Freddie Mac and Fannie Mae, Explained

What are Freddie Mac and Fannie Mae

Freddie Mac and Fannie Mae are two Government Sponsored Enterprises (GSEs) that provide a secondary market for home mortgages. They do this by purchasing mortgages from the original or lender.

Fannie Mae was originally founded in 1938 by Congress as a chapter in the New Deal. It was a successful attempt to fuel a stale housing market by allowing low to middle income borrowers to qualify for a mortgage loan. In 1970, the US Congress created a secondary GSE, Freddie Mac, to help further stabilize the residential market. 

The Mortgage Loan Ecosystem

The way the mortgage loan ecosystem works is broken down here:

  • A future homeowner, or borrower, applies for a mortgage loan through a primary lender. Lenders can be brokers, but usually are larger banks or credit unions. 
  • Borrowers typically can only put a small percentage of the value of the house towards a purchase, so the primary lender ends up purchasing the house for the borrower, while the borrower pays the lender for the home with added interest. 
  • Lenders can only buy a finite amount of liquid capital, so eventually they would also have to borrow money in order to purchase new mortgages. This becomes risky business if the original borrower were to default on their mortgage. The primary lender would lose money and risk not being able to pay their lender back either.
  • As a solution, Congress created Freddie Mac and Fannie Mae as government funded programs. These enterprises purchase mortgage loans from lenders on a secondary market, thus securing the loan from the original borrower. Lenders no longer need to borrow money in order to keep approving mortgage loans.
  • The GSEs then package the loans they have purchased on the secondary market into Mortgage Backed Securities (MSE). They then sell the MSE to other institutions such as investment bankers, insurance companies or pension funds. 

The Subprime Meltdown

More capital for banks and lenders means more mortgages get approved. And a secondary market means that primary lenders get to do business with little risk. This system allowed primary lenders to sell over $5 trillion dollars on the secondary market, which is what led to the housing market meltdown in 2008. Lenders were approving borrowers in the subprime market, or high risk borrowers, because their overall financial situation made them more likely to default on their loans. When these borrowers defaulted on their loans, the housing market was flooded with foreclosures causing the housing prices to plummet and the economy as well. 

The Fannie and Freddie Bailout 

In 2008, the government stepped in via the Federal Housing Finance Committee and took control of both Freddie Mac and Fannie Mae. The government had to bail out the companies with taxpayer dollars. The GSEs were granted over $187 billion in total. $116 billion of that going to Fannie Mae and another $71 billion to Freddie Mac. Since the bailout, the GSEs have been able to repay the bailout to the US Treasury with over $58 billion in profit. Had the Government not stepped in to bailout the secondary market, millions of homeowners would have lost their homes or not been able to purchase once since. But why did the government bail out the Freddie and Fannie? In order to understand that, it’s important to understand what a GSE is.

Why They Got Bailed Out

Government Sponsored Enterprise is, essentially, is a private company that is backed by the government. Freddie Mac and Fannie may are not just private companies. They are also publicly traded companies with incredible stock value. They have profit goals of a private company with a safety net of the US Treasury and taxpayer dollars. So the GSEs were accepting risky loans that would boost their stick prices in the short run. They did this knowing that when a meltdown would happen, the government would be able to bail them out.