Understanding the GSEs Fannie Mae and Freddie Mac

Fannie Mae and Freddie Mac are two of the world’s largest corporations, operating in the rapidly expanding mortgage industry of the US. Lovely names for Federal National Mortgage Association and Federal Home Loan Mortgage Corporation. These are two names that people working in the lending institutions keep hearing on a day-to-day basis.

However, not all lenders have a clear understanding of what role these two companies play in the market, how they work, and why they were set up. This blog post is thus aimed towards throwing light upon a variety of aspects related to Fannie Mae and Freddie Mac, explaining all that you need to know about them.

Fannie Mae and Freddie Mac–the GSEs

GSE, an abbreviation for Government-Sponsored Enterprise refers to an organization that is owned privately but is supported by the Federal Government. The two GSEs—Fannie Mae and Freddie Mac—have made a secondary market for mortgages available to the Americans. As part of their responsibilities they buy mortgages from lending institutions, holding some of them while securitizing the rest. They aim to enlarge the availability of money for mortgage lending and home buying.

Delving into the history of the organizations

Continuous attempts had been made after the Great Depression of 1930s to revive the real-estate industry in the US. In order to support and sustain these efforts, Fannie Mae was established in 1938 as part of the New Deal. Later in the year 1968, Fannie Mae split into two parts–one of them was a private corporation, and the other a public institution. This publicly financed organization came to be known as Ginnie Mae (Government National Mortgage Association) that gave explicit guarantees regarding its mortgages. This was quite contrary to the way Fannie Mae worked because these loans were guaranteed by the government.

In 1970, Freddie Mac was brought into the market by the Congress to compete with Fannie Mae, thus enhancing the supply of mortgage loans.

Types of mortgages purchased by the organizations

GSEs that include Fannie Mae and Freddie Mac are permitted to purchase conforming mortgage loans from lenders. These loans have to fulfill certain size limits that are created with respect to the average cost of the home.

What support does the government give?

As already mentioned, Fannie Mae, Freddie Mac started working as Government entities, only to be privatized later while keeping the government support. This was done to push the growth of a private secondary market for mortgage loans.

These two GSEs are supported via the credit lines of the US Treasury. Thus the mortgage securities guaranteed by them are deemed to be at par with that issued by the Federal Government. Fannie Mae and Freddie Mac are always supported in case they fall into any financial trouble.

Though these two corporations have fulfilled the purpose for which they had been receiving the Federal support, they are not willing to give it up. Many attempts have been made to take away the support but, over the years, the enterprises have become so powerful that they can now easily overcome such efforts.

Elimination of financial risk in the event of withdrawal of government

A vital question whose answer every investor seeks to find is if the government support can be removed from Fannie Mae and Freddie Mac without hurting the lending institutions and avoiding a financial disaster.

The answer is that this can be done, but only in the following way – by repealing GSE’s credit line with the US Treasury, and then giving straightforward Federal guarantees for all outstanding GSE guarantees and debts, as accounted on the date of repeal. Such explicit Federal guarantees would help in averting all kinds of repercussions, besides notifying the markets that the new loans are not guaranteed. Thus, after a particular period of time, there will be a gradual fall in the volume of guaranteed loans.