NEW YORK (CNN/Money) - So far, the imbroglio at Freddie Mac has prompted a bit of hand wringing in the stock market, but little else. Let's hope it stays that way.
The mortgage-finance company's sacking of its three top executives Monday, and its stated concerns over the "cooperation and candor" of its chief operating officer, pulled the rug out from under its stock.
Freddie Mac (FRE: Research, Estimates) tumbled 16 percent in heavy trading and fellow government-sponsored mortgage-finance company Fannie Mae (FNM: Research, Estimates) sank 4.8 percent. The Dow, meanwhile, fell 82 points -- a down day, but by no means horrible.
But trouble at the mortgage finance companies could carry serious implications for the overall economy. If credit market players begin to seriously question either Freddie or Fannie's business, their borrowing costs could shoot up. That would send mortgage rates -- currently at all-time lows -- higher.
That would ripple badly through a financial sector which has become increasingly dependent on investments in the tradable bundles of mortgages called mortgage-backed securities to make profits.
"Imagine you're a bank," said Lehman Brothers chief economist Ethan Harris. "The corporate sector isn't interested in borrowing, so you can't lend to it. So where do you go? Well, mortgages. They pay a reasonable rate. They're seen as a safe investment. Load up on mortgage-backed securities."
Indeed, banks have been loading up on mortgage-backeds at a prodigious rate -- at the end of May they held 43 percent more than they did a year ago, according to the Federal Reserve.
Other investors, too, have been "surfing" the yield curve by taking advantage of low short-term borrowing costs to buy mortgages. The Fed, after all, in its all-out bid to revive the economy, has more or less promised to keep short-term rates low, so buying up mortgages doesn't seem so dangerous.
And those low mortgage rates are doing wonders for the economy. The Mortgage Bankers Association estimates that there will by over $3 trillion in mortgages originated this year, up from about $2.5 trillion last year. Mortgage refinance activity is going strong, putting money into consumers' pockets and keeping spending going. Problems in mortgage-land could put an end to all that.
Which, of course, is not something that anyone wants to see happen. Various officials, like Fed Chairman Alan Greenspan, sometimes complain that when it comes to Freddie and Fannie, investors have become too complacent, believing that the two mortgage companies are "too big to fail," and that in the event of serious trouble, the government will bail them out.
Given the present circumstances, can you imagine that the government wouldn't?
