On Monday, August 8, Standard & Poor’s downgraded the credit rating of Fannie Mae and Freddie Mac from AAA to AA+, the same lower rating it assigned the U.S. government the previous Friday. The rating agency also issued rating downgrades to dozens of banks and three major clearinghouses that operate with government-guaranteed debt. The unprecedented downgrades sent the stock market plunging 300 points and engendered fear in the residential housing industry that the action would result in higher mortgage interest rates, adding another obstacle in the path of housing recovery.
But as the dust began to settle, analysts dismissed the significance of the rating downgrade, pointing out that Fannie and Freddie still have the backing of the U.S. government, and U.S. debt is still considered the safest investment in the world.
“It’s a nonevent,” says Mark Zandi, chief economist at Moody’s Analytics. “I don’t think [the downgrade] will have any effect. Both of the other rating agencies [Moody’s and Fitch] reaffirmed the government’s triple-A rating, so with just Standard & Poor’s downgrade nothing’s going to happen.”
“We haven’t felt an impact because of the downgrade,” says Patty Boerger, a spokeswoman for Freddie Mac. “We just completed a $1 billion debt offering and investors remained with us. We didn’t slow down.”
But while most analysts doubt that mortgage rates will rise as a result of Standard & Poor’s action, there is still concern about the psychological impact on homebuyers. Fannie and Freddie guarantee virtually every new mortgage written and the two organizations, which were taken over by the government in 2008, own or guarantee about half of all U.S. mortgages. That’s approximately 31 million loans worth about $5 trillion. Mortgage interest rates are pegged to the yields on U.S. Treasury securities, which a rating downgrade could affect. But even after Standard & Poor’s action, Treasury yields remained low and the strength of the dollar increased, indications that the United States is still considered a safe bet, especially in the current parlous global economy.
In the end, analysts say, the move to downgrade Fannie and Freddie has little to do with the mortgage industry. Instead, it is viewed as a procedural move: Once the government’s rating was lowered, it follows logically that organizations and agencies that function with government debt guarantees will receive the same treatment.
Indeed, some housing industry analysts believe the government takeover of Fannie and Freddie has made the two mortgage giants sounder investments than at any time in their history. Over the past few months, mortgage insurance companies have been lowering their fees, a reflection of fewer loan defaults and better loan performance.
James Shilling, a professor at DePaul University’s Institute of Housing Studies and a former ULI fellow, claims that Fannie and Freddie have stabilized the housing market and in the current economy are being recognized as a vital cog in a housing recovery. “Last February, the Obama administration recommended winding down Fannie and Freddie, saying the federal government should get out of the business of operating a secondary market for residential mortgages,” says Shilling. But now, he says, the administration is “none too eager to move forward with closing down Fannie and Freddie.”
The reason, says Shilling, who recently completed a report documenting the positive impact Fannie and Freddie have had on the U.S. housing market, is that under government supervision the organizations have operated more efficiently and, in addition, at the moment, private sector lenders are not stepping forward. “In my report, I estimate that a public Fannie Mae and Freddie Mac have probably raised housing affordability in the U.S. by about 15 percent in the current environment,” Shilling says.
While most analysts say the downgrade of Fannie and Freddie will have minimal impact on the cost of capital, there is a psychological component to the downgrade that has to be considered. “Confidence among homebuyers has already been hard hit,” notes Zandi. “This will just add to it.”