Fannie & Freddie: Uncle Sam to the Rescue
By Stephen Smith
August 5th, 2008
Fannie Mae was created during the Depression to make sure that sufficient funds were available to mortgage lenders, and then re-chartered by Congress in 1968 as a publicly traded company. Freddie Mac was created by Congress in 1970 and acts similarly to Fannie Mae. Fannie and Freddie work like this: they take mortgage loans from banks and repackage them in the form of mortgage-backed securities, these mortgage-backed securities are then sold to investors. There are limits on the type and size of the loans but they are guaranteed to be paid back to the investors from Fannie and Freddie if there is a default. Fannie and Freddie also borrow money from the debt markets at traditionally lower rates because of the implied guarantee from the United States government and use those funds to buy mortgages that it then holds as its own investments, which injects new money into the housing market.
Fannie Mae and Freddie Mac own or guarantee about half of the nation’s $12 trillion mortgage market. The delinquency rate on their mortgage portfolios is rising due to the housing and credit crisis; therefore, investors are concerned about the health of these government-sponsored enterprises (GSE). In response to the growing concerns about the capital adequacy and long term viability of the GSEs, Treasury Secretary Henry Paulson proposed legislation containing three key points:
• Raising the credit line from the U.S. Treasury to the GSEs from the current $2.25 billion;
• Authorizing the Treasury to purchase equity in Fannie Mae and Freddie Mac; and
• Providing the Federal Reserve with a consultative role in setting capital standards and
other prudent requirements.
The bill passed by the House contained all of the key elements requested by the Treasury, but added a few key conditions:
• A Federal Housing Finance Agency will be created to oversee the GSEs and the Federal
Home Loan Bank System. This new regulatory body will have expanded authority over the operations and capital standards of the GSEs similar to that of the bank regulators.
• The Treasury’s authority to buy the debt and stock of the GSEs will be temporary and expire
in 18 months unless extended by Congress.
• The Treasury must make an emergency determination that action is necessary to stabilize
markets.
• The conforming loan limit will be raised in high cost areas to 115% of the local median home
price but not to exceed a maximum of $625,000, effective January 1, 2009.
• The total amount of credit provided to the GSEs will be constrained by the federal debt limit,
which will be raised to $10.6 trillion.
The bill is now in the hands of the U.S. Senate and is expected to be passed and signed into law by the President. The linkage of the GSEs to the federal government will be stronger and send a positive message to the capital markets that the U.S. government will support Fannie Mae and Freddie Mac which will help to stabilize the troubled housing market.
