Vicious Cycle

Time of Reckoning For
Fannie Mae, Freddie Mac

Center stage on Wall Street this week: the plight (fate?) of Fannie Mae and Freddie Mac.

Both entities took big plunges yesterday, and are now fetching prices not seen since the early '90's. Why should home buyers and sellers care? Just as the Federal Reserve is the lender of last resort, Freddie Mac and Fannie Mae are the home mortgage buyers (and insurers) of last resort.

The problems facing these two quasi-government loan giants illustrate the dynamic gripping the increasingly intertwined housing and credit markets: the fall in housing prices cripples lenders' balance sheets, which curtails their ability to originate (as well as purchase, insure, trade, and securitize) mortgage loans. In turn, tighter, more limited credit crimps demand for housing . . which causes housing prices to fall further.

Until the Fed, the President, or someone (Warren Buffett? the Tooth Fairy?) figures out how to interrupt this vicious cycle, the problems facing the housing market -- and the broader economy -- aren't over.