As we all heard by now, Fannie and Freddie are in trouble. With falling home prices in the Midwest, California, and Florida, there is an even greater risk of Fannie’s and Freddie’s assets falling further. As these assets fall, Fannie and Freddie will have to raise large amounts of capital reserve to cover the write downs on their mortgage backed securities. Given the fact that the government will be stepping in to help these ailing institutions we must ask two questions. First, what does it mean if the government did not step in and allowed Fannie and/or Freddie to fail? Second, what does it mean for markets if/when the government steps in to help?
If Fannie and/or Freddie were allowed to fail, it would send a ripple through global financial markets that has never been seen in the history of the world. We would run a great risk of our markets freezing. In other words, the flow of capital would stop. Without the flow of capital, it would be virtually impossible for the economy to pull out of its current recession. Furthermore, housing prices would fall sharply due to a buyer’s inability to borrow. And there would be more foreclosed real estate hitting markets that already have too much surplus of real estate inventory.
The best scenario is for the government to step in to aid the ailing institutions. What does it mean for the American tax payer if the government steps in? Well in simple terms you pay the bill to bail out the institutions. However, given the former option, it is to the average Americans benefit for the government to step in. Otherwise the risk is too great of falling into a prolonged recession for us. Furthermore, worst case scenario, it could throw the country into a depression. With the current problem for Fannie and Freddie, a silver lining exists for real estate professionals.
To understand the inherent opportunity one only has to look back to the Savings and Loan crisis of the 1980’s. In the 1980’s the government had to step in to take over bank assets which ultimately turned into government owned real estate. Next, the government would create third party companies that would auction off the real estate at substantial discounts! The real estate professionals who specialized in this area made millions by brokering deals for deep pocketed investors. As always, deep pocketed investors brought in the capital but, still needed the assistance of an insider who understood the historical values of the properties within the area.
Although it is tragic that Fannie and Freddie are in their current positions, one thing we can count on is that the government will not allow these institutions to fail. Henry Paulson and Ben Bernanke have been having meetings as to how to “shore up” Freddie and Fannie if/when the worst happens.
Knowing the inevitable, investors and real estate professionals must look beyond to the inherent opportunity that is being created through this crisis.
Cliff Pape
Home-Buddies