|
 |
Home >> Keeping Your Money Safe
What are Fannie Mae and Freddie Mac?
I have heard the names 'Fannie Mae' and 'Freddie Mac' in association with the US mortgage market crisis and Federal Government bailouts in the financial sector. What are Fannie Mae and Freddie Mac? |
|
 Fannie Mae is the popular moniker of the Federal National Mortgage Association (FNMA) and Freddie Mac is the popular name of the Federal Home Loan Mortgage Corporation. Fannie Mae and Freddie Mac were created in the 1930s as government agencies but are run as private corporations. Both Fannie Mae and Freddie Mac play a very important role in the United States mortgage market. Fannie and Freddie are responsible for about 80% of the $12 trillion US mortgage market. Fannie and Freddie are now controlled by the US government as a result of the difficulties in the US financial sector.
Fannie Mae and Freddie Mac are in the business of buying mortgages. Fannie Mae and Freddie Mac purchase mortgages from a bank and then either 'repackage' the mortgage into mortgage-backed securities (such as bonds) or just hold the particular mortgages. The practice of buying mortgages from banks gives the selling banks money to make new loans and frees the bank from preoccupation with the risks associated with the mortgages. The bank gets needed liquidity and Fannie or Freddie takes on the risk of the mortgage. Normally, a bank would have to lend money at a fixed rate of interest out of the funds the bank has on deposit. However, the bank then has to pay a variable interest rate to new depositors to attract their money. A bank could be in deep trouble if the rates the bank has to pay are greater than the rates the bank collects from lending (depending on what interest rates are in the overall economy). The bank may also face a problem if rates are low and the demand for loans is greater than the deposits available. Fannie Mae and Freddie Mac act as an insurer against the problem by buying the mortgages and issuing bonds for sale in the open market. The bank gets needed funds for lending and the borrower can get the money. Fannie and Freddie in effect 'guarantee' the payment of the mortgage to the bank.
The system goes on very much behind the scenes: individuals whose mortgages are sold have no idea that their mortgage is now owned by Fannie Mae or Freddie Mac, because the mortgage holder still makes payments to the same bank. The bank now passes the payment on to Fannie or Freddie who in turn pay the holders of the new 'mortgage-backed' bonds that Fannie or Freddie issue. Fannie and Freddie act to guarantee that the holders of the bonds get paid if one (or more) of the mortgage holders fails to make a payment or defaults altogether on the mortgage. Fannie and Freddie cover any losses on the loan if a borrower does not pay in full. Fannie and Freddie also buy loans outright using borrowed money, the object being to make more money on the loans than Fannie or Freddie have to pay for the borrowed money a strategy that does not always work.
In exchange for the assumption of the risk Fannie and Freddie get paid 'guarantee fees'. Fannie and Freddie also make money on the difference between the rate paid for the retained mortgages and the interest rate paid on the same mortgages (from the mortgage holders). Think of the whole operation like building a house. The bank is the general contractor, and Fannie and Freddie are subcontractors, who do part of the work so the general contractor (the bank) doesn't have to do it. Fannie and Freddie in turn subcontract out to other 'subcontractors' (bond investors) who then do some of the work so the other subcontractor doesn't have to. The house still gets built, but no one entity has to take on the responsibility of doing everything. Of course, the project only works if all of the subcontractors perform as expected, and as in real construction situations, that does not always happen.
The popular myth about Fannie and Freddie is that while both are referred to as Government Sponsored Entities (GSEs) neither Fannie or Freddie receive ANY actual government assistance for the mortgages either Fannie or Freddie directly assumes or sells as bond securities. The US Federal Government does not in any way guarantee the lending or securities; the prevailing mentality in the US capital markets is (or rather was) that Fannie and Freddie were 'too big to fail' and the government would never allow either Fannie or Freddie to go out of business. However, the US government (specifically the Federal Housing Finance Agency) has now had to take an outright ownership stake in Fannie and Freddie because of the problems in the housing market and the increased number of defaults on the mortgages that Fannie and Freddie have purchased or that make up the 'underlying' for the bonds Fannie and Freddie have issued to investors. Fannie and Freddie were in a position to go bankrupt before the government invested funds into both corporations, and prevented the collapse of two major facilitators of the US mortgage lending market.
The coming months will tell what will be the fate of Fannie and Freddie but for now the US government has taken effective control of the two powerful corporations and it is likely that the very useful function in the capital markets that Fannie and Freddie once provided will now be carried out by Federal authorities It remains to be seen how the new situation in the capital markets will develop.
Published on BankingQuestions.com 10/22/08
|
| |
|
Accounts
Article
Q&A
Podcast
Video
Blog
Discussions
PDF
Powerpoint
