The market for mortgages in the United States is highly liquid and very stable, thanks to Fannie Mae and Freddie Mac. If you want a home mortgage loan and you can afford it, usually you’ll have no trouble finding one.
Commonly referred to as Fannie and Freddie, these two companies were chartered by Congress to support the U.S home finance system. Fannie Mae and Freddie Mac do this by purchasing mortgages from lenders, packaging them into securities, and selling the securities to investors.
How Fannie Mae and Freddie Mac Help You Get a Mortgage
Fannie Mae and Freddie Mac exist to support the U.S. home mortgage system. But they don’t lend money to individuals. Instead, they buy mortgage loans from the banks and financial institutions that originate them. This keeps money flowing back into lending institutions so they have plenty of funding on hand to write more mortgages and help more people buy homes.
Fannie Mae was chartered by Congress in 1938 during the Great Depression. The crisis had wreaked havoc on the housing market, and leaders wanted to increase funding for home buying and make homeownership more affordable and accessible. Fannie Mae changed the way mortgage lending worked, making it possible for lenders to extend long-term mortgage loans with smaller down payments, and it greatly expanded the mortgage credit market.
Fannie Mae remained a government owned entity for the first three decades of its existence, with a near monopoly over the secondary mortgage market. Fannie Mae was privatized in 1968, and Freddie Mac was created in 1970 as a competitor to dilute its monopolization of the market.
Fannie Mae and Freddie Mac Are Government Sponsored Enterprises
Fannie and Freddie are private corporations that were chartered by Congress—the formal term for this kind of company is a Government Sponsored Enterprise (GSE). There are several other GSEs, like the Farm Credit System. While GSEs are publicly traded companies, they all serve a very public mission of supporting the nation’s financial system. Because of the large role they play in the economy and their governmental affiliation, some investors assume they are implicitly guaranteed by the federal government. This means they believe the government would bail out Fannie and Freddie if they couldn’t pay back their debts.
Even though Freddie Mac and Fannie Mae are technically shareholder-owned, they have been under government conservatorship since the Great Recession. Many investors who hold stock in the two companies are eagerly waiting for them to emerge from government control so their stock can trade on public exchanges again.
What Is Fannie Mae?
Fannie Mae is formally known as the Federal National Mortgage Association (FNMA). In the beginning, FNMA was designed to maintain liquidity for government-backed loans from the Federal Housing Administration and the Veterans Administration.
Over time Congress expanded Fannie Mae’s ability to participate in the mortgage market. In 1954 the company was converted to a mixed-ownership corporation—making it both publicly and privately owned. However, by 1968, Congress decided to allow FNMA to become entirely private, and in 1970 it allowed the company to begin buying conventional mortgages.
Later, during the 1980s, Fannie Mae began issuing mortgage-backed securities. These investments bundle mortgages into a security format that makes it easier for investors to buy. With investors involved, FNMA gained more liquidity and was able to buy more government-backed and conventional mortgages.
What Is Freddie Mac?
Freddie Mac’s official name is the Federal Home Loan Mortgage Corporation (FMCC). In 1989, Congress reorganized FMCC to be a publicly owned company.
One of the biggest ways Freddie Mac makes a difference in the mortgage market is by buying loans from smaller banks. The idea is that by getting home loans off the balance sheets of community banks, these types of institutions are able to offer affordable mortgages to a wider variety of consumers.
Regulatory Oversight of Fannie Mae and Freddie Mac
Because they are government sponsored enterprises, and because they were created by Congressional charter, Fannie Mae and Freddie Mac have a high level of special oversight from the government.
Fannie and Freddie are regulated by the Federal Housing Finance Agency (FHFA), which currently holds the conservatorship for both companies. Some things to keep in mind about these two companies include:
- The Treasury buys securities from Fannie Mae and Freddie Mac.
- Fannie and Freddie don’t have to pay state and local taxes.
- Some of the board members are appointed by the president.
For now, the federal government has complete oversight of FNMA and FMCC due to the conservatorship arrangement. However, all parties involved, including the FHFA, have retained advisers to help them get back on track for non-governmental ownership.
The Role of Fannie Mae and Freddie Mac in the 2008 Financial Crisis
Fannie Mae and Freddie Mac played a starring role in the financial crisis of 2008, thanks to their “implicit guarantee.” Remember that both companies were chartered by Congress and filled federally mandated roles to maintain the stability and functioning of the mortgage market. But they were also public companies, whose bonds and shares were widely held by investors.
Given their importance, most investors in Fannie and Freddie assumed that they were too big to fail. If the companies ever ran into trouble, they assumed the government would bail Freddie and Fannie out. This wasn’t something stated explicitly in any laws or regulations. Nevertheless, this made FNMA and FMCC seem to be less risky investments than many other similar companies.
This especially gave Freddie and Fannie favorable treatment in the bond market. The implicit guarantee made their bonds less risky bets than bonds from other financial companies, helping them borrow money more cheaply. Even the highest-rated debt of top financial companies couldn’t compete. Fannie and Freddie borrowed trillions of dollars, meaning that their bonds were very widely held—further ensuring they became too big to fail.
Fannie Mae and Freddie Mac Help Inflate the Housing Bubble
Fannie Mae and Freddie Mac pumped more and more money into the U.S. home finance system in the years leading up to the financial crisis, buying an outsized number of mortgages on the secondary market. This helped support the bubble in home prices that emerged in 2005 through 2007.
Together with lax oversight and financial engineering at big investment banks, unsustainable mortgages took off, with many people getting mortgage loans who might not have qualified for home loan financing in more normal times. Both homebuyers and the financial system as a whole became overleveraged and unbalanced, driven by financing from Freddie Mac and Fannie Mae.
The unwinding of the housing bubble in 2007 and the financial crisis that followed in 2008 hit Fannie and Freddie hard. To avoid a complete collapse, the FHFA seized the companies and put them into conservatorship on September 6, 2008—just days before Lehman Brothers filed for bankruptcy and sent the financial markets into a tailspin.
When Will Shares of Fannie Mae and Freddie Mac Trade Again?
Today, shares of Fannie Mae and Freddie Mac are traded over the counter (OTC), meaning you can’t buy them on a major stock exchange. The shares of FNMA and FMCC are both valued at less than $1 a share as of September 2021.
Investors who still hold the shares are anxious for the companies to leave conservatorship, which would let them trade on a stock exchange again and rise in value.
In 2014, FHFA published a strategic plan for releasing Fannie and Freddie from conservatorship. The plan has three big goals:
- Prevent foreclosures and keep mortgage credit flowing in a safe and sound manner to keep housing finance markets resilient, liquid, and efficient.
- Reduce taxpayer risk by encouraging more private capital in the mortgage market. This goal would decrease the role that Freddie and Fannie play in mortgages.
- Build a new infrastructure for securitizing single-family residential mortgages.
- The idea is to create a system that keeps mortgages affordable and accessible, but without the implicit guarantee that contributed to the financial crisis of 2008.
The FHFA has developed a scorecard that is released each year to measure progress towards these goals. However, Congress must also decide that Fannie and Freddie can be moved out of conservatorship.