Understanding Freddie Mac & Fannie Mae

If you thought that the financial industry was all about throwing around big words and catchy acronyms, here’s your chance to do it as well, that too without necessarily being a business major. But more importantly, the government takeover of Freddie Mac and Fannie Mae has been described as one of the most sweeping government interventions in private financial markets.

Things have come full circle in a way for Fannie Mae, which was founded as part of FDR’s plan in the wake of a crashing housing market during the Great Depression. To understand the scale of what level of water these two were treading, it may be useful to know that their combined debt is almost in line with the public debt of the entire nation ($5.4 trillion).

They were both classified under the category of Government sponsored enterprises (GSE). They were privately owned but publicly chartered. Freddie Mac stock prices hit a low of 0.25 on September 17, compared to a value of over 71 as recently as November last year. This indicated a drop in value of over 99% during this period.

FAQs you should know answers to:

Who? Federal Home Loan Mortgage Corporation (Freddie Mac)

What? According to the charter stated in its own website, the purpose of the institution is to provide liquidity, stability and affordability to the housing market.

How? As one of the major players in the secondary mortgage market, it buys mortgages after the deal has been ‘closed’ in the primary market, package them into

securities, and sell them back to investors on Wall Street. These are bundled into

what are called Mortgage backed securities (MBS).

James Lockhart, President of the Federal Housing Finance Agency (FHFA), along with Treasury Secretary Henry Paulson, announced at a press conference on September 7th that the two institutions would be put under the conservatorship of the FHFA. By law, a conservatorship is the legal transfer or shift in control of an entity to another person or entity. Lockhart attributed the reasons for this change in authority to flawed models in GSE and to correction in the housing markets. Is this is a signal for increased regulation in the 12 Federal Home Loan Bank in the coming days? Does the government’s move heighten the risks the economy is under? Or are there enough reasons to feel a lot safer now?

Even though the word ‘nationalization’ is rarely used in the U.S. context, it may become an increasingly used term in the coming days, with more and more corporations and financial firms coming under the radar. There have been several debates in the academic and the online community discussing if there are actually any differences between the two concepts or if there is simply a matter of terminology. Of course, Americans as a group will never agree to be following a socialist concept, so this is mostly talked about as an ‘alternative’ or a necessary emergency solution.

FAQs you should know answers to:

Who? Federal National Mortgage Association (Fannie Mae)

What? The government created this to expand the flow of mortgage funds in all communities, at all times, under all economic conditions, and to help lower the costs to buy a home. It served as a government agency since it was founded in 1938 until 1968, when it became a shareholder-owned company.

How? Fannie Mae does not make home loans — it helps mortgage lenders serve homebuyers. Apart from MBS, they also participate in mortgage investments and other housing investments. They also borrow money at low interest rates from foreign investors at low rates because of the support they get from the U.S. government.

Needless to say, it is the taxpayers’ money that is used for all of the decisions mentioned above. The focus of the government thus far has been ad-hoc and uncoordinated. This is certainly a testing time for both Wall Street as well as Main Street. Time will tell if they can come together in time to prevent the continued sustained economic downturn which is starting to affect more than just the housing markets now.



1 http://www.ofheo.gov/newsroom.aspx?ID=456&q1=0&q2=0 – Office of Federal Housing Enterprise oversight, Statement by FHFA director James B. Lockhart

Abhay Agarwal

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