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Catching Up with Fannie Mae and Freddie Mac


The Creation of Fannie Mae and Freddie Mac

The Federal National Mortgage Association (Fannie Mae) was created as a New Deal-era government program in 1938 in order to help low-income families secure mortgages. In 1968 the organization was restructured into a government-sponsored enterprise (GSE) that's shareholder-owned, not government owed.

The Federal Home Loan Mortgage Corporation (Freddie Mac) came about in 1970, as a way to build a more robust secondary mortgage-funding market. Unlike Fannie Mae, Freddie Mac was never part of a government program. It was established as a GSE with the purpose of supplying more funds to mortgage lenders so they can make more home loans.

The purpose of GSEs is to improve the availability and flow of credit while reducing the cost within specific finance sectors, such as home mortgages. However, after years of deregulation, pressure from stockholders to keep profits high and general mismanagement, the two institutions became more involved in the high-risk subprime loan sector.  

By September 2008, the two were declared insolvent and were put into the conservatorship of the Federal Home Financing Agency (FHFA). This sweeping government intervention led to big shake-ups in both organizations including a change in ownership. The Treasury now owns 79.9% of both Fannie Mae and Freddie Mac after infusing each with hundreds of billions of dollars. At the time the government made the investment because they said the GSEs were "too big to fail".

At that time the two entities owned, guaranteed or underwrote about half of the country's mortgage market.  

How Fannie Mae and Freddie Mac Work

First, you should understand what a secondary mortgage market is, because that's the industry both Fannie Mae and Freddie Mac operate within.

Understanding the Secondary Mortgage Market

A secondary mortgage market is where originators of loans (i.e. banks) sell the mortgages they've made with home buyers to mortgage securitizers (i.e. Fannie Mae or Freddie Mac). The securitizers then package the loans together and sell them as mortgage-backed securities to investors (i.e. insurance companies, banks, even local community organizations).

The concept is very involved with loans being shifted back and forth, which is why it's hard to grasp.

Fannie Mae and Freddie Mac Operations: Similarities and Differences

While Fannie Mae and Freddie Mac both act as mortgage securitizers, they operate using different business strategies and do compete with each other in the secondary mortgage market.

As a mortgage securitizer, Fannie Mae and Freddie Mac act as a sort of middle men. When they buy a loan it gives the bank more capital needed to make another mortgage thus keeping the mortgage market liquid. They then package many loans together into mortgage-backed securities (MBS) to sell to investors.

The thought is, that by pooling together a number of loans into a MBS it reduces risk overall because if one loan is defaulted on the others can make up for it. This makes for a "safer investment" is the eyes of many investors who should profit off of the interest buyers pay on their mortgage. This process works fine unless there is a real estate market meltdown like we experienced in late 2008 where may people are unable to pay their mortgages.

Fannie Mae and Freddie Mac both have 3 different segments within their businesses:

Single-family Credit Guarantee: this arm of Fannie Mae oversees the buying and securitizing of single-family home mortgages.

Housing and Community Development: this is the segment which oversees the buying and securitizing of multifamily mortgage loans into mortgage-back securities.

Capital Markets: this segment manages the investments that Fannie Mae makes, keeping track of its own liquidity and buying.

Both organizations make money through selling MBSs, securities that they keep for themselves rather than selling and also from the guaranty fees paid to Fannie Mae and Freddie Mac for assuming risk by guaranteeing the repayment of the mortgages.  In fact, guarantee fees are the primary source of income for Freddie Mac.

Contrary to widely-held beliefs, neither Fannie Mar nor Freddie Mac see any federal funding or guarantees, though they are now largely controlled by the government.

What's Next for Fannie Mae and Freddie Mac?

For the time being, any large-scale reforms of Fannie Mae and Freddie Mac are on the back burner until other issues in the financial market are settled.  

At the moment Fannie Mae and Freddie Mac are part of the Obama administration's Hope for Homeowners and Making Home Affordable programs. The programs are aimed at stabilizing the housing market, partly through home loan refinancing, particularly for homeowners who are upside-down on their mortgages and those threatened by foreclosure.  

A push to cut the credit lines of Fannie Mae and Freddie Mac was short-lived, as they are perceived to be "too big to fail" considering their huge role in the mortgage-funding market. There's talk of putting the two into complete privatization and cutting all ties to the government, but nobody knows how far that will go.  One thing for sure...Fannie Mae and Freddie Mac are likely to stay in conservatorship with FHFA for at least another four to five years.  



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