation the alternatives that can be suggested by the researcher are as follows Forbearance: When a debtor is facing the short term financial crunch, then he might needed temporary assistance with the mortgage. In that situation the lender may offer the forbearance to the debtor. The debtor may be unable to pay one or two payments to the lender. The debtor may reduce the payment or suspend the mortgage payments for a time period, which may be for up to six months. The debtor gets another six months for payment and in that time period he may be able to make himself suitable for the payment. Refinance: The borrowers may refinance the mortgage which would help the borrower to replace the current mortgage loan, the monthly payment rate or the interest rate may be decreased. The mortgage type can be converted from one type to another through this process. A borrower may take the refinancing option when he has enough equity in his home for taking another loan. If the borrower has acceptable level of credit then he may be able to get refinancing. There is a program called Home Affordable Refinance Program (HARP) in United States after the fall of Freddie Mac and Fannie Mae which has been implemented. If the two companies own the mortgage of the borrowers and they are pay the mortgage payments timely but the borrower doesn’t have more equity in his home then they may be able to refinance through the Home Affordable Refinance Program (HARP) for a more stable mortgage or able to get a lower interest rate. The borrower can refinance through the existing lender or he can refinance through a different participating lender. By this strategy the mortgage term can be decreased for the borrower. May be it was for 30 years previously but it can be 15 years for the refinancing. Through this the organizations would be able to pay its liabilities earlier which would help the country to survive from the recent financial crisis. The accounting transparency act of the U.S. federal government suggests about the fair value accounting in the process as well as the fair disclosure of the assets and liabilities in the financial statements which would be done in a transparent manner. The government finds it helpful for preparing the budget for the next financial year. So if these two organizations can attract the clients for the refinancing option through Home Affordable Refinance Program then the liabilities of the companies are set to decrease, which means the liability of the country would decrease, the debt limit of the U.S. government would decrease. In this scenario the refinancing strategy through the home affordable refinancing program would be a good alternative for implementation by the government. The interest rate on the mortgage would also likely to be decrease which would reduce the burden from the debtors. It will be helpful for the debtors to repayment as they are getting the refinance and also the interest rate is lower in the refinancing, also it would be helpful for Freddie Mac and Fannie Mae as they get the chance to be out from the way of their tough financial condition. Repayment Plan: If the condition is that the borrower is few months behind of the repayment plan, then this repayment plan would be helpful for the borrower for make up the missed payments. The late fees are needed over the year, which the borrowers have to pay those late fees with the missed payments. This repayment option can be helpful if the borrower has recovered from the short term financial turbulence. The borrower has to pay the late fees along with the scheduled payments, end of these payments the borrower has to pay the amount of the mortgage. This plan can be added with the option of forbearance, as the borrower can get the option of repayment after six months, if the financial condition of the borrower is good or tends to be good. This option may be good for some kinds of borrowers, though the numbers of such borrowers are not so much in United States at present. But there are some people as the economy is not as poor as it was during the time of global financial crisis. Freddie Mac and Fannie Mae can offer this policy; this can be helpful for the organizations for make the financial condition better, which make the financial condition of the country better in turn. Reinstatement: In this case the borrower can be able to make the loan current and avoid the legal activities from the lender if the borrower has missed the payments or have received the default notice. This strategy also can be combined with the forbearance policy for repayment of the loan. The borrower can only have the policy of Reinstatement along with forbearance if he can show that in future he can receive some bonus, or can get the tax refund from the government, or he has got some new employment so that he would have cash inflow in near future. In the current economic scenario when the unemployment rate in United States is high this strategy can’t be a good option for the general people of the country. As there is less chance of getting employment, the chances of getting tax returns is lower as the economic condition of the government is not so good, so the option is not so viable to get implemented by the two organization and the government. Most probably this option would not boost the financial condition of Freddie Mac and Fannie Mae as well as the government budget. Modification: Traditional modification can be made when the homeowners are several months behind the mortgage. The debtor and the mortgage company can come to an agreement and they can change some of the original notes in the document. It would make the payment more affordable for the debtor. The debtor may get the help of the home affordable modification program so that the monthly mortgage payment of the borrower comes down to 31% of the verified gross income of the homeowners. This modification can be implemented by the government as there is the chance to get the large amount of debt taken by the people of U.S.A. In the current situation when the liabilities of the two companies have raised the debt ceiling, this flexible policy can be implemented by the federal government as there are many persons who are far behind their mortgage payments. If they get the ways of this flexible policy then it would also be helpful for the debtors as well as the organizations. The liabilities of the organization would come down; as a result the debt limit of the federal government would decrease. Recommendation The main problem with the two organizations is the raising amount of mortgages held by the two companies Freddie Mac and Fannie Mae. The two companies were acquired by the U.S. government. The budget of the companies would hamper the budget of the federal government itself, as these organizations are fully owned by the government. When the budget would be prepared there would be higher liabilities of the companies. So the organizations have to identify some policies so that the liabilities level would decrease. At first the organizations should publish the actual conditions of the company through the financial statements. The inside scoop of the organizations are the government, as the companies are fully owned by the government it would be helpful to implement the policies easily than the private companies. Some alternatives have been discussed by the researcher about this matter. The advantages and disadvantages of the options are also been discussed in the previous section. The refinancing policy should be undertaken by the federal government. The refinance strategy through the Home Affordable Refinance Program should be implemented by the federal government. In the current economic scenario of United States when the borrowers are far behind of the mortgage payment or they have just gone through a financial tough situation; it would be helpful for them to gone under the refinance strategy and the modification strategy. If the borrower who are not far behind of the mortgage repayments, or missed certain periodic payments; it would be easy for them to get refinanced. The interest rate of their mortgage would be much lower in this case but they have to pay their mortgage amount in less time. It would be helpful for the borrowers as they get the chance to pay less as the interest rate is lower and it would be helpful for the two organizations as they get the amount of the mortgage much earlier than the scheduled time. It would help them to make lower the liabilities in the balance sheet as well as the debt crunch of the government would come down. The modification strategy along with the forbearance strategy should also be implemented. There are several people in America who are much behind of the mortgage payment. The agreement between the lender and the borrower can be revised which would make it affordable for the borrowers to make the payment. Conclusion In this paper the researcher has proposed some alternatives which can be implemented by the federal government so that the borrowers can repay their loans and the liabilities of the organizations come down. Analyzing the current economic scenario it can be said by the researcher that there are several borrowers who are far behind the periodic payments of the mortgage, also there are several borrowers for whom the financial condition is improving, though they are behind the payments. The researcher has suggested that the refinancing policy should be implemented by the federal government so that the people who are not so far behind the payments can get an option to pay their liabilities. Also there is an option for the people who are far behind their mortgage payments so that they have flexibility to pay their liabilities. Implementing these options can make the liabilities lower for the two organizations as this is the main concern for the organization as well as the federal government. If they are able to implement this option then it would be helpful to get out of the financial crunch in the near future. Reference Davidson, P. (2010). Fannie, Freddie bailout to cost taxpayers $154 billion. USA Today. Retrieved on 20th February, 2012 from < http://www.usatoday.com/money/economy/housing/2010-10-21-fannie-mae-freddie-mac-bailout_N.htm>. Duhigg, C. (2008). Loan-Agency Woes Swell From a Trickle to a Torrent. Business. Retrieved on 20th February from . Executive Office of the President. (2005). STATEMENT OF ADMINISTRATION POLICY. Retrieved on 20th February, 2012 from < http://georgewbush-whitehouse.archives.gov/omb/legislative/sap/109-1/hr1461sap-h.pdf >. Garrett, S. (2012). House Passes Garrett Budget Process Reform Legislation. Press Releases. Retrieved on 20th February, 2012 from < http://garrett.house.gov/press-release/house-passes-garrett-budget-process-reform-legislation>. Herszenhorn, D. (2008). Congress Sends Housing Relief Bill to President. Washington. Retrieved on 20th February, 2012 from < http://www.nytimes.com/2008/07/27/washington/27housing.html>. Holmes, S. (1999). Fannie Mae Eases Credit To Aid Mortgage Lending. The New York Times. Retrieved on 20th February, 2012 from . Levitin, A. and Wachter, S. (2011). Explaining the Housing Bubble. Retrieved on 20th February, 2012 from . Read More