A lot as been made of the role mortgage giants Fannie Mae (Stock quote: FNM) and Freddie Mac (Stock quote: FRE) have played in the current economic crisis, but many Americans have little understanding about what these two entities are and how they affect the housing market. Understanding the purpose and function of Fannie and Freddie is essential to understanding what has happened in the mortgage market.
Fannie Mae, the common name for the Federal National Mortgage Association (FNMA), and Freddie Mac, the common name for the Federal Home Loan Mortgage Corporation (FHLMC), are both congressionally authorized government-sponsored enterprises (GSEs). They are hybrids in that they are privately owned by shareholders but enjoy government backing. The U.S. Department of Housing and Urban Development (HUD) is charged with regulating both Fannie and Freddie.
The mission of Fannie and Freddie is virtually the same -- "to provide liquidity and stability to the U.S. housing and mortgage markets," according to the Fannie Mae web site, and "to provide liquidity, stability and affordability to the housing market," according to the Freddie Mac web site. They both pursue this mission buy purchasing residential mortgages that conform to certain standards from lenders. They then either hold these mortgages or use them to issue mortgage-backed securities to be traded in the capital markets. Currently, Fannie and Freddie hold or guarantee about 50% of the nation’s outstanding home mortgages.
The major difference between these two enterprises is in how and when they were created. Fannie Mae was created in 1938 during the Great Depression. Originally it was a government agency charged with making mortgages more affordable for low-income families to help improve the economy. It was made private in 1968 at which time it stopped guaranteeing government-issued mortgages. In 1970, Congress created Freddie Mac to help improve the secondary mortgage market by adding competition. Freddie has always been a privately owned company, but it still enjoys the same government backing as Fannie Mae.
Fannie and Freddie do not operate directly with consumers. Their role is to work only with lenders in the secondary market. Consequently, most homeowners do not know if Fannie or Freddie owns their home loan. A large percentage of conforming mortgages are owned by Fannie or Freddie, however.
The major problems with Fannie and Freddie started as a result of falling home prices and rising mortgage defaults. Because lenders could depend on Fannie and Freddie purchasing their mortgages, lending standards were severely relaxed. Consequently, many borrowers who could not conservatively afford mortgages received them anyway often using subprime and exotic loans. When these borrowers began to default on their mortgages, the housing market began a downward spiral. Because all of Fannie and Freddie’s assets are tied to mortgages, these two firms suffered major losses.
In September 2008, the government initiated a rescue plan to deal with Fannie and Freddie and prevent these two firms from failing. Both firms were placed into the conservatorship of the Federal Housing Finance Agency (FHFA). U.S Treasury promised capital support of up to $100 billion for each firm in exchange for $1 billion of senior preferred stock with a 10% coupon.
Recently, the administration announced the Making Homes Affordable program targeted at preventing foreclosure. This program is available for Fannie and Freddie mortgages and offers a refinancing opportunity for homeowners who owe more than 80% of their home’s current value. By refinancing at lower interest rates, monthly payments will decrease. Homeowner’s can check with their mortgage servicers or with Fannie or Freddie directly to see if they are eligible.