Fannie Mae & Freddie Mac Come Back to the Nest

Now that the entities known as Fannie Mae and Freddie Mac have been thrust to the forefront of national media coverage due to their rapid decrease in stock values which has resulted in a multitude of emergency congressional hearings, cabinet sessions, press conferences, and government conservatorship, many Americans have been left confused as to what role these two enterprises have actually played in the mortgage industry.

Both Fannie and Freddie are commonly referred to as “government sponsored enterprises” or “G.S.E.s” and are the largest buyers and insurers of mortgages in the United States. These two entities hold or back a total of $5.3 trillion of mortgage debt, about half the outstanding mortgages in the nation. Fannie and Freddie are considered to be “government sponsored” since they were initially created and funded by the federal government, but they now operate as public corporations with their stock traded on the open market.

Fannie Mae was created as part of the 1938 Federal Housing Act when millions of low and middle income families could not afford to buy or retain homes after the great depression. After the depression depleted the cash reserves of most banks, prospective home buyers were faced with exorbitant mortgage interest rates as lending institutions were wary to part with precious capital. The Federal National Mortgage Association (now Fannie Mae) was created to buy bank mortgages to enable the banks to free up more reserves to generate more loans at affordable interest rates. Fannie then pools the mortgages and sells them to investors, effectively making it the middleman between banks and investors.

In 1968, Fannie Mae was made a shareholder-owned corporation to decrease government involvement and later permit Fannie’s mortgage-backed securities to be sold on the open market. Shortly thereafter, the government established the Federal Home Loan Mortgage Corporation (now Freddie Mac) in 1970 to further expand the secondary market for mortgages and to ensure competition for Fannie Mae. The establishment of Fannie Mae and Freddie Mac has frequently been cited as the cause for the dramatic increase of homeownership in America from 43% in 1940 to over 70% today.

Despite the fact that most of the mortgages now owned or insured by Fannie Mae and Freddie Mac are traditionally safe prime mortgages, these two public entities lost a combined $5.1 billion in 2007 and $2.4 billion in the first quarter of 2008 amid struggling housing and financial industries. This rapid depletion of reserves comes at a time when it has become increasingly difficult to sell mortgage-backed securities to investors in order to replenish Fannie and Freddie’s financial reserve cushion, thereby contributing to their stock values losing over 95% of their value in 2008.

The federal government was forced to urgently re-acclimated itself with these two institutions in 2008 as the Federal Reserve first acted to allow them to borrow at the same rate given to commercial banks and large Wall Street firms by “opening the discount window” to them. The Securities and Exchange Commission then restricted investors from selling Freddie and Fannie’s stock “short” – when investors profit after a stock decreases in value. Finally, the government was forced to take the ultimate step by placing these entities in conservatorship and infusing billions of dollars into their coffers in order to prevent their impending failure. Whether more government involvement is required to adequately ensure Fannie Mae and Freddie Mac’s survival remains to be seen. Nonetheless, as was the case with private banks in the post-depression era, if Fannie Mae and Freddie Mac were to cease to exist, significantly higher mortgage interest rates would be sure to follow.

Brian S. Icenhower, Esq., BS, JD, CRB, CRS, ABR, a California Association of Realtors Director, practicing real estate attorney, a real estate expert witness and litigation consultant, a prosecution consultant of Tulare County District Attorney Real Estate Fraud. He may be contacted at bicenhower@icenhowerrealestate.com, or www.icenhowerrealestate.com.