President Trump has just announced plans to seek substantial
reorganization of the Federal National Mortgage Association (FNMA) and known
commonly as Fannie Mae, and the Federal Home Loan Mortgage Corporation and
known commonly as Freddie Mac, the two main government sponsored entities that
provide the funds for nearly half of the residential mortgage loans in the
United States.
Fannie Mae
was formed in 1938 during the Roosevelt Administration as a government agency
to expand mortgage lending so as to encourage homeownership and home
building. Prior to its creation, most
mortgage loans were short term with a balloon feature, as banks were mostly
dependent on their own savings accounts to fund the home loans. Any long-term
lending meant tying up capital, precluding new, potentially more lucrative, new
home loans and with defaults as high as 25% in the 1930s. substantial risk
Fannie Mae
allowed banks to make long term, fixed rate mortgages without the commensurate
tying up their capital (or default risk) by buying the mortgage loans from banks. They created a secondary mortgage market wherein
loans purchased by Fannie Mae would be sold as collateralized mortgage
obligations or later as mortgage-backed securities (MBS) to investors. This freed up the banks to make new loans and
receive a fee for each loan originated and sold to Fannie Mae. In addition, the loans sold by Fannie Mae
were guaranteed by the full faith and credit of the United States making the
loans less risky even if the underlying borrower stopped payment and the
mortgage was foreclosed.
In 1954,
Fannie Mae was reorganized into a mixed ownership corporation, selling off
common shares to the public while the federal government retained control
through its ownership of Fannie Mae preferred shares. Further changes occurred in 1968 when Fannie
Mae was converted into a fully private corporation, splitting the entity into
Fannie Mae and the Government National Mortgage Association (commonly known as
Ginnie Mae, which remained a government organization, and which insures certain
mortgages such as loans by the Veteran’s Administration).
To increase competition
in the secondary mortgage market (which Fannie Mae had controlled for thirty years),
the government created a new government sponsored entity, Freddie Mac. Freddie Mac was also a public company and
also bought mortgage loans for sale on the secondary market.
The 1970s saw
the steady rise of mortgage backed securities as the main vehicle of bundling
of large blocks of mortgage loans. The
attractiveness of these MBS was due, in part, to the implied belief that the
MBS was guaranteed by the United States, even though the entities were no
longer owned by the government.
The 1990s and
early 2000s saw the push towards expansion of the loan market to (i) increase
home ownership, (ii) expand lending in areas that were previously avoided by
lenders (known as redlining), and (iii) assist low to moderate income parties
to obtain a mortgage loan. This led to
loosening of credit standards to meet these homeownership goals. In addition, competition from private
investment companies, who were also bundling more attractively priced mortgage
backed securities, led to a more aggressive, riskier approach in lending
approval by Fannie and Freddie
This led to
the subprime mortgage crisis in the mid to late 2000s with substantial defaults
and failures of private investment firms and banks. As of 2008, Fannie and Freddie owned one-half
of the estimated 12 trillion-dollar mortgage market, and a true public collapse
would have substantially damaged an already weak home loan market. Instead, and as a result of mounting losses
at Fannie and Freddie, the federal government placed both entities into
conservatorship (essentially bankruptcy) to stabilize the housing market.
After
investing hundreds of billions of dollars into Freddie and Fannie, the
institutions stabilized, and eventually became profitable, paying back the
monies invested. In fact, they have now
repaid the full amount invested and a profit of nearly 110 billion dollars to
the federal coffers.
Given this
state of affairs, and the deregulatory mindset of the President, it is no
surprise that he would propose modifying or even ending conservatorship. The stated goal is to create a limited role
for the federal government in the housing finance system, enhance taxpayer
protections and increase the role of private sector competition. This would be done by reducing the dividend
paid to the federal government, allowing Fannie and Freddie to increase its
capital reserve (now at only three billion dollars), a limited public offering
and the long-term goal of total privatization.
Given a
divided Congress and the bad taste of 2008’s housing crisis, it appears that
any materially changes may take years to settle. In the meantime, low interest rates and high
profits continue to benefit the federal government by holding onto Fannie and
Freddie.
