Business101 By Mary Yanni, The Star-Ledger
Meet Fannie Mae and Freddie Mac
heir chummy names make them sound like old pals — comfortable, “government-sponsored entities,” created by Congress to encourage
uncomplicated. homeownership. Still, they are publicly traded companies with shares listed on
In truth, there’s nothing simple about Fannie Mae and Freddie Mac. the New York Stock Exchange.
They are extremely complex, and they are critical to the workings of the Their business keeps money flowing into the mortgage market, giving banks
mortgage market. Especially now. the cash they need to keep making home loans.
What are these companies, and how do they play such an integral role? Here’s a look at the companies that drive 40 percent of the $10.9 trillion
Fannie and Freddie — we’re on a first-name basis at this point — are mortgage market.
how they work the stocks ...
Fannie and Freddie are a bridge between mortgage lenders and investors. They securities, but none have ties to the government. As a result, Fannie and Freddie get FNM
package loans into securities — bonds — that can be sold to investors, who are then IOU
their hands on about 40 percent of all loans.
entitled to receive the interest and principal payments made by the homebuyers. Fannie Fannie and Freddie profit in a number of ways: charging a fee to guarantee loans
and Freddie guarantee timely payments — a guarantee that is implicitly, but not 50
and package them as securities for sale to investors; collecting income from mortgages
explicitly, backed by the government. and mortgage-backed securities they hold as investments; and borrowing money to buy
There are lots of institutions that buy mortgage loans and package them for sale as loans at a lower rate than the return on those loans. FRE
mortgage market mortgage market
Fannie Mae (FNM) $49.80 ▲ $0.01
Freddie Mac (FRE) $43.82 ▼ $1.31
’02 ’03 ’04 ’05 ’06 ’07
... and the scandal
IOU Most investors should file Fannie
and Freddie under “Don’t invest in
something you don’t understand.”
While both are in the Standard
& Poor’s 500 index and both are
homebuyers mortgage fannie mae, wall street seen as financially strong, for the
lenders freddie mac investors average person, they are ridicu-
lously complicated and risky.
The homebuyer gets a The lender packages a Fannie and Freddie keep some Any business this heavily involved
mortgage loan from a number of loans that loans on their books. The rest are with interest rates carries a lot of
bank or other lender. meet certain criteria and sells them packaged into bonds called mortgage-backed risk — Fannie and Freddie can lose
to Fannie or Freddie. This gives the securities. money any time rates change, and
The bank can either hold onto the they use complex hedging strate-
lender access to the cash it needs to
IOU the criteria: FannieIOU can
loan, keeping it on its books as an This is where Fannie and Freddie differ. gies to manage those risks. It’s also
asset, or sell it. make more loans.
Fannie creates the securities, guarantees them very hard to regulate income from
and Freddie and then gives them back to the lender (all mortgages, since there’s no telling
buy loans no larger than $417,000 (a for a fee, of course). The bank can then either when someone will fall behind on a
limit that changes periodically, based keep the securities on its books or sell them to loan or pay it off by refinancing or
on home prices), and they must have investors. selling the house.
20 percent down or some kind of
mortgage insurance — in short, the Freddie straight up sells the securities And then there is the accounting
buyers who took out these loans are it creates — and guarantees — to investors. scandal that hit the companies
the least likely to default. starting in 2003. Between
them, the two misstated
As if the long, earnings by more
slow recovery from their than $11 billion,
accounting scandals weren’t in the interest
what government oversight means why they’re enough, now Fannie and Freddie of making their
have been dragged into the results seem
The government’s relationship with Fannie and Freddie fannie, freddie — and you important today investigation of inflated appraisals. less volatile.
makes them different from other companies. This is Fannie and Freddie are virtually invisible to home- Fannie and Freddie have New York Attorney General Andrew (And also, it
clearly an advantage — the Congressional Budget Office owners, except for one thing: lower interest rates been in the news a lot since Cuomo on Wednesday asked the seems, in the
has estimated this relationship is worth more than on many loans. The loans Fannie and Freddie can the credit crunch hit the fan. companies for information on loans interest of
$10 billion a year to the companies — but it also comes buy typically have an interest rate about one-half bought from banks including ensuring big
The companies themselves,
with some significant restrictions. to three-quarters of a percentage point lower than Washington Mutual. If any turn out to bonuses for top
along with a number of
The big advantage is the perception their bonds are as larger loans. (The spread reached 1½ percentage be based on bad appraisals, the executives.)
lawmakers, have been pushing
secure as U.S. Treasury bonds. In fact, their bonds are not points this summer, as the market for “jumbo” loans lender would have to buy the
to have restrictions loosened in The companies
guaranteed by the government, but any serious problems soured on Wall Street, but it is back below loans back from Fannie
order to improve the credit paid hundreds of
with Fannie and Freddie likely would be too damaging 1 percentage point now.) and Freddie.
market — and the faltering housing millions of dollars in
to the mortgage market for the government to ignore. market. The proposals generally take penalties, and the loose
Fannie and Freddie have about $1.5 trillion in debt on two forms: ends are just now being tied
their books; you can imagine the mayhem if one of them U.S. HOMEOWNERSHIP RATE
69.2* 68.2 n lift the portfolio cap: Increasing the limit on the up. On Tuesday, regulators finally
failed. That’s why Fannie and Freddie are said to be risky 61.9 62.9 64.4 64.2 66.2
total value of the companies’ portfolios — now roughly reached a financial settlement with
for taxpayers — because if there were a bailout, it would 55.0
Freddie’s former chief executive.
$1.4 trillion — would make the credit market more liquid,
be with taxpayer money. 43.6 essentially putting more cash in the hands of lenders. And today, when Fannie releases its
the specifics One proposal on the table, from Democrats Barney quarterly earnings, both companies
Here are some of the specific ways their entanglement Frank and Chuck Schumer, would temporarily raise the at last will be completely up-to-date
with the government makes Fannie and Freddie special: lending caps by about $140 billion, with 80 percent of with their financial reporting.
n They are restricted to residential mortgage finance, that money earmarked for “subprime” loans. One prob-
and are forbidden from originating mortgage loans. lem with this plan is Fannie and Freddie don’t typically
1940 1950 1960 1970 1980 1990 2000 2004 2007
buy loans made to people with credit problems — Fannie the cousins
n They can’t buy loans worth more than $417,000, and * Historic high
has less than 2 percent of its portfolio in subprime loans; If you know Fannie and Freddie,
the loans must have a 20 percent down payment or Freddie, about 6 percent. Congress can’t force Fannie and you’ve probably heard of their
some form of mortgage insurance. why homeownership? Freddie to take on more risk than they want to. cousins, too:
n Fannie and Freddie are subject to government oversight The government has a long history of encouraging The companies’ regulator, OFHEO, already has agreed ginnie mae: Unlike Fannie and
by the Department of Housing and Urban Development homeownership, starting with Fannie Mae’s to raise Fannie’s limit to $735 billion — the same as Freddie, the Government National
and the Office of Federal Housing Enterprise Oversight. founding in 1938 during the Great Depression, and Freddie’s — and to allow both to increase their Mortgage Association is a wholly
OFHEO, as it’s called, is responsible for the “safety and continuing today with tax deductions for interest portfolios 2 percent per year. But it pays to remember owned government corporation
soundness” of the companies; it limited the size of payments and property taxes. these caps were imposed because of a within the Department of Housing
Fannie’s and Freddie’s loan portfolios in the wake of a multibillion-dollar accounting scandal and Urban Development.
Why? A high rate of homeownership is thought to be
massive accounting scandal (more on that later). arising from rapid portfolio growth Ginnie Mae performs a simi-
good for society as a whole. Homeowners are more In the late
n The companies are exempt from state and local income likely to vote, volunteer and otherwise take an active — a scandal the companies are lar function to Fannie and
1990s, both Fannie Freddie, but it deals only
taxes, although they do pay federal income taxes. role in the community. They’re also more likely to still recovering from. OFHEO
and Freddie adopted with loans backed by the
n They also are exempt from the SEC’s registration and maintain and improve their homes, creating more says it still has concerns about
their nicknames in place government, primar-
reporting requirements, although both companies stable, safer neighborhoods. “ongoing safety and soundness
of the bureaucratic-sounding ily the Federal Housing
voluntarily comply. issues” at both companies.
It’s also good for individuals. Studies show home- originals, Federal National
n raise the limit on the Administration and the
n The securities issued by Fannie and Freddie are treated owners report higher self-esteem and satisfaction Mortgage Association and
size of loans they can buy: Department of Veterans
in many ways just like Treasury securities: There is no with their lives and even better physical health. But Federal Home Loan
FNM Allowing Fannie and Freddie Affairs.
limit on the amount of their securities banks and savings the best measurable affect is financial. Home equity Mortgage Corp.,
and loans can buy; they can be used as collateral for is the biggest source of wealth for American families. to buy loans worth more than respectively. sallie mae: The Student
public deposits; and they can be bought by the Federal the median net worth of homeowners is vastly $417,000 would lower interest rates Loan Marketing Association
Reserve in open-market operations. They are even classi- higher than that of renters: on bigger loans and, theoretically, was conceived in 1972 to do
fied as “U.S. agency securities.” soothe the downturn in the housing for student loans what Fannie and
FRE annual income owners renters
market. Nationwide, jumbo loans make up about Freddie do for home loans. Sallie’s
n Each has a credit line with the U.S. Treasury for up to $80,000 and up $451,200 $87,400 20 percent of the mortgage market, but in some areas ties to the government were cut
25 used it.
$2.25 billion; neither has ever
$50,000-$79,999 $194,610 $25,000 where home prices are higher, including the New York in 2004. The break-up had one big
n Fannie and Freddie are the only public companies area, this percentage is much higher. Federal Reserve benefit for the company, now called
$30,000-$49,999 $126,500 $10,600
Fannie Mae (FNM) $49.80 ▲
that can use the Federal Reserve’s electronic book entry$0.01
Freddie Mac (FRE) $43.82 ▼ $1.31 Chairman Ben Bernanke has weighed in on this issue, SLM Corp.: It could start originating
system — the same system0used to issue and transfer $16,000-$29,999 $112,600 $4,240 expressing concern about the prospect of increasing the student loans, rather than simply
Treasury securities. ’02 ’03 ’04 ’05 ’06 ’07 Under $16,000 $73,000 $500 number and size of loans with an implicit government greasing the skids for other lenders.
SOURCES: Fannie Mae; Freddie Mac; Bankrate.com; Reuters, Associated Press and MarketWatch news reports; FM Policy Focus; Moody’s Economy.com; Office of Federal Housing Enterprise Oversight; Federal Reserve and Census Bureau data
Business 101 appears occasionally in The Star-Ledger’s Business section. Some past installments can be found online at nj.com/business/ledger/biz101. Mary Yanni may be reached at email@example.com.