Why would the failure (or need for government support) by Fannie or Freddie cause mortgage rates to rise?

Question

How does that correlation work?

How do mortgage rates respond to the circumstances of Fannie and Freddie?

Answer 1

There is a risk correlation. The more and bigger failures there are, the higher rates will go. The higher rates serve to help pay the off the bad debts from all the other bad loans.

Answer 2

The simplest way to explain it is the supply and demand for mortgages.

Fannie and Freddie create a high demand for mortgages. If they go under, the total demand for mortgages will go down. If that demand goes down, less people can create new mortgages (i.e. buying a new homes) because no one would want to buy the new mortgage contract.

In this scenario, the only way to increase the demand would be to raise the interest rates of the mortgages, so that they are more financially attractive to Fannie, Freddie (if they are still intact) or private investment banks.

Hope this helps!

Answer 3

Fannie and Freddie are set up to buy and market packages of mortgages from banks.  By doing this, they provide for a more efficient market as well as a larger market (banks can take the money they get from selling the mortgages and reinvest in new mortgages).  Without this market, banks would have to sell mortgages on their own, a less efficient task, which would raise costs and hence rates.  Also, by packaging a wider range of mortgages (in terms of risk), banks can more easily make riskier mortgages since they know they can package them with less risky mortgages and sell the package.  This allows the banks to offer lower rates on riskier mortgages.