Fannie Mae & Freddie Mac: Who Are They, Why Do They Exist & How Exactly Do They Work?
Back in college I was a science major… Political Science to be exact. 😉
As if my education wasn’t irrelevant enough, I also pursued a minor in Digital Arts. So while my peers learned how to be accountants, engineers, lawyers, and doctors, I took courses called “The Politics of Sexuality” and “Color Theory.” Needless to say, the skills that I attained during four years of undergrad have rarely transferred over to my adult life as a pilot or as a real estate investor.
But not for long. So let’s talk politics!
Blog Caveat: Plenty of articles have been written on the topic of the sub-prime mortgage crisis, so I plan to kind of gloss over that aspect of their respective histories. My goal is merely to clarify exactly what these two organizations are for the unfamiliar investor, not to debate their pros and cons.
Who Are These Fannie & Freddie Characters?
If you have ever purchased a house (or were alive back in 2008), chances are you’ve heard of Fannie Mae and Freddie Mac. You know that they are somehow involved in the lending industry and are some kind of nebulous business/government thingy.
If that’s the case, you’re on the right track!
Technically speaking, Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are Government-Sponsored Enterprises (GSEs). As you can see, both names are semi-acronyms based on their original government moniker. Put simply, GSEs are financial service corporations created by Congress in order to enhance the flow of credit to different parts of the economy and to reduce the risk to investors.
In fact, there have been eight GSEs created since 1916, of which seven are still active. These GSEs were adopted within the following sectors.
- The Federal Home Loan Banks (FHLBanks) (1932)
- Federal National Mortgage Association (Fannie Mae) (1938)
- Federal Home Loan Mortgage Corporation (Freddie Mac) (1970)
- Financing Corporation (FICO) (1987)
- National Veteran Business Development Corporation (NVBDC) (1999)
- SLM Corporation (Sallie Mae) (1972-1995)
- Federal Farm Credit Banks (FCBanks) (1916)
- Federal Agricultural Mortgage Corporation (Farmer Mac) (1987)
A Brief History
Prior to the 1930s, housing finance was exclusively a product of the private sector. Commercial banks, thrifts, and life insurance companies provided much of the mortgage funding throughout the country (think the Bailey Bros Building & Loan Association from It’s a Wonderful Life). Terms were strictly regional and differed drastically across the country due to the fact that there was no nationwide housing financial market.
When the Great Depression hit the country in 1930, it took a toll not only on the economy but also on the housing market. Approximately one fourth of all homeowners defaulted on their mortgages, and the Federal Government decided to step in.
In 1938, Fannie Mae (FNMA) was created as part of an amendment to the National Housing Act. At its inception, Fannie Mae was considered a federal government agency. Her role was as a secondary mortgage market that could purchase, hold, or sell loans that were insured by the Federal Housing Administration. The Charter Act of 1954 then transformed Fannie Mae from a federal government agency to a private/public (i.e. mixed ownership) corporation. Changes occurred again in 1968, when the Housing and Urban Development Act turned Fannie Mae into a for-profit, shareholder-owned company.
In 1970, Freddie Mac (FHLMC) was created when Congress passed the Emergency Home Finance Act. The goal of Freddie was to expand the secondary mortgage market and reduce interest rate risk for banks. A reorganization occurred in 1989, when just like Fannie, Freddie was turned into a shareholder-owned company through the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA).
Ok. Cool. So, How Do They Work?
Contrary to popular belief, mortgage lenders don’t make the bulk of their money on interest. Banks don’t want to wait around 30 years to get their money back. They wan’t that money now—and that’s where Fannie and Freddie come in.
Nearly 80% of residential mortgages in America are backed by Fannie Mae and Freddie Mac. These two GSEs purchase loans from mortgage lenders that conform to their criteria. After purchasing a number of these identical mortgages, they combine them together and sell them as Mortgage-Backed Securities (MBS). This frees up the capital of the mortgage lender so that they can loan that same money again. Lather, rinse, repeat.
As of September 6th, 2008, Fannie Mae and Freddie Mac were placed into a “conservatorship” under the purview of the Federal Housing Financial Agency (FHFA). This decision was made in the wake of the sub-prime mortgage crisis in order to restore the two organizations to a sound financial situation.
While Fannie Mae and Freddie Mac are “technically” still private corporations, the FHFA currently has powers of board, management, and shareholders.
The FHFA defines their role as “conservator” in the following way according to their website.
“While FHFA has very broad authority, the focus of the conservatorships is not to manage every aspect of Fannie Mae’s and Freddie Mac’s operations. Instead, under conservatorship, we are responsible for the overall management of Fannie Mae and Freddie Mac and have delegated many operational and other duties to their management and boards. However, they must consult with, and obtain approval from us, as conservator, on critical matters.”
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In summation, to describe Fannie Mae and Freddie Mac as a “nebulous business/government thingy” is actually a pretty spot on assessment.
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