By Michelle Garcia Gilbert
Congress charted Fannie Mae (Federal National Mortgage Association, or FNMA) in 1938 as part of the New Deal and Freddie Mac (Federal Home Loan Mortgage Corporation, or FHLMC) in 1970 as corporations chartered by the federal government but owned by private shareholders. They were created for the public policy purpose of making home ownership affordable for the lower and middle class and other underserved Americans.
In theory, these government-sponsored enterprises (GSEs) purchase mortgages from lenders and package them into mortgage-backed securities, which they either keep as investments or sell to institutional investors, thus providing liquidity and increased credit.
In practice, they have dominated the mortgage finance market based on the illusion of a government guarantee. In the 1990s, they promoted low down-payment mortgages to low- and middle-income families, and they loosened underwriting guidelines, which contributed to the housing bubble. In the early 2000s, Wall Street increased trading of loans — often non-GSE, riskier loans — that were securitized, which also contributed to the bubble. By 2005, the GSEs, which were losing market share, loosened underwriting guidelines even further and took on even more risk without increased capital reserves.
As the bubble began bursting in 2008, some in Congress wanted the GSEs to take on more risk, but U.S. Treasury officials, alarmed by continued devaluation of GSE loan portfolio, GSE weak capital reserves, potential investor sell-off, and impact on global markets, persuaded the GSEs to consent to conservatorship in September 2008. The Housing and Economic Recovery Act, enacted in July 2008, created the Federal Housing Finance Agency, the GSEs’ conservator since 2008.
Fannie and Freddie dominate the secondary mortgage market: They have more than $5.6 trillion in obligations and owned about 61 percent of all new residential mortgage loans in the United States in 2012. Only $5.2 billion in residential mortgage-backed securities were issued without government support in the same time period.
Freddie and Fannie received a $188 billion bailout from the Treasury, which has been paid back. They continue to be profitable, and, along with the Federal Housing Administration (FHA), own nearly 90 percent of all residential mortgages.
Both ends of our political spectrum agree that GSE reform is required: Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., introduced a bill in June 2013 that would replace the GSEs with federal insurance for mortgage, similar to FDIC-insured bank deposits. A government insurance program assuages the concerns of consumer and trade groups, which prefer the status quo, about the availability of mortgages, the mission of Fannie and Freddie.
On the other end are advocates of a free market system. They propose winding down the GSEs while legislating the definition of a prime loan that would be the standard for a private finance market.
Almost everyone agrees that something needs to be done with the GSEs and recognizes that this will be a complex undertaking in our housing and financial markets. Work on GSE reform is ongoing, though serious housing reform will not occur until after national elections.
