Fannie & Freddie Downgrade Won't Hurt Housing, Yet

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NEW YORK (MainStreet) -- Those rascals from Standard & Poor’s are at it again. After rocking the global financial markets by cutting Uncle Sam’s creditworthiness from “AAA” to “AA+” on Friday, S&P set its sights on the fragile U.S. housing market - especially mortgage giants Fannie Mae (Stock Quote: FNM) and Freddie Mac (Stock Quote: FRE).

This morning, S&P downgraded the credit ratings of both agencies, signaling that any financial entity with close ties to the U.S. government faces increased scrutiny from credit agencies.

The downgrades, from AAA+ to AA+, are a reflection of Fannie and Freddie’s close financial dependence on Uncle Sam, S&P says. "The downgrades of Fannie Mae and Freddie Mac reflect their direct reliance on the U.S. government," S&P noted in a statement released today.

So what’s the fallout going to feel like for Main Street home loan borrowers, and the homeowners who are counting on Fannie and Freddie to guarantee the loans that will be used to buy their houses? Let’s take a look at three key points:

Their link to the government hurt both agencies. Fannie and Freddie practically own the U.S. home loan market. Currently, both agencies have taken $141 billion out of the housing market from U.S. taxpayers, and together they control up to 80% of the nation’s mortgages. What S&P is saying is that its debt leaves both agencies vulnerable financially, and that any further economic deterioration could leave the federal government open to further downgrades if it doesn’t meet its debt obligations, taking Fannie and Freddie down with it.

So far, no real panic. While the Dow fell 635 points in Monday trading, the bond market – which is closely tied to the national housing market via interest rate levels – held up fairly well. Instead of Treasury yields rising, indicated a flight out of bonds, those yields fell, as millions of investors near and far gorged on safe-haven investments as the stock market fell. So if the there was a near-term takeaway from the Freddie and Fannie news, it was much ado about nothing to big bond market investors. Apparently, the “full faith and credit of the U.S. government” still means a great deal to investors.

Fannie Mae’s financial picture is actually brightening. Even as S&P slapped a “higher credit risk” note on Fannie’s forehead, the agency has posted financial results from the second quarter of 2011 that show that its financial health is improving. According to the agency, net losses for the quarter were in the red (-$2.9 billion) but that beats first-quarter numbers (losses of $6.5 billion) by a long shot.

That’s not to say Fannie Mae is out of the woods yet, though. The company stated today that “the loss in the second quarter of 2011 reflects the continued weakness in the housing and mortgage markets, which remain under pressure from high levels of unemployment, underemployment, and the prolonged decline in home prices since their peak in the third quarter of 2006. Pursuing loan modifications, a key aspect of the company’s strategy to reduce defaults, also contributed to its loss in the quarter. Fannie Mae expects its credit-related expenses to remain elevated in 2011 due to these factors.”

All in all, the S&P credit downgrade on Fannie Mae and Freddie Mac isn’t the bombshell that investors feared. But there’s a long way to go before this story plays out fully, especially as activity in the bond market impacts Fannie, Freddie and home mortgages going forward.

—For more on what the debt downgrade does to your wallet, check out MainStreet’s look at how the downgrade affects bank rates!

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