Homebuyers May Get Lower Loan Rate After Fannie, Freddie Rescue

By Kathleen M. Howley

Sept. 9 (Bloomberg) -- The U.S. government takeover of Fannie Mae and Freddie Mac on Sunday may provide relief for homeowners who want to refinance mortgages and prospective buyers shopping for a loan.

Thirty-year fixed rates dropped about a quarter of a percentage point by Monday and may head lower, said Keith Shaughnessy, president of Foundation Mortgage in Littleton, Massachusetts. The average 30-year fixed is now 6.08 percent, according to Bankrate Inc., a research firm in North Palm Beach, Florida. In July, the rate was half a percentage point higher, increasing monthly payments enough to price some potential buyers out of the market.

By December, or at least by the start of the spring selling season in April when the bulk of U.S. home sales occur, fixed rates may be near 5.5 percent, Shaughnessy said in an interview.

``I think we are at the beginning of a slow and steady decline that will end up with rates half a point lower in three to six months,'' said Shaughnessy, who in January 2007 correctly predicted the subprime market collapse that began a month later.

Mortgage rates dropped this week in reaction to the federal seizure of the mortgage giants, Shaughnessy said. He's advising borrowers who want to take advantage of the decline by ``locking in,'' or accepting a lender's interest rate offer: ``Wait if you can -- they're probably heading lower.''

U.S. Treasury Secretary Henry Paulson, the former chief executive officer of Goldman Sachs Group Inc., and Federal Housing Finance Agency Director James Lockhart on Sunday placed the world's two largest mortgage buyers in a government conservatorship, ousted their CEOs and eliminated their dividends.

The Treasury may purchase as much as $200 billion of stock in the firms to keep them solvent, Paulson said.

Shares Fall

Fannie Mae and Freddie Mac, which own or guarantee about half of the nation's $12 trillion of home loans, lost more than 80 percent of their market value on Monday as the price of their shares fell below $1. That was on top of a 93 percent decline over the prior 12 months as investors worried the financers lacked sufficient capital to cover losses on mortgages they hold.

The FHFA will run the conservatorship, according to the government plan. Lockhart, the head of the agency, immediately ejected Fannie Mae CEO Daniel Mudd, 50, and Freddie CEO Richard Syron, 64, replacing them with Herbert Allison, 65, former CEO of TIAA-Cref, and David Moffett, 56, who was a US Bancorp vice chairman.

``It's clear that there was no other choice but to do a rescue type of operation,'' Neal Soss, chief economist at Credit Suisse in New York, said in an interview. ``In the short term, it's constructive because it will allow for some financing and home sales that wouldn't have happened. In the long term it raises the question of how intimately we want the government involved in directing the use of capital.''

Affordable Housing

The takeovers bring Fannie Mae, formed after the Great Depression and spun off in 1968, and Freddie, created in 1970, back to their original one-track mission: to provide affordable mortgages to homebuyers, Lockhart said.

Mortgage rates fell after the announcement of the takeover while Treasury 10-year notes were little changed. Before the credit crunch that began last year, fixed mortgage rates tended to move in tandem with long-term government notes, according to Bob Walters, chief economist at Quicken Loans Inc. The Livonia, Michigan-based lender dropped fixed rates by about a quarter of a percentage point after the federal takeover, he said.

The difference between the 10-year government bond yield and U.S. fixed mortgage rates has averaged 2.3 percentage points this year through last week, compared with 1.6 percentage points during the prior four years, as lenders and investors demanded higher rewards for owning mortgage bonds.

``That spread will narrow dramatically because investors now will perceive that much of the risk of owning mortgages is gone,'' Walters said. ``It's been eliminated in one fell swoop by the government stepping in.''

Risk Spread

Now that the federal government is backing Fannie Mae and Freddie Mac, that ``risk spread'' will move closer to the historical average, Walters said. That indicates rates could drop by as much as much as three-quarters of a percentage point, based on Bloomberg data.

The average U.S. rate for a 30-year fixed mortgage was 6.35 percent last week, according to Freddie Mac. The world's No. 2 mortgage buyer, based in McLean, Virginia, will release this week's average rate on Thursday.

Sales of previously owned homes probably will drop to 4.87 million in 2008, down 31 percent from the all-time high of 7.08 million in 2005, according to an Aug. 14 forecast by Washington- based Fannie Mae. The median sale price is set to tumble 6.6 percent this year and 4.5 percent in 2009, the report said.

Housing Market

The federal bailout of the mortgage giants may temper the slide in home prices, Pacific Investment Management Co.'s Bill Gross said in an interview yesterday. The median U.S. home price may tumble to $185,400 by next year, 17 percent below its high of $222,900 in 2006, according to Fannie Mae's August forecast.

``It means if they were going to go down 15 percent, perhaps they will only go down about 11 or 12 percent, so we have already seen some positive moves and positive actions in terms of today's moves and market behavior,'' said Gross, manager of the world's largest bond fund.

The government seizure of Fannie Mae and Freddie Mac will restore ``credibility'' to the mortgage market and encourage investors to buy mortgage bonds, said Foundation Mortgage's Shaughnessy. It is not without risk, though.

``If the government needs to borrow so much money for the bailout that Treasury yields start to rise, they could begin to compete with mortgages and have the opposite effect,'' Shaughnessy said. ``I think the plan will work, but if it doesn't we'll see rates going up.''

To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net.