U.S. takeover of mortgage giants starts to lower rates

The takeover of Fannie Mae and Freddie Mac by the U.S. government has eased the companies' funding costs and started to lower interest rates for homebuyers.

"While multiple factors are involved, conventional conforming mortgage rates have dropped by over a half percentage point in the past two weeks," Freddie Chief Executive Officer David Moffett said in written testimony delivered Thursday to the House Financial Services Committee. "In response, there has been a considerable increase in mortgage applications."

The companies, which already own or guarantee more than 40 percent of the $12 trillion in U.S. home loans, have been pushing more money into the market by ramping up mortgage-bond purchases since regulators seized their operations three weeks ago, Moffett said.

Mortgage rates did drop the week of the Sept. 7 takeover, yet have crept higher since because of turmoil surrounding other financial companies including Lehman Brothers Holdings.

The Federal Housing Finance Agency (FHFA) put Fannie and Freddie into conservatorship after examiners at the Federal Reserve and Treasury Department agreed that the companies' losses and accounting threatened to erode capital and further damage markets.

The action was enabled by Congress, which in July expanded oversight of the enterprises and gave Treasury Secretary Henry Paulson the authority to pump $200 billion into the companies as needed.

"You all can be darn glad you gave us the bazooka because we need it," Paulson told the Senate Banking Committee last week. "Thank goodness that was done and they were stabilized before we had some investment banks reporting earnings, or let me tell you, this would be a much more serious situation than it is today."

Foreign central banks and investors began reducing purchases and holdings of bonds and mortgage-backed securities from Fannie and Freddie in June on concern the companies couldn't weather the housing slump.

Paulson's pledge on July 13 to provide federal support wasn't enough to curb the retreat. That contributed to the decision to take over the government-sponsored enterprises, FHFA Director James Lockhart said in testimony Thursday.

"Central banks ceased buying and began selling enterprise securities," Lockhart said in his prepared remarks. "Relatively small sales triggered large price moves. Despite financing 30-year mortgages, the enterprises had to rely on short-term discount notes" to fund operations, he said.

Congress created Fannie and Freddie to expand homeownership by increasing mortgage financing. The companies make money by holding mortgage assets and on guarantees of mortgage-backed securities they create out of loans bought from lenders.

The takeover led to an initial jump in borrower activity that week, with the Mortgage Bankers Association's index of applications to refinance a loan jumping 88 percent, the most since 2001. The group's refinancing gauge dropped 11 percent the following week as borrowing costs rose again.

Mortgage rates, which fell to a five-month low on average of 5.82 percent for a 30-year fixed-rate loan the week of the bailout, rose a week later even as yields on Treasury securities dropped. That reflected the tightening of credit that prompted the federal takeover of American International Group and pushed Lehman into bankruptcy.

The average rate on a 30-year fixed-rate loan has now risen to above the prerescue level, to 6.08 percent, the latest Mortgage Bankers Association report showed.

Moffett also said Freddie has begun a "mass-modification" pilot program to approach delinquent borrowers with new loan terms that are preapproved.

Freddie currently has 124,000 loans that are seriously delinquent, which are 90 or more days past due. The company has completed 48,000 loan workouts so far this year, focusing on extending repayment terms and lowering interest rates, instead of reducing principal, Moffett said.

"Workouts are critically important, but they will not help stabilize the market unless borrowers are able to sustain homeownership going forward," Moffett said.