Fannie Mae, Freddie Mac and You
Fannie Mae and Freddie Mac are the oddballs of American finance. These government-sponsored enterprises (GSEs) were once federal agencies -- then they became private corporations with many privileges (such as exemption from state income taxes) and a virtual monopoly on mortgage lending in the U.S.
What do they do, exactly, and how does it affect your home loan?
Mortgages in the Depression Era
Fannie and Freddie are the products of an earlier and larger mortgage meltdown. During the Great Depression, 50% of borrowers were late or in default on their mortgages (sound familiar?) and banks became dangerously strapped for cash. So President Franklin D. Roosevelt and Congress created the Federal National Mortgage Association (Fannie Mae) in 1938. The agency's mission was to buy mortgages from lenders, providing liquidity that could be used to make more loans.
Fannie Mae's creation allowed lenders to loan money to low- and middle-income buyers who otherwise might not have been considered creditworthy. According to the St. Louis Federal Reserve, mortgage lending before Fannie Mae was very different from the way it is done today. Lenders typically required 50% down payments. Moreover, they usually structured their home loans with short terms -- terms as brief as five years, after which the borrower had to come up with a "balloon payment" for the remaining balance. As a result, homeownership was out of reach for most American households.
Fannie Mae and Freddie Mac's charters specify roles that they should take in promoting homeownership affordability. If your parents own their homes, chances are it's because of Fannie Mae that they were able to finance their purchases.
Freddie Mac: Fannie Mae's Younger Brother
Fannie Mae grew so large over the years that in 1968, with the pressures of the Vietnam War straining the national budget, President Lyndon Johnson took Fannie Mae's debt portfolio off the government's balance sheet. Fannie Mae was converted into a publicly traded company owned by investors. Two years later, the Federal Home Loan Mortgage Corporation (Freddie Mac) was launched, mainly to keep Fannie Mae from functioning as a monopoly. Freddie went public in 1989. Freddie Mac's guidelines and pricing structure are almost identical to Fannie Mae's.
The Conforming Mortgage
Fannie's purchasing power allows it to pretty much dictate underwriting and pricing terms to mortgage lenders: As long as a mortgage is underwritten in accordance with Fannie Mae's guidelines, the lender can sell the loan to Fannie. This is why loans destined for Fannie Mae (and Freddie Mac) are referred to as "conforming" mortgages -- they conform to the guidelines established by these mortgage giants.
If your application package doesn't conform to their guidelines, chances are you'll have to pay considerably more to get mortgage financing.
2008: The Government Takes Back Fannie and Freddie
Fannie Mae and Freddie Mac's influence in the U.S. and world economies is so pervasive -- they get trillions of dollars in investments from mutual funds, pension funds and foreign governments -- that the Federal Reserve and the U.S. Treasury felt they had little choice but to take over and prop up the companies when they got into financial trouble in the wake of the subprime debacle.
The U.S. government's placement of Fannie and Freddie into "conservatorship" caused mortgage rates to drop half a point, as investors were assured that the federal government would stand behind the companies' mortgage-backed securities.
While you may not agree with the government's decision to bail out the mortgage giants, the modern home loan market has been built around them. Without the federal support, mortgage lending would have largely come to a halt. With federal support, these markets for financing and refinancing remained open, and if you refinanced a mortgage or bought a home in the last two years, you probably paid substantially less each month than you would have had the bailout not taken place.
What's Ahead for Fannie and Freddie?
Fannie and Freddie got into trouble largely because they differ from other market makers in one key respect -- the GSEs are supposed to promote affordable housing (a government mandate) while making money for their shareholders (a corporate mandate). It's partly that split mission that pushed the firms deeper into subprime and Alt-A lending, and most of their losses came from those loans. Since they are government-backed they could not simply shut down their operations to protect themselves from losses as so many Wall Street firms did.
The fact that Fannie Mae and Freddie Mac need to be reformed (in some manner) is pretty much the consensus in Washington. But what reforms should be undertaken is still up for debate. You can express your viewpoints to the White House and Congress about reforms -- ones that will hopefully get the mortgage giants off the public books and keep them solvent in the years ahead.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.