Housing: The Next Shoe to Drop

The credit crunch has finally hit the traditional mortgage market.

Investors are now shunning mortgage-backed securities issued by government sponsored enterprises Fannie Mae and Freddie Mac, which have been critical in keeping the real estate market from completely falling apart.

For those who can still get a loan, the tremors in the mortgage-backed securities market has made loans more expensive for borrowers. As the prices of mortgage-backed securities have fallen, their yields have risen, leading to higher mortgage rates.

Rising defaults and delinquencies effectively shut down the subprime and jumbo mortgage markets last summer, but borrowers with good credit could still get conventional loans that met the agencies' criteria. That's because investors continued to buy securities – backed by Fannie and Freddie.

Federal regulators said recently they would allow mortgage finance giants Fannie Mae and Freddie Mac to reduce the capital they are required to keep on hand, a move that could pump $200 billion into mortgage markets.

The rule change was announced by the Office of Federal Housing Enterprise Oversight, (OFHEO), a normally low-profile agency which sets rules for the two government sponsored companies that between them hold or guarantee nearly $5 trillion in mortgages.

Both firms have been working in recent years to clean up accounting problems. During that process, the agency has been requiring them to keep 30% extra capital in reserve. The rule change allows them to reduce that excess capital to only 20%.

Experts said they don't think traditional mortgages will disappear. But if they are harder to get, it will take longer for the housing market to recover as a glut of unsold houses could lead to even more declines in real estate values.