UCI News

Financial matters

Vandell explores the first cracks in the struggling U.S. economy

by Jason Mednick, University Communications | September 29, 2008
Financial matters

The U.S. government implemented a historic takeover of Fannie Mae and Freddie Mac earlier this month to help stabilize the mortgage market and counteract the pressures of tight credit, falling house prices and a rising number of homes in foreclosure.

Despite those actions, recent events have shown the problems plaguing the two mortgage finance giants are not the only cracks in a struggling economy.

Kerry Vandell, UC Irvine’s Paul Merage School of Business Center for Real Estate director, has conducted research on Fannie Mae’s and Freddie Mac’s lending activities. He answers some questions about the takeovers and how they might affect real estate.

Q: Why did federal regulators take over Fannie Mae and Freddie Mac?

A: The economy needs to have a stable credit market for housing. Fannie Mae and Freddie Mac play a large role in their sector of the market, which in and of itself is a significant sector of the overall capital market. The government had to do something to ensure that part of the market was secure.
Q: What was your initial reaction to hearing about the Fannie Mae and Freddie Mac takeovers?

A: I was expecting something to happen. I knew the financial circumstances were bearing heavily on the market, and there was still a lot of uncertainty and a perception of lack of confidence in future government support for Fannie and Freddie. So, I felt something had to happen to right that.
Q: What could have happened if the takeovers did not occur?

A: If Fannie and Freddie were to fail – if they became insolvent and had to declare bankruptcy – it would cause many hundreds of billions of dollars of their securities to decline considerably in value and create significant losses. If the government stood back and did not help, I think it would have caused havoc in capital markets worldwide. You have to remember, U.S. investors aren’t the only ones involved – there also are sovereign wealth funds, the assets of countries and banks across the world that are invested in their securities or exposed to Freddie or Fannie debt. It points to the fact that the world economy is very interrelated. When you have large parts of it exposed, it can cause a lot of ripples elsewhere in the system. I don’t think most people realize just how substantial a risk failure of this part of the system could have been.
Q: How might the takeovers affect local real estate?

A: The takeovers are good – relative to the previous situation – because they have removed a large component of the uncertainty about the housing market. It’s pretty clear the government is prepared to play a full role in this if necessary. That will help provide confidence to Wall Street, which will allow Fannie and Freddie to make loans, sell their securities and continue to provide liquidity to the market. Unfortunately, we still have a situation where banks, insurance companies and financial institutions have lots of other liquidity problems unrelated to Fannie and Freddie. This makes Fannie and Freddie’s problems seem small by comparison and will demand an even greater commitment by the government to address.
Q: Could this be the key move that shores up the housing market?

A: I think this is a very important component. Now we’re waiting for signs that the corner has been turned in the real estate market – not that the bottom has been hit and we’re starting up – but at least the corner has been turned and the rate of decline has started to slow. We’re seeing some signs of that in terms of house prices and transaction volumes in some markets, even though a significant portion of these are driven by foreclosures. There are still concerns about adjustable-rate mortgages resetting higher from low teaser rates. And, we still have a reasonably high amount of housing inventory that could take a year or so to cut into. We are not out of the woods yet, but at least for housing, there may be a glimmer of light at the end of the tunnel.