When researching home financing it is likely that you will encounter information about Fannie Mae and/or Freddie Mac. The goal of this article is to provide a brief history of “Fannie” and “Freddie”, describe their role in the housing market and explain what it means to you, a prospective homebuyer or a current homeowner.
In 1938, the housing crisis brought about by the Great Depression prompted Franklin Delano Roosevelt and Congress to create Fannie Mae with the mandate to purchase mortgages from lenders to free up capital for those lenders to make new loans. As a government agency, Fannie was authorized to borrow funds from the Federal Housing Administration to purchase loans. This created the nation’s first liquid market for residential mortgages.
By 1968 Fannie had grown substantially and the government sought to remove its now substantial debt from the national balance sheet, so Fannie was privatized and in 1970 it became a publicly traded company. In conjunction with Fannie’s privatization, Congress created Ginnie Mae to take over Fannie’s financing activities for lower down payment loans (FHA & VA). “Ginnie” created securities from these loans and backed them with the explicit guarantee of the US government and Fannie’s charter was revised to focus on what have become known as conventional loans.
Now with access to public capital and authority to purchase conventional loans, Fannie was viewed by legislators as a potential monopoly in waiting. To address this concern, Congress created Freddie Mac in 1970 to provide some competition in the consumer home loan market. Fannie and Freddie continued to grow through the 90s as they were encouraged by both Republican and Democratic administrations to increase their lending to low and moderate income borrowers.
By 2003 many investment banks started experimenting with purchasing and securitizing subprime mortgages - loans made to individuals with poor credit histories. Because securitization allowed the banks to transfer the risk of these loans to the securities’ investors, there was little incentive for the banks to focus on the quality of the loans or the borrowers’ ability to repay them. The growth of these so-called private-label securitizations shifted volume away from Fannie and Freddie and led to rapid growth of riskier mortgage products that borrowers did not understand and a further deterioration in underwriting standards. Fannie & Freddie responded by reducing their own underwriting standards in an effort to recapture lost market share.
As delinquencies and defaults increased at the Agencies, it was clear that Fannie & Freddie would require additional capital to continue operations and avoid a freeze of the US housing market. The US government formulated a plan to bailout the Agencies, ultimately leading to their takeover by the Federal Housing Financing Agency (FHFA) in 2008. Under this conservatorship, the FHFA has provided almost $200m in capital to the Agencies to assure a functioning housing finance market.
Today, Fannie & Freddie are largely owned by the US taxpayers, yet continue to operate as an essential sources of liquidity in the US mortgage market. In addition to their role as a source of capital for lenders, they also serve to set the universal underwriting guidelines that most all lenders adhere to. These guidelines not only help determine general borrower eligibility, but also the rate premiums that borrowers will pay for different scenarios. For example, a borrower with a 3% down payment will pay a higher rate than a borrower with a 25% down payment.
Collectively, the Agencies guarantee over $6 Trillion in outstanding mortgage backed securities, which makes it one of the largest markets for debt in the US and the world. The sheer size of the market, its standardization and the government’s guarantee, provide homeowners with the access to some of the lowest borrowing cost available anywhere. To put this in perspective, in 2016 a US homebuyer could borrow for 30 years at a rate of approximately 3.75%, fixed for the life of the loan. Meanwhile at that time, the US Government’s 30 year borrowing cost — i.e. the rate the US must pay investors on its 30 year treasury bond was 2.62%. So on a theoretical $300k loan, US homeowners would pay only $189 more per month than the US Government, an institution that can literally print money. For better or worse, we can thank the presence and growth of the Agencies for this privilege.