Future Still Shaky for Fannie Mae, Freddie Mac

The news that new home sales plunged by 33-percent in May -- to the lowest level on records dating back to 1963 -- was disturbing for homeowners. But that is also bad news for taxpayers, because the government mortgage giants Fannie Mae and Freddie Mac remain mired in a swamp of shaky loans that taxpayers may get the bill for.

Taxpayers may be more exposed to the housing market than they think, because the government owns Fannie Mae and Freddie Mac. And they own or guarantee half of all the mortgages in the country.

Senator Jim DeMint, a Republican from South Carolina, says that means "one of our most important private sector economic activities is controlled in large part by the federal government."

And taxpayer exposure is growing. In the first quarter of this year, Fannie and Freddie saw about 1,000 foreclosures a day, one about every 90 seconds. That's 91,000 in just three months.

And the government, meaning the taxpayers, has inherited more than 163,000 foreclosed homes.

Because the federal government took over Fannie and Freddie, that means the taxpayers own all those homes, and own or guarantee the mortgages for 31 million more.

Fannie and Freddie have already soaked up 145 billion in taxpayer funds. Some fear it could go to 500 billion.

How did this happen? During the Clinton years, the federal government set out to expand homeownership to low income people. Fannie and Freddie encouraged that by buying up mortgage loans from the original lenders.

Knowing they could dump their loans to Fannie and Freddie, lenders were perfectly willing to make shaky ones -- with no money down (or teaser rates) or no documentation of income, known as liar's loans.

Diana Furchtgott Roth, a former chief economist for the Labor Department, now at the Hudson Foundation, says the lenders "didn't check as carefully on the payments because they knew that they weren't going to get stuck with the actual loan itself."

That spread the practice of weaker loans and, some argue, laid the groundwork for the recent financial meltdown.

"Most of us believe that Fannie Mae and Freddie Mac played a large role in causing the financial meltdown, says Senator DeMint, "certainly the housing bubble with subprime loans, the securitized subprime loans that brought down the worldwide financial system."

And many of those loans were bundled into mortgage backed securities and sold to investment funds, pension funds and all sorts of banks. So when they failed, the weak loans spread like a virus.

Furchtgott Roth says they "basically spread all over the world, as peoples as far away as Europe and Asia purchased these mortgage-backed securities."

When the housing market in the U.S. collapsed, so did many investments that held those mortgages. Because no one could quite tell which mortgages were good and which were not, confidence in mortgage-backed securities collapsed.

Now, as the Congress debates a new financial regulation bill, many republicans propose getting rid of Fannie and Freddie altogether, or at least restructuring them.

Democrats only partly agree. Sen. Chris Dodd of Connecticut, a key player on financial issues, recently conceded there was cause for concern. "Look, this program needs to be fixed," he said. "There's no question about you need an alternative housing finance system. that is without question."

But Sen. Dodd rejects the idea of dealing with Fannie and Freddie in the legislation now working its way through Congress.

So, Democrats want to wait to talk about Fannie and Freddie. And the current financial bill does not address them at all.

Republicans, on the other hand, say with the government already neck deep in debt, it needs to figure out a way to get out of the home loan business as soon as possible.