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Who are Fannie and Freddie and Why are they Important to You?
Friday, June 8, 2008 by Andrew Hoffman • Albuquerque Journal North

Fannie and Freddie always sound to me like somebody’s country cousins from Iowa. In reality, they are companies that are critical to the mortgage industry.

Federal National Mortgage Association (FNMA or Fannie Mae) was created in 1938, at a time when millions of families could not become homeowners, or risked losing their homes, for lack of a consistent supply of mortgage funds across America. In 1968, to help balance the federal budget, Fannie Mae was converted into a private corporation. Fannie Mae ceased to be the guarantor of government-issued mortgages.

The Federal Home Loan Mortgage Corporation (FHLMC), commonly known as Freddie Mac, is a government-sponsored enterprise (GSE) of the United States Government. As a GSE, it is a stockholder-owned corporation authorized to make loans and loan guarantees. The FHLMC was created in 1970 to expand the secondary market for mortgages.

The key to understanding both Fannie and Freddie is that they are instrumental to the secondary market for mortgages. When I make a loan, my company borrows money to fund the loan, and then sells it to a company like Countrywide, who likewise borrows money to fund the loan. Countrywide then packages the original loan with $100,000,000 of other loans and either sells it to Fannie or Freddie (if it fits their guidelines) or sells it directly to investors like pension funds, life insurance companies and foreign investors. Fannie/Freddie either keep the loans in their own portfolio or sell them to similar investors, but with an implied government guarantee.

Both Fannie and Freddie work under similar guidelines and loan limits (more about this below) and have an implied (but not actual) government guarantee for their loans. There is speculation that the Federal Government would bail out Fannie or Freddie in a pinch, but this has never been tested. They are private companies that, at one time, were very well capitalized, who put their stamp of approval on the mortgage-backed securities that they sold. In return for the implied guarantee, they are able to sell their securities at a lower interest rate.

When we talk about Fannie guidelines, we are speaking about loan limits (which are now below $417,000) and a whole host of other rules that have been established over 70 years to standardize mortgages. All loan programs, whether Fannie, Freddie or other are based on these guidelines and their variations. If you vary (e.g. go over $417,000), you don’t fit Fannie, and it costs more.

In the last six months, Fannie and Freddie loans (also called conforming) have carried the lowest rate of interest and have pretty much kept the mortgage market afloat. Fannie and Freddie set the ground rules for the whole mortgage industry and have been able to keep it liquid throughout the credit crunch; they have handled almost 80% of new mortgages in the market. Those lenders outside of the conforming loan world have had a tougher time and we have seen the virtual disappearance of stated income loans and very high interest rates for loans above $417,000.

Have Fannie and Freddie been affected by the crunch? Will conforming loans go the way of jumbos?

Bear in mind that these companies are private companies operating in a very big arena with an implicit government guarantee. The government “controls” them by oversight and their allowing lending limits based upon their capital base. Today they must have capital equal to 3% of their total assets. Their stocks are publicly traded and their books are open to public review and governmental oversight. In the past, both companies have been subjected to scrutiny for their accounting or business practices.

Some observers believe that Fannie and Freddie are in trouble. Their combined cushion of $83 billion—the capital they are required to have—underpins a colossal $5 trillion in debt. Both companies reported $9 billion in losses for 2007, and it is estimated that they could be sitting on as much as $19 billion in additional loss. Accordingly, the Federal government wants both companies to raise capital; both have resisted although they have agreed in principal to raise additional capital, in return for congressional approval for them to have an additional $200 billion in purchasing power based upon their present capital base.

Both of these companies were extraordinarily successful from 1990 to 2000 when their stock price grew by 500% and their executives were very well compensated. As other lenders entered the field and made it more competitive, Fannie and Freddie were forced to buy more speculative securities and by the end of 2007 had guaranteed or invested in $717 billion in non-conforming loans. While their stock prices have suffered over the last six months, if housing rebounds they stand to reap substantial profits. If housing does not rebound, they could falter and they are really the last line of defense for the mortgage industry.