Fannie Mae and Freddie Mac

If you listen to the news much or are considering buying a home then no doubt you’ve heard of Fannie Mae and Freddie Mac. But like many, you may not have a clue what they are.

Should you even care?

Yes and I’ll explain why. But first a little background.

Fannie Mae is actually a nick name for The Federal National Mortgage Association. It was founded in 1938 during the Depression and was part of Franklin Roosevelt’s New Deal. It is what is known as a Government Sponsored Enterprise(GSE). Though today it’s actually partly owned privately so that the money involved would not be part of the Federal Budget’s debt.

It purpose is to increase the available funds for mortgages by securitizing mortgages in the form of mortgage-backed securities (MBS). This is suppose to encourage lenders to reinvest assets into more lending so that there is that much more money available to buy homes. This also lowered the risk involved and the government hoped it would mean that more people could get loans and have their homes.

The shorter version is it makes federal money available to banks for loans ostensibly for low-income and minority homeowners.

In 1970, the government through Fannie Mae, created a second GSE, the Federal Home Loan Mortgage Corporation(FHLMC), commonly known as Freddie Mac. Freddie Mac was suppose to compete with Fannie Mae and make for a stronger secondary mortgage marketplace. In other words, to make even more money available to lenders and borrowers.

The Government Tries To Get More People Buying Homes

Then in 1992, George H.W. Bush, the elder signed the Housing and Community Development Act. It’s goal was to get Fannie Mae and Freddie Mac to..

“… have an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families in a manner consistent with their overall public purposes, while maintaining a strong financial condition and a reasonable economic return;”

This forced Fannie Mae and Freddie Mac to meet “affordable housing goals” that would be set by the Department of Housing and Urban Development (HUD).

Then in 1999, Fannie Mae was pressured by the Clinton administration increase loans to low and moderate income borrowers to increase the number of first-time homeowners.

Also at the time, institutional lenders who used Fannie Mae and Freddie Mac for funds, encouraged them to lower credit requirements allowing them to create sub-prime loan products that started at low interest rates but over the life of the loans would actually cost more than conventional loans. This made it easier for first time buyers to afford a loan, at least in the short run. Lenders made more money in the long run.

Can you see where this is going?

So even though the GSE of Freddie Mac and Fannie Mae made more money available with government backing, and additionally had pretty strong loan standards, or underwriting as it is called, many private investors went on their own and offered more risky loans.

Hindsight Is 20/20

As Daniel Mudd, then President and CEO of Fannie Mae, testified in 2007…

“Unfortunately, Fannie Mae-quality, safe loans in the subprime market did not become the standard, and the lending market moved away from us. Borrowers were offered a range of loans that layered teaser rates, interest-only, negative amortization and payment options and low-documentation requirements on top of floating-rate loans. In early 2005 we began sounding our concerns about this “layered-risk” lending. For example, Tom Lund, the head of our single-family mortgage business, publicly stated, “One of the things we don’t feel good about right now as we look into this marketplace is more homebuyers being put into programs that have more risk. Those products are for more sophisticated buyers. Does it make sense for borrowers to take on risk they may not be aware of? Are we setting them up for failure? As a result, we gave up significant market share to our competitors.”

So even though Fannie Mae and Freddie Mac offered stable loan products, private institution’s offered more aggressive, riskier loans thinking that the housing boom would continue and rising home prices would “cover their bets.”

So when these sub-prime loan’s, with their adjustable rates, interest rates went up and borrower’s could no longer keep up with payments, they began to default in record numbers. This eroded the market and caused home prices to start going down. Money for loans dried up. The house of cards began to collapse and the this lead to the foreclosure crisis we still have today.

What Does This Mean To Fannie Mae and Freddie Mac?

The benefit of Fannie Mae and Freddie Mac to institutional lenders and investors is they guarantee loans and make money available that is backed by the federal government. If loans default they have to pay.

The fall in home prices led to growing losses for the GSEs, which back the majority of US mortgages. In July 2008, the government attempted to ease market fears by reiterating their view that “Fannie Mae and Freddie Mac play a central role in the US housing finance system”.

The US Treasury Department and the Federal Reserve took steps to bolster confidence in the corporations, including granting both corporations access to Federal Reserve low-interest loans (at similar rates as commercial banks) and removing the prohibition on the Treasury Department to purchase the GSEs’ stock. Despite these efforts, by August 2008, shares of both Fannie Mae and Freddie Mac had tumbled more than 90% from their one-year prior levels.

This all had to be paid for by tax payers. FHFA estimates revealed that the bailout of Freddie Mac and Fannie Mae will likely cost taxpayers $224–360 billion in total, with over $150 billion already provided.

As the economy and the housing market has stabilized the GSE’s are looking a little better. Even though losses have been significant, they still play an important role in the housing market. Still, they are controversial entities and Congress continues to debate their future roles.