The U.S. mortgage market depends on Fannie Mae and Freddie Mac, two government-sponsored entities (GSEs) founded in 1938 and 1970, respectively. Together, they play a crucial role in ensuring the availability of funding for mortgage loans. In this comprehensive article, we will examine how these giants work and what sets them apart, while demonstrating the significance of their influence on the housing market and the economy.
Charting Their History: Fannie Mae and Freddie Mac’s Origins
In the midst of the Great Depression, it became apparent that the U.S. needed a dependable mortgage market. Thus, the government stepped in:
The Birth of Fannie Mae
- Established as part of Franklin D. Roosevelt’s New Deal in 1938
- Objective: Create a secondary market for mortgages
- Initially a government agency, it turned into a private, profit-seeking corporation in 1968
The Arrival of Freddie Mac
- Created in 1970 to reduce Fannie Mae’s growing market dominance
- Shares a similar mission: Maintain a thriving secondary mortgage market
- Coincided with the establishment of the Federal Home Loan Mortgage Corporation
Understanding the Machines: How Fannie Mae and Freddie Mac Work
These GSEs primarily purchase mortgages from banks and financial institutions, bundle them into mortgage-backed securities (MBS), and sell them to investors. This process ensures a flow of credit for homebuyers while reducing the risk for mortgage lenders.
Mortgage Market Mechanics
- Primary Market: Lenders, like banks and credit unions, provide mortgage loans to homebuyers.
- Secondary Market: GSEs purchase mortgages, bundling them into MBS and selling them off.
- Investors: Bondholders receive periodic interest payments from the underlying mortgages.
| Key Differences | Fannie Mae | Freddie Mac |
|---|---|---|
| Affiliation | Federal National Mortgage Association | Federal Home Loan Mortgage Corporation |
| Mortgage Types Supported | Conventional, FHA-insured, VA-guaranteed | Conventional |
| Market Share | About 44% in Q2 2021 | About 18% in Q2 2021 |
The Conforming Loan Standards
In order to streamline mortgage processing, the GSEs impose requirements on the loans they can purchase:
- Loan limit: The maximum for single-family mortgages is $548,250 in 2021 ($822,375 in high-cost areas).
- Loan-to-value (LTV) ratio: Usually, the LTV ratio should not exceed 80%.
- Debt-to-income (DTI) ratio: Borrowers’ DTI ratio should typically be below 50%.
- Credit score: A minimum credit score of 620 is generally necessary.
The Dominoes Fall: The Impact of Fannie Mae and Freddie Mac’s Collapse
In 2008, the subprime mortgage crisis brought the U.S. housing market to its knees. Enforced lax underwriting standards and increased securitization by the GSEs contributed to the crisis. To prevent a market collapse, they were placed under government conservatorship:
| Timeline | Event |
|---|---|
| Aug 22, 2008 | Reports emerge of likely government bailout |
| Sep 7, 2008 | Fannie Mae and Freddie Mac placed in conservatorship |
| Sep 2009 – Sep 2010 | The U.S. government injects $187.5 billion to keep the GSEs afloat |
| Jan 2010-Jan 2012 | Government control reaches 79.9% of the GSEs |
What Lies Ahead: Fannie Mae and Freddie Mac’s Future
As Fannie Mae and Freddie Mac continue to operate under conservatorship, solutions to exit it and preserve a stable mortgage market are debated:
Options for GSEs
- Government Ownership: Continuing conservatorship or even turning them into government agencies
- Privatization: Returning GSEs to private shareholders with enhanced regulation
- Reform: Introduce competitive GSEs into the market, reducing the dominance of the existing duopoly
Drawing Conclusions: The Significance of Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac’s essential roles in maintaining the U.S. mortgage market cannot be understated. Through their facilitation of the secondary mortgage market, these GSEs stimulate housing demand, reduce interest rates, and safeguard a continuous flow of capital to lenders. Their missteps leading up to the 2008 financial crisis and their persistent conservatorship highlight the need for prudent regulation and oversight. As the government and policymakers continue to grapple with their future roles, the importance of striking a balance between market stability and responsible
