The Shrinking of Fannie Mae

Fannie Mae and Freddie Mac are both trying to shore up anemic balance sheets to regain healthy cash reserves. But that guarded approach to mortgage lending might send mortgage rates higher and make mortgage qualification much more difficult for the average American.

After a government takeover, Freddie Mac, which, along with Fannie Mae, insures about half of all mortgage lending in the U.S., has seen its investment portfolio shrink dramatically. The company's holdings dropped by an annualized 56.2 percent rate, which, according to a company spokesman, is its largest percentage drop on record. In August, Freddie's mortgage lending portfolio was worth about $40 billion less than it was just one month earlier.

Caution: Mortgage lending

Freddie, Fannie Mae, and all other major mortgage lending institutions are finally taking a more cautious approach to mortgage qualifications. Because of uncertainty in the credit markets-particularly in the mortgage lending sector-the nation's credit liquidity has stalled, virtually paralyzing the credit of the entire country. That's because money that usually pours in from investors buying mortgages has nearly evaporated. Unless and until institutions like Fannie Mae sell the mortgages that they already own, they can't free up money to make new loans. That's the main reason their mortgage lending portfolios are shrinking.

Looking at new mortgage qualifications

Stock prices have also fallen, so much of the capital used by institutions like Fannie Mae, whose stock fell from around $70 a share to under a dollar a share within the past year, have less cash to pay for their own borrowing needs. If they're unable to borrow, or get behind on their payments to their own creditors, then investor confidence deteriorates even more. Fearful shareholders sell, investors panic, and a downward spiral of more losses and tighter credit continues to feed upon itself.

In an urgent effort to regain their financial credibility and stability, they're raising underwriting standards and, in many cases, raising mortgage rates and fees associated with many of their mortgage lending products. As mortgage lending becomes scarce and mortgage qualifications undergo a revamping, the Mortgage Bankers Association (MBA) reports that the volume of mortgage applications is also falling.

Desperate to refinance

But the number of mortgage refinances has not dropped because Americans have suddenly lost interest in refinancing their debt. Millions of homeowners are, in fact, desperate to refinance. They need to switch out of ARM loans, for example, that have mortgage rates and payments scheduled to rise. Or they're burdened by exotic hybrid loans and mortgages with negative amortization. Unless they can get out of these hazardous products, they'll inevitably lose their homes.

Hopefully, the rescue plan from Congress will provide needed liquidity by helping buy the stalled and languishing assets of lenders. Once those bad debts begin to turn back into needed cash, mortgage lending should pick up again and, hopefully, consumers can borrow their way back to a more stable financial condition and save their homes from foreclosure.