The credit ratings of US mortgage giants Freddie Mac and Fannie Mae were downgraded by Fitch Ratings late Thursday. As a deal to resolve the debt ceiling dispute continues to be worked out in Washington, but even the warning is affecting mortgage lending, a reduction is not expected.
The warning comes as ratings for Fannie Mae and Freddie Mac are tied to the United States’ sovereign rating. The watchful ratings agency warned on Wednesday that the US credit rating could be downgraded if the debt ceiling showdown is not resolved soon.
Fannie and Freddie, which account for roughly 70% of the nation’s mortgage loans, do not directly insure borrowers, but instead buy loans from lenders and repackage them for investors. Each is a government-sponsored enterprise, or GSE, chartered by Congress.
The purpose of Freddie and Fannie is to provide liquidity to the mortgage market and enable reliable, affordable cash flow for mortgage lenders. This will ultimately allow more homeowners to borrow at affordable rates.
The enterprises buy loans from lenders, consolidate them and sell them as collateral to investors. Because they are backed by the government, these securities are considered less risky than other investments and are considered as creditable as the US government.
But if the United States defaults on its debt, that flow could be disrupted, Fitch warned.
Putting the GSEs on the watch for downgrades, which Fitch calls a “rating clock negative,” is a direct result of uncertainty about the United States meeting its debt obligations and the level of support the GSEs expect if the U.S. rating is downgraded. drop off.
However, Fitch added, a US sovereign downgrade due to debt ceiling challenges would not necessarily result in an immediate downgrade of housing GSEs — as long as housing GSEs continue to meet their obligations.
Fitch notes that GSSs primarily cover their obligations through cash flows from operations, as opposed to relying directly on the federal government.
“Housing GSEs continue to benefit from meaningful financial support from the US government,” Fitch said in a statement. “Fitch equates GSS ratings to US ratings because of their critical role in the US housing finance system and the US Treasury’s Senior Preferred Stock Purchase Agreement. Fitch believes Fannie Mae and Freddie Mac will continue to fulfill their mission to provide affordable payments, stability and affordability to the housing finance industry.
Under the stock purchase agreement, the Treasury is required to inject funds into Fannie Mae and Freddie Mac to prevent each company from being declared technically bankrupt by the government regulator, the Federal Housing Finance Agency. At the end of March, Fannie Mae’s net worth was $64 billion, while Freddie Mac’s was $39.1 billion. The current version of the agreement allows the GSEs to hold their funds until each meets the minimum capital levels required to exit government regulation.
Already, the announcement is having an impact on mortgage rates, with the 10-year Treasury yield — which mirrors mortgage rates — rising on Friday.
“What Fitch is doing is a stark reminder of the trouble that defaults can have in the economy,” said Melissa Cohn, regional vice president of William Ravis Mortgage.
A recent Zillow analysis of the impact of US debt defaults on the housing market shows that home buying costs could rise by 22 percent and mortgage rates could rise by more than 8 percent.
Although a US default and the collapse of Freddie and Fannie are unlikely, the US government is insolvent and unable to provide the necessary support to its corporations.
Most of the funding for the GSEs comes from its own operations rather than government support, but Cohn said, if mortgage rates rise and revenues flow into Freddie and Fannie, they may need that funding.
“If rates go to 8% or higher? The rate of home purchases will stop, it’s scary,” said Cohn, adding that because current homeowners have mortgages of 2% to 4% that are too low, buying a home at 8% will destroy their affordability.
But the decline can be avoided, says Fitch, if there is a solution to the problem.
And for the typical home buyer looking at homes and trying to get a good loan rate, the recent deal is a good deal.
“The typical home buyer is focused on finding a home – if they qualify for a mortgage – knowing what they have to agree to, contract negotiations and the end of the month payment,” said Jessica Lautz, Deputy Chief Economist and Vice President. Research on the National Association of Realtors.
“When politics is at play, the ratings clock is right — clock,” she said.