Who Are Fannie And Freddie?

In 1938, as part of the New Deal, President Franklin D. Roosevelt created The Federal National Mortgage Association, commonly known as Fannie Mae, to expand home ownership by providing banks with federal money to make mortgage loans. Fannie purchases mortgage loans from lenders and bundles them into mortgage-backed securities that it sells to investors. The securitization process removes the mortgage loans from the banks’ books, thereby freeing them to make new mortgage loans. The Federal Home Loan Mortgage Corporation, or Freddie Mac, was created in 1970 to further expand the secondary mortgage market. Today, Fannie and Freddie back about two-thirds of new mortgage loans.

Reality Vs. Perception

Fannie and Freddie are government-sponsored enterprises. Both agencies were created by Congress, and Fannie once could count on the government coming to its rescue should it get into trouble. That changed in 1968, when Fannie, which was then jointly owned by the U.S. government and private investors, became a privately owned company and spun off the Government National Mortgage Association, or Ginnie Mae, another housing agency.  Fannie-backed securities no longer enjoy government guarantees that they will be repaid. Neither do those backed by Freddie Mac. In contrast, Ginnie Mae securities have the government’s backing.  

No matter that their securities lacked explicit government guarantees, much of the public assumed Fannie and Freddie had an implicit guarantee that the government would bail the agencies out should they stumble. The perception of government backing allowed the agencies to borrow at lower costs than comparable publicly-owned companies, and exempted them from certain regulations.  

Rescue And Recovery

In fact, the government did come to the two agencies’ aid. The large losses logged by Fannie and Freddie following the housing sector downturn and fears that they might go bankrupt eventually led the two to be placed into the conservatorship of the Federal Housing Finance Agency, resulted in dismissal of top management and replacement of their boards of directors, and forced them to issue massively dilutive stock and warrants in the fall of 2008.
But with the help of government aid, the housing sector’s comeback in the last two years, and credit-quality improvement, Fannie and Freddie are now back in the black. To date, the two have paid dividends to the U.S. Treasury amounting to over 75% of the government infusion received, which they technically do not have to pay back.

What’s Ahead?

Despite Fannie and Freddie’s improved circumstances, it’s generally agreed that steps should be taken to limit the risks borne by taxpayers in a housing downturn, and that housing finance should rely more heavily on private capital.  There’s considerable disagreement on the government’s role, however.
In the United States, homeownership is viewed as an important financial goal and is much more widespread than in many other nations. The homebuilding industry also plays a key role in supporting economic growth in the United States.  Recently, President Obama indicated that, while he isn’t for maintaining Fannie and Freddie’s quasi-public status, he would support a system that facilitated middle-class access to long-term, fixed-rate mortgages.  However, some question whether providing even limited government support would result in a quasi-public mortgage finance system similar to the current system, in effect perpetuating the implicit guarantee concept.

On the other hand, the alternative, a fully privatized system, might result in more expensive mortgages, limiting home ownership and negatively affecting the homebuilding industry’s profitability. Moreover, investors might not have as much of an appetite for mortgage securities as in the past in the absence of government participation in housing finance.

Note also that in the past, Fannie and Freddie were required to allocate certain percentages of their mortgages to low- and middle-income borrowers. Should a new housing finance system include similar goals? Some believe pressure to reach those goals caused a weakening of credit standards that contributed to the surge in mortgage defaults following the 2008 housing crisis.

Meanwhile, Congress has been busy. A bill introduced by Senators Mark Warner and Bob Corker, that has both Republican and Democratic supporters, would replace Fannie and Freddie with private companies and limit government guarantees to catastrophic circumstances. Details of how such a system would work still need to be ironed out.  Another bill, introduced in the House of Representatives, would dismantle Fannie and Freddie and sharply reduce government support, but many believe it has little chance of passing. 

These early efforts are only a starting point for further discussion of how to restructure the mortgage finance system. Congress probably will take up the matter in the near future, but the problem may not be resolved this year, and it’s unclear just how much will ultimately change.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.