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The Federal National Mortgage Association ("Fannie Mae") and the Federal Home Mortgage Corporation ("Freddie Mac") were chartered by Congress to create a secondary market for residential mortgage loans. They are considered "government-sponsored enterprises" (GSEs) because Congress authorized their creation and established their public purposes.
Together, Fannie Mae and Freddie Mac are the largest sources of housing finance in the United States. Here's how it works:
- You secure a mortgage to buy a home.
- Your lender probably resells that mortgage to Fannie Mae or Freddie Mac.
- Fannie Mae and Freddie Mac either hold these mortgages in their portfolios or package the loans into mortgage-backed securities (MBS) that they then sell to the public.
The theory is that by providing this service, Fannie Mae and Freddie Mac attract investors who might not otherwise invest funds in the mortgage market. This, theoretically, increases the pool of money available to potential homeowners.
By the third quarter of 2007, Fannie Mae and Freddie Mac held mortgages valued at $4.7 billion-about the size of the total publicly-held debt of the U.S. Treasury. By July 2008, their portfolio was called a $5 trillion mess.
History of Fannie Mae and Freddie Mac
Even though Fannie Mae and Freddie Mac were Congressionally-chartered, they are also private, shareholder-owned corporations. They have been regulated by the US Department of Housing and Urban Development since 1968 and 1989, respectively.
However, Fannie Mae is more than 40 years old. President Franklin Delano Roosevelt's New Deal created Fannie Mae in 1938 to help jump-start the national housing market after the Great Depression. And Freddie Mac was born in 1970.
In 2007, EconoBrowser noted that today there is "no explicit government guarantee of their debt." In September 2008, the US government seized both Fannie Mae and Freddie Mac.
- Federal Farm Credit Banks (1916)
- Federal Home Loan Banks (1932)
- Government National Mortgage Association (Ginnie Mae) (1968)
- Federal Agricultural Mortgage Corporation (Farmer Mac) (1988)
Contemporary Congressional Action Regarding Fannie Mae and Freddie Mac
In 2007, the House passed H.R. 1427, a GSE regulatory reform package. Then-Comptroller General David Walker stated in Senate testimony that “A single housing GSE regulator could be more independent, objective, efficient and effective than separate regulatory bodies and could be more prominent than either one alone. We believe that valuable synergies could be achieved and expertise in evaluating GSE risk management could be shared more easily within one agency.”
Subprime Mortgage Crisis
A subprime mortgage crisis occurred in the United States between 2007-2010, in part as a result of a weakening economy but also as a housing bubble which had pushed housing prices higher and higher collapsed. Houses were large, their price tags steep, but mortgages were inexpensive and easy to get, and the prevailing real estate theory was that it was smart to buy (much) more house than you needed because it was a solid investment. If they wanted, buyers could refinance or sell the house because the price would be higher than when it was purchased.
Fannie and Freddie's concentrated exposure to US residential mortgages, coupled with their high leverage, turned out to be a recipe for disaster. When the inevitable crash in home prices occurred, it created an associated spike in mortgage defaults, and Fannie and Freddie were holding hundreds of thousands of underwater home mortgages-people owed more, in some cases far more, on their houses than the houses were worth. That situation contributed greatly to the 2008 recession.
Collapse and Bailout
By mid-2008, the two firms had expanded to almost $1.8 trillion in combined assets and $3.7 trillion in combined net off-balance sheet credit guarantees. Over the same period, however, they posted $14.2 billion in losses and their combined capital only amounted to about 1 percent of their exposure to mortgage risks. Despite efforts in the summer of 2008 to prop up the failing GSEs (the Housing and Economic Recovery Act on July 30 temporarily gave the US Treasury unlimited investment authority), by Sept. 6, 2008, the GSEs held or guaranteed $5.2 trillion dollars in home mortgage debt.
On Sept. 6, the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into conservatorship, taking control of the two firms, and entering into senior preferred stock purchase agreements with each institution. The U.S. taxpayer ultimately paid a $187 billion bailout to the two GSEs.
One stipulation to the bailout was that going forward the quality of housing loans backed by Fannie Mae and Freddie Mac had to improve. Investigations by economists Dongshin Kim and Abraham Park reported in 2017 indicate that the quality of post-crisis loans is indeed higher, particularly in the requirements on the levels of debt-to-income (DTI) ratio, and credit scores (FICO). At the same time, loan-to-value (LTV) requirements had been loosened since 2008, allowing a steady increase in the number of first-time home buyer loans.
By 2017, Fannie and Freddie had paid back $266 billion to the US Treasury, making their bailout a tremendous success; and the housing market has recovered. However, Kim and Park suggest that continued monitoring of the quality of the mortgages would be prudent. While FICO and DTI are indicators of the borrower's ability to pay their mortgages on time, the LTV is an indication of the borrower's willingness to pay. When the house value falls below the loan balance, people are less likely to pay on their mortgages.
- Boyd, Richard. "Bringing the GSEs Back In? Bailouts, U.S. Housing Policy, and the Moral Case for Fannie Mae." Journal of Affordable Housing & Community Development Law 23.1 (2014): 11-36. Print.
- Ducas, John V. Subprime Mortgage Crisis 2007-2010. Federal Reserve History. November 22, 2013.
- Frame, W. Scott, et al. "The Rescue of Fannie Mae and Freddie Mac." Journal of Economic Perspectives 29.2 (2015): 25-52. Print.
- Kim, Dongshin, and Abraham Park. "How Sound Are the Fannie Mae and Freddie Mac Recoveries? Are There Vulnerabilities for History to Repeat?" Graziadio Business Review 20 (2017). Print.
- Agency/Government Sponsored Enterprises (GSEs) Product Overview 200
- What Are the Origins of Freddie Mac and Fannie Mae?