Taxpayers Bear Brunt of This Bailout

Since the creation of the mortgage-backed securities market in the 1970s, Fannie Mae(FNM) and Freddie Mac(FRE) have allowed homeowners to secure lower mortgage rates.

All the benefits from the past thirty plus years, however, will likely be washed away by the federal bailout of the two firms now on the table, which critics say will eventually leave taxpayers holding the bill.

It's difficult to say exactly how much homeowners have saved on lower mortgage rates from having Fannie and Freddie around.

The two government-sponsored entities, which collectively own or guarantee about $5 trillion in U.S. residential mortgages, receive tax breaks and have lower costs of capital. This allows them to purchase mortgage loans and mortgage-backed securities at lower yields.

In turn, banks and mortgage lenders can offer lower interest rates on mortgages to homebuyers, knowing they can sell the loans to Fannie and Freddie.

Fannie's and Freddie's lower cost of capital results from Wall Street's perception of an implicit guarantee that the federal government will back up the two firm's debt if they ever face insolvency -- as some argue is happening today.

Thus, in effect, the federal government provides a subsidy to both firms, with the presumption that the subsidy will be passed on to homebuyers in the form of lower mortgage rates.

David Reiss, a professor at Brooklyn Law School who thinks both Fannie and Freddie should have been privatized a long time ago, says any eventual bailout will result in an income transfer from taxpayers to homeowners -- who were the ones benefiting from lower mortgage rates.