The Case Of Freddie Mac, Fannie Mae and Ginnie Mae

The role that the government played in causing the subprime mortgage crisis is highly debatable. However, the same cannot be said regarding the role performed by the so called government sponsored entities.

The Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae) and Government National Mortgage Association (Ginnie Mae) are three such entities. The newspapers, media and even the general population were of the opinion that these corporations have caused mayhem in the mortgage markets. In the aftermath of the subprime mortgage crisis, these agencies required the highest bailout financed by taxpayers dollars.

These agencies were created many years before the crisis. The reason behind their foundation was to make home ownership more affordable in the United States. These agencies were formed to create a secondary mortgage market meant to provide liquidity to the originators of residential mortgages. These agencies were empowered as and when the political motives behind Community Reinvestment Act became strong. In this article and the next we will study in detail, the workings and shortcomings of these agencies.

Government Sponsored Entities

Freddie Mac, Fannie Man and Ginnie Mae were all government sponsored entities. The average person may not even know the meaning of these words. A government sponsored entity is a weird combination between a government entity and a corporate entity. Hence it is often known as a quasi-government entity.

This means that these agencies were created because a special legislation was passed by the US Congress for each of their creation. Therefore, they got a charter from the government. However, they are also publicly listed corporations which trade on the market! Hence, they are both public and private at the same time which confuses a lot of people.

Government Control

Freddie Mac, Fannie Man and Ginnie Mae are also subject to a lot of control from the government. At least this was supposed to be theoretically the case. Some of the restrictions levied are as follows:

• The government has the authority to appoint five of the 18 board members in these coporations. Hence, theoretically, the management of these firms is controlled by the governments.

• Freddie Mac, Fannie Man and Ginnie Mae are not allowed to participate in the primary mortgage markets. This means that they cannot directly make any loans to the borrowers. They have to form the secondary mortgage markets leaving the task of loan origination to commercial and trust banks.

• Freddie Mac, Fannie Man and Ginnie Mae are also subject to limits which govern the maximum size of the mortgages that they buy. This size is linked to the housing price index. This is done to ensure that these quasi government agencies are actually buying the mortgages that help the lower and middle income groups rather than financing the wealthy households.

• These agencies are also subject to regulations which govern the quality of mortgages that they can purchase from the open market. The rules stated that Freddie Mac, Fannie Man and Ginnie Mae can only buy a mortgage if the borrower has put in at least 20% of the margin money or the mortgage is guaranteed by an external credit enhancement like insurance. However, later these rules were circumvented by these agencies.

• Freddie Mac, Fannie Man and Ginnie Mae are also subject to regulatory checks just like commercial and trust banks. These audits are conducted at periodic intervals.

It is for this reason that the bonds sold by these quasi government agencies were not listed either under government or private bonds. Rather, a special new section called “government sponsored agencies” was created to list them.

Monopoly

Freddie Mac, Fannie Man and Ginnie Mae were started in the 1970’s. They really started to pick some traction by the 1990’s. These agencies had a first mover advantage in the secondary mortgage markets section. This coupled with the fact that they had major advantages by being a quasi government entity created a virtual monopoly of these agencies.

Freddie Mac, Fannie Man and Ginnie Mae have held more than 90% of the secondary mortgage market for decades ever since their inception. It was only in the late 1990’s and early 2000’s that Wall Street investment banks also wanted a piece of the secondary mortgage pie.

This is when they took advantage of the limitations present in the charter of Freddie Mac, Fannie Man and Ginnie Mae. They started buying mortgages which were greater in value than those which these agencies were allowed to buy. They also started buying mortgages which were more riskier i.e. did not meet the minimum down payment criteria or did not have an external credit enhancement.

Once the Wall Street took to buying such riskier loans, they started getting more and more share of the security mortgage markets. Seeing their market share erode Freddie Mac, Fannie Man and Ginnie Mae also started buying riskier mortgages by finding ways to circumvent the laws.

These riskier mortgages were what later caused the subprime mortgage crisis. Since both Wall Street banks as well as government agencies were aggressively buying and selling these mortgages, both of them found themselves close to bankruptcy when the market went bust and both of them were later bailed out with taxpayer dollars. The story of how that unfolded will be covered in later modules.