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Meet Fannie Mae and Freddie Mac

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					  Business101                                                                                                                                                                                          By Mary Yanni, The Star-Ledger



Meet Fannie Mae and Freddie Mac
T
     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 ...
                                                                                                                                                                                                              $75
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
                                                 IOU
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
                                                                                                                                                                                                               25
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                                                                                                                                  IO
                                 primary                                                     secondary
                                                                                                                                                                                                                    YESTERDAY
                             mortgage market                                              mortgage market
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                                                                                                                                    U
                                                                                                                                                                                                                    Fannie Mae (FNM) $49.80 ▲ $0.01
                                                                                                                                                                                                                    Freddie Mac (FRE) $43.82 ▼ $1.31


                                                                                                 IOU
                                                                                                                                                                                                                0
                                                                                                                          IOU
                                   IOU
                                                                                                                                                                                                                    ’02   ’03   ’04    ’05   ’06   ’07


                                                                                                                                                                                                              ... and the scandal
                                                                                                                                        IOU                                                                   Most investors should file Fannie
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                                                                                                                                                                                                              and Freddie under “Don’t invest in
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                                                                                                                                                                                                              something you don’t understand.”
                                                                                                                                                                                                              While both are in the Standard
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                                                                                                                                                                                                              & Poor’s 500 index and both are
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 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
                          $75
                                                                                                                                          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
                            50
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
                             YESTERDAY
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.
                                                                                                                                          guarantee.

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 myanni@starledger.com.

				
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