Consumers still face the prospect of rising mortgage rates, inflation and tighter credit despite the federal government's move to rescue Fannie Mae and Freddie Mac and avert a meltdown in the lending industry, economists and banking experts say.
Most agree that the situation would be much uglier if the Bush administration had not stepped in over the weekend to shore up financial confidence on Wall Street for the two largest mortgage finance companies in the U.S.
More than half the nation's mortgage lending activity is backed by Fannie Mae and Freddie Mac, and disaster for them could have meant soaring mortgage rates and plummeting access to credit for consumers. Consumer spending represents two-thirds of the economy - much of it borrowed.
However, financial experts point out the investments and loans for Fannie and Freddie merely preserve the status quo and do nothing to reverse the underlying problems that are fueling recession concerns and causing consumer confidence to fall precipitously.
Financial markets remain in turmoil, with financial stocks taking another beating yesterday amid worries of more bank failures.
It all adds up to uncertainty for U.S. companies, making them wary of hiring or doing major deals. Unemployment has ticked up in recent months, and many economists say the country is headed for a recession, if it isn't in one already.
"If the Federal Reserve and the Treasury had turned a cold shoulder toward Fannie Mae and Freddie Mac, we would have had a disaster on our hands," said Greg McBride, a senior financial analyst for Bankrate.com. "Now that we've avoided the catastrophe, we'll have to catch our breath and focus on the same things we've been dealing with for the last year."
Markets fell again yesterday as investors grew increasingly worried that the government's moves to support Fannie and Freddie won't be enough to stabilize financial markets. Shares of Freddie Mac fell 64 cents, or 8.3 percent, to close at $7.11; Fannie Mae shares lost 52 cents, or 5.1 percent, to close at $9.73.
Shares of both companies - which started the year above $30 - plunged by double-digit percentages last week as concerns about their finances grew.
Financial shares saw their biggest drop in eight years yesterday as investors grew concerned about the solvency of several regional banks. The Dow Jones industrial average lost 45 points to close at 11,055.19, and the S&P; slid 11.19 points to end trading at 1,228.3.
The Treasury Department announced plans over the weekend to extend more credit to Fannie and Freddie and to buy shares in them if needed. In a separate move, the Federal Reserve said it will lend to the firms at the same rate given to commercial banks and Wall Street firms.
The Fed also announced new rules yesterday to crack down on questionable lending practices that contributed to the housing crisis. The rules bar lenders from issuing loans without proof of a buyer's income. They also require lenders to ensure that high-risk buyers set aside enough money to pay for taxes and insurance, among other things.
The series of actions came after federal regulators took control last week of the $32 billion IndyMac Bank, which was failing as a result of its real estate lending problems. Since then, jittery investors have grown increasingly worried that other regional banks could face similar problems, given the housing and credit crunch.
The plan to shore up Fannie and Freddie puts taxpayers on the hook to secure the flagging mortgage industry, which has experienced soaring delinquencies fueled by subprime lending during the real estate boom. Some blame the companies for taking on too much risk.
But many experts say Fannie and Freddie are too important to let fail. Both increased their purchases of mortgages after a number of mortgage companies collapsed last summer, leaving a lending gap in the industry.
Fannie and Freddie play a critical role in the economy by buying mortgages from lenders, freeing the lenders to use those funds to underwrite new loans. The two package the loans into securities, which are sold to Wall Street firms.
If either went bankrupt, it would leave a gaping hole in the industry and send mortgage interest rates soaring. In the past decade, Freddie Mac alone has invested $114.6 billion in Maryland mortgages, serving more than 772,000 homeowners and renters, the company says.
"You almost can't overstate the importance of Fannie and Freddie to the development of mortgages and home ownership to Americans," said Jeff Tjornehoj, a research analyst for mutual fund tracker Lipper Inc.
He said the government rescue will save them from bankruptcy, helping investors in the companies and sending a signal to markets that the government will cover their debt. Treasury and company leaders, however, insist that Freddie and Fannie are in no financial danger but that the moves were designed to restore confidence on Wall Street about the businesses.
"But for the average taxpayer - especially those who have little or no interest in the fortunes of Fannie and Freddie - this looks like just another example of government taking a 'too big to fail' approach and forcing everyone to participate in Fannie and Freddie's mistakes," Tjornehoj said.
Consumers are already feeling battered because of falling home values, fewer jobs and rising gas and food prices, said Stuart Hoffman, chief economist of PNC Financial Services Group. On top of that, many are seeing their retirement accounts and pensions deflate with the market in bear territory.
"I think the risk is that companies become more cautious about their hiring, and individuals become even more cautious about their spending," he said. Both outcomes would further dampen economic growth.
Fallout from the government rescue plan will also factor into the rising price of commodities, including oil, said Cameron Findlay, chief economist for online mortgage lender LendingTree.com.
By bailing out Freddie and Fannie, the U.S. government is making its own finances shakier by taking on more debt, potentially contributing to the falling value of the dollar, he said. When the dollar is falling, investors seek the safety of commodities, which has fueled the soaring cost of oil and grains for food.
At the same time, the government's rising debt will make foreign investors more likely to shy away from government-sponsored debt instruments, Findlay said. That will hurt bond prices and contribute to rising interest rates for consumers who want to buy a house, take out a home-equity line of credit or secure other loans.
But several economists said a tug of war of factors - namely a weak economy and inflation - means consumers will continue to see fluctuations in mortgage rates and not much movement on interest rates by the Fed.
The Federal Reserve would be hard-pressed to raise rates and further dampen the economy, while an interest-rate cut by the policymaking body could fuel inflation at a time when oil and gas prices are skyrocketing.
"Mortgage rates have been bouncing up and down between a range," said McBride, the Bankrate.com economist. "That's going to continue until we have a little more visibility on outlook for the economy and inflation."
But some economists said Fannie and Freddie are still likely to tighten underwriting standards and raise mortgage costs, despite the promised federal bailout. Guy Cecala, publisher of Inside Mortgage Finance, said the perception in the financial markets is that the entities don't have a good idea of how their business will be affected by foreclosures and losses.
"They have to deal with the reality of the market that doesn't have any confidence in their ability to manage their losses," Cecala said. "The typical borrower in the country is going to be paying more, and to some extent it's going to be difficult to get any loan at all."
The Federal Reserve cracks down on some practices of mortgage lenders. Page 1d