IndyMac Bank fails, seized by FDIC

Fannie Mae & Freddie Mac in trouble

The second largest bank failure in US history happened yesterday around 5:30pm. They held a majority of junk mortgages and were technically insolvent. NY Senator Chuck Schumer publicized a few letters to regulators questioning IndyMac’s solvency. Everyone ran to take out their deposits before the bank collapsed in on itself which it was forced to do. About $1billion of its holdings were not FDIC insured and will be repaid at 50% of their holding size. Goodbye, $500million! Schumer saved those smart enough to get out when he put up the warning sign. Others may blame him for causing the run, but it would have happened sooner than later.

IndyMac was the 11th largest mortgage lender at the time of its failure. This should have some effect on interest rates, but the scarier issue is what happens to Fannie Mae & Freddie Mac.  Together, they back half of all US mortages at $5trillion in value. They are also responsible for about 80% of new mortgages, from what I’ve read recently.

Much has been said about their potential insolvency lately and their share prices have dove off a cliff the past week as it looks like they may be bailed out if the worst happens. If that happens, shares of the company are effectively worthless. These companies can simply not be allowed to fail. If they do, mortgage interest rates would skyrocket to the 10-15%+ range as banks would have to assume the risk themselves, instead of getting guarantees from Fannie Mae & Freddie Mac. (That’s their primary business model, guaranteeing the loans will be paid out in exchange for a fee.) If the rates skyrocket to those levels, the housing market will fall even further than it currently is looking to do. On top of that, if the FDIC takes them over, they’d sell all their assets to pay out their dues. That would flood the market with many more homes and you know what happens then.

One option for those companies besides failing, is to stop to taking on new loans, which would force rates to skyrocket as well and is a slightly better option. They will also likely not give out dividends to their shareholders which would send the stock down further as its return on investment would be less. (Dividends for both companies are hefty.)

Much of this hinges on what happens on Monday when they will be auctioning off $2 billion in their current loans. If they can sell these, they will be able to raise capital to continue taking on new mortgages.  If they don’t, the above options come into play.

The result of all of this should be their stock prices flying down over the next week (SHORT SHORT SHORT) even further and the housing market starting to have its shaky legs cut out from under them. The market was looking for buyers as home prices were flying down and rates stayed acceptable and mortgages were attainable.  It looks like prices will continue to fall but rates will be jacked up and mortgages will be harder to get. Either of which will send the market further downward.

Buckle up!