March 10, 2003
"What are Fannie Mae and Freddie Mac,
and what do they do?"
Fannie Mae and Freddie Mac are
"government-sponsored enterprises" (GSEs). This means that they are
privately owned, but receive support from the Federal Government, and assume
some public responsibilities.
The GSEs provide a secondary market in home
mortgages, purchasing mortgages from the lenders who originate them. They hold
some of these mortgages, and some are "securitized" -- sold in the
form of securities which the GSEs guarantee.
The two GSEs today are among the largest
corporations in the world.
What mortgages do the GSEs purchase?
"Conforming mortgages" as they are
called consists of all home mortgages that meet the underwriting requirements of
the agencies, and are no larger than the largest loan the GSEs are allowed by
law to purchase. In 2003 the maximum was $322,700. It is raised every year in
line with increases in home prices. The mortgages the GSEs can purchase account
for roughly 80% of the conventional (non-FHA/VA) home loan market.
What kind of support do the GSEs receive from
The major support consists of the credit
lines with the US Treasury. This, along with their histories -- both were public
institutions before they became privately owned -- mark them as having a special
claim for Government assistance in the event they ever get into financial
trouble. As a result, investors consider the notes they issue and the mortgage
securities they guarantee almost as good as securities issued by the Federal
Do the GSEs have competitors?
Not in the conforming loan market. Because of
their Government backing, the GSEs can sell notes and securities at a lower
yield than any strictly private secondary market firm. This gives them a
monopoly -- or rather a duopoly, since there are two of them -- in the market in
which they operate.
The GSEs do have emulators, however, in the
non-conforming market. While the cast of players changes, at any one time there
are usually 15 or more strictly private firms that purchase non-conforming loans
and securitize them in much the same way as the GSEs.
"Why do two private firms receive
Government support, while the others don�t?"
The Government did not select the two firms
for special treatment. Both the GSEs began as Government entities, and the major
objective in privatizing them (while retaining Government support) was to
encourage development of a private secondary market. The other firms arose
later, based on the GSE model, so that objective was achieved.
If the objective was achieved, why do the
GSEs continue to receive special support?
The GSEs are unwilling to give it up, and
they have become so powerful politically that they have managed to thwart the
several attempts that have been made to take it away.
Do I have anything at stake in this issue?
If you are a potential borrower eligible for
a conforming loan, your interest rate will probably be about 1/4% lower than it
would be absent the GSEs. This reflects their relatively low funding costs, part
of which is passed through to borrowers.
In addition, if you are a low or
low-to-moderate income borrower, and/or reside in an underserved area, you might
find a loan through a GSE. As part of their public responsibility, the GSEs
commit to purchase specified numbers of such loans. How many would not be made
without the GSEs, however, is not clear.
As a taxpayer, on the other hand, you have a
cause for concern. The low borrowing costs of the GSEs is based on implicit
Government backing for their $3+ trillion of debt and guarantees. If the GSEs
ever have a financial disaster, the Government will have to bail them out and
you and I will be on the hook for the cost.
"Is anybody regulating the GSEs to
prevent such a disaster?"
A few years ago Congress gave that
responsibility to the Department of Housing and Urban Development (HUD). Very
few informed observers believe that HUD is up to the task.
"Is there a way to eliminate the risk of
a financial disaster by removing Government support without hurting investors
who rely on that support?"
It could be done by 1) revoking the credit
line the GSEs now have with the Treasury, and b) providing an explicit Federal
guarantee of all debt and GSE guarantees outstanding on the date the credit line
is revoked. An explicit guarantee on the old claims would prevent any
repercussions in the financial markets, yet put the markets on notice that news
ones are not guaranteed. Over time, the volume of guaranteed claims would
Copyright Jack Guttentag 2003