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Fannie, Freddie Downgrades Effect Muted

NEW YORK ( MainStreet) -- Those rascals from Standard & Poor's are at it again. After rocking the global financial markets by cutting Uncle Sam's creditworthiness to "AA+" on Friday from "AAA," S&P set its sights on the fragile U.S. housing market -- especially mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE)

S&P downgraded the credit ratings of both agencies, signaling that any financial entity with close ties to the U.S. government faces increased scrutiny from credit agencies.

The S&P credit downgrade on Fannie Mae and Freddie Mac isn't the bombshell investors feared.

The downgrades, to AA+ from AAA, are a reflection of Fannie and Freddie's close financial dependence on Uncle Sam, S&P says. "The downgrades of Fannie Mae and Freddie Mac reflect their direct reliance on the U.S. government," S&P noted in a statement released Monday.

So what's the fallout going to feel like for Main Street home loan borrowers and the homeowners counting on Fannie and Freddie to guarantee the loans that will be used to buy their houses? Let's take a look at three key points:

Their link to the government hurt both agencies.
Fannie and Freddie practically own the U.S. home loan market. Both agencies have taken $141 billion out of the housing market from U.S. taxpayers, and together they control up to 80% of the nation's mortgages. What S&P is saying is that its debt leaves both agencies vulnerable financially, and that further economic deterioration could leave the federal government open to further downgrades if it doesn't meet its debt obligations, taking Fannie and Freddie down with it.

So far, no real panic.
While the Dow fell 635 points in Monday trading, the bond market -- which is closely tied to the national housing market via interest rate levels -- held up fairly well. Instead of Treasury yields rising, indicated by a flight out of bonds, those yields fell, as millions of investors near and far gorged on safe-haven investments as the stock market fell. So if there was a near-term takeaway from the Freddie and Fannie news, it was much ado about nothing to big bond market investors. Apparently, the "full faith and credit of the U.S. government" still means a great deal to investors.

Fannie Mae's financial picture is actually brightening.
Even as S&P slapped a "higher credit risk" note on Fannie's forehead, the agency has posted financial results from the second quarter of 2011 that show that its financial health is improving. According to the agency, net losses for the quarter were at $2.9 billion, but that beats first-quarter numbers (losses of $6.5 billion) by a long shot.

That's not to say Fannie Mae is out of the woods. The company stated that "the loss in the second quarter of 2011 reflects the continued weakness in the housing and mortgage markets, which remain under pressure from high levels of unemployment, underemployment and the prolonged decline in home prices since their peak in the third quarter of 2006. Pursuing loan modifications, a key aspect of the company's strategy to reduce defaults, also contributed to its loss in the quarter. Fannie Mae expects its credit-related expenses to remain elevated in 2011 due to these factors."

All in all, the S&P credit downgrade on Fannie Mae and Freddie Mac isn't the bombshell at investors feared. But there's a long way to go before this story plays out.

For more on what the debt downgrade does to your wallet, take a look at how the downgrade affects bank rates!

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