Why The Takeover Of Fannie and Freddie Is Lowering Rates

When comparing two investments with equal risk, a rational person will choose the investment with a higher rate of return.This behavior is called Risk Aversion and is a basic tenet of personal investing.

An off-shoot of Risk Aversion is that a rational person will only invest in an instrument of greater risk if the returns are greater, too.

A “spread” is the difference among investment return rates. Typically there is a 1.5% difference between government and mortgage debt.

In July, 2007 we began to hear about the increasing number of mortgage delinquencies and the now well known Credit Crunch. This occurred when the “spread” grew and mortgage investment was a higher risk.

The “spread” almost doubled in a year. On September7, 2008 the takeover of Freddie Mac and Fannie Mae was announced by the federal government. This action offered the “risk free guarantee” for mortgage debt. After the announcement of the takeover the “spread” decreased.

This is one reason why mortgage rates fell Monday and why they should continue to stay low over the near-term. With the U.S. government backing the mortgage market, there’s no room for the risk premium that helped keep rates high this past year.

This will not mean more people will be able to get mortgages. However, those who qualify may find that financing is cheaper.

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