Freddie-Fannie bailout just the start of 'once-in-a-century crisis'

Published September 7, 2008 3:51 am
Local finance experts explain the pros, cons of the government's plan to shore up the mortgage giants
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The federal bailout of Fannie Mae and Freddie Mac raises scores of questions, fanning the fires of uncertainty that engulf the financial markets.

Two Salt Lake City-based finance experts mostly agree the move is necessary - and should rescue interest rates - but offer a far-from-rosy picture on the future of real estate.

Keith Debus, chief market strategist for Drexel Financial Group, points to a reckless lack of regulation on an industry he insists is worse off than most people realize.

"We are only in the second inning of a once-in-a-century crisis," he says, fingering a real estate "myopia" that has dominated the decade.

And George Hofmann, executive vice president over business banking for Zions Bank, fears another bloated bureaucracy that cannot operate with the efficiency of the open market.

"In the near term, I could see the availability of long-term financing being substantially reduced," Hofmann says. "There's nobody existing right now to replace Fannie Mae and Freddie Mac."

Following is the analysts' take on what the bailout may mean for you.

Why should I care?

Debus: These two firms hold half of the mortgages in America. Right now, they're about the only entities that are actually buying mortgages. These guys need to remain viable if the housing market is going to remain viable. If the federal government steps in and guarantees the securities of Freddie and Fannie, mortgage interest rates should fall.

Hofmann: The loss of [Fannie and Freddie] without the government coming in and somehow replacing the work that they do is going to leave a huge void for individuals as they try to have home ownership.

Is this a good thing?

Debus: If a good thing is to keep the mortgage and housing market from totally collapsing, the answer is yes. But the government should not be in the business of bailing out failing businesses. Fannie Mae and Freddie Mac took crazy risks. The downside if they don't do the bailout: This collapsing real estate market in the United States will get even worse.

Hofmann: No, fundamentally. Government bailouts ultimately end up being a huge drain on our tax dollars. It would be better for the market to take care of itself.

Taxpayers are going to be on the hook for tens of billions of dollars. Where do you draw the line?

Debus: Given the mistakes of the last 20 years, there is no choice. The lack of regulation of the federal government has put all of us in a box. We're in the infancy of this crisis.

Hofmann: The government hasn't demonstrated a tremendous ability to be as efficient as the market. I could see them building another huge bureaucracy that wouldn't efficiently operate.

If you're a shareholder in Freddie or Fannie, what does this mean? Have you lost everything? What kind of options might you have?

Debus: You've lost everything. The value of stock in those two companies has fallen by over 90 percent in the last year. I'd be very surprised if they get that last 10 percent.

Hofmann: The shareholders' value is basically going to be flushed down the drain.

What if you're a shareholder in other financial services? Might you see a short-term gain?

Debus: You could envision a scenario where the Federal Reserve and the Treasury pump this economy full of money. That would bail everybody out. The downside of that is, you create really serious inflation. What they're trying to do is simply slow the fall.

Hofmann: No, I don't think you're going to see a short-term gain. For the financial sector, this is going to increase short-term worries. The private sector is much more efficient in solving problems than government.

What about other investment classes, such as the dollar or treasuries?

Debus: You cannot overstate the severity of this crisis. The bubble has burst. The dollar is doing better in the last month or so. But we're going through an implosion in the global financial market. China's stock market is down 60 percent. Russia's stock market is down 40 percent. Fannie Mae and Freddie Mac and Bear Stearns - their problems are related to the myopia [since 2001].

Hofmann: Everything is going to be better off. What they're experiencing isn't necessarily true losses. Looking forward, most of those investments will be sound and have true gains to them.

What steps can you take with your own portfolio to minimize exposure?

Debus: All asset classes are in a downtrend. One of the things investors can do is switch to cash or possibly make money on the short side. There are funds that have lost value to invest in.

Hofmann: We fortunately have very little housing exposure. I'd recommend not doing any radical shifts in anybody's portfolio and understanding this is just a market correction, and over time we will find ourself in much better shape.

If you're in the market, does this impact your ability to get a loan?

Debus: Right now, yes. Definitely yes. All of the financial institutions have tightened up dramatically. If you look at the national data . . . basically the banks are not making loans. They've frozen the whole market. Consumer loans is about the only area with some growth.

Hofmann: Depending on what the government does to replace the securitization . . . potentially yes. You have to assume that people in government will put steps in place that will ensure the availability of housing financing isn't dried up. Without that, the economy is going to be even more distressed.

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