Fannie Mae and Freddie Mac
For decades, the mortgage giants Fannie Mae and Freddie Mac were the fat and happy foundation of the U.S. housing market. By buying and packaging home loans into bonds and absorbing much of their risk, they made it easier for homebuyers to get mortgages, and to get them on easier terms than are available in most countries. Created by the government and then spun off as shareholder-owned corporations, Fannie and Freddie churned out steady profits, as investors treated their debt as virtually risk-free. It was the best of both worlds — until the housing market melted down in 2008. The government's bailout of Fannie and Freddie cost $187.5 billion. Fannie and Freddie have more recently become hugely profitable, and the housing market is more dependent on them than ever. But their days as wards of the state may be coming to an end.
U.S. Treasury Secretary Steven Mnuchin said before his confirmation that Fannie Mae and Freddie Mac should leave government control and that the new administration “will get it done reasonably fast.” He didn’t give details, and President Donald Trump had taken no position on the question during the campaign. Since 2008, bills for revamping the companies have been introduced in Congress but have not come up for a vote. The action has been elsewhere. Fannie and Freddie have been pouring money into the U.S. Treasury, which has received more than $240 billion in dividends from them since 2012. That prompted lawsuits by a number of investors who challenged a change in the terms of the bailout that reserved all profits for the government. In February 2017, an appeals court mostly upheld a lower-court judge’s 2014 decision to dismiss one of the shareholders’ cases against the government. The new decision could be appealed.
Congress created the Federal National Mortgage Association in 1938 as a government agency with a mission of reviving the mortgage market after its collapse in the Great Depression. Traditionally, banks that made mortgages held on to them. By buying mortgages from lenders, Fannie Mae, as it became known, freed up money that the banks could use to make more loans. After World War II, that process helped fuel a housing boom and made 30-year fixed-rate mortgages the American norm — in most other countries mortgages have shorter terms or adjustable rates. In 1968, Congress converted Fannie into a for-profit, shareholder-owned company, in part to ease a debt burden fueled by spending on the Vietnam War. Freddie Mac, the Federal Home Loan Mortgage Corporation, was created as a federally-chartered corporation in 1970 to give Fannie Mae some competition. It was turned into a publicly traded company in 1989. The companies helped the market for mortgage-backed securities grow by guaranteeing the payments of bonds it sold — bonds that many investors treated as nearly as safe as those of the U.S. Treasury, because of what was seen as an implicit government guarantee. That meant the companies could borrow more cheaply than other lenders. Some conservative economists say their collapse was caused by Congressional requirements to back lending in poor areas. But most studies have pointed to their small capital reserves and decision to expand their investments in loans packaged by Wall Street during the housing boom, including subprime bonds. Fannie and Freddie now stand behind about half of new U.S. mortgages, compared with about a third in 2005.
Mnuchin said that government ownership of the companies displaces private mortgage lending. But he didn't say they should be wound down or eliminated, as a number of prominent Congressional Republicans have called for. Most of the plans put forward in Congress so far have involved shrinking the amount of mortgage-credit risk backstopped by the government, but opponents worry that such a move could make loans more expensive for consumers. The stalemate is leading some affordable housing groups, small lenders and investors — including hedge funds that bought shares in Fannie and Freddie for pennies on the dollar after the government put them in conservatorship — to argue that a more strongly regulated Fannie Mae and Freddie Mac should be allowed to retain profits to build capital reserves. That could allow them to leave governmental control. That “recap and release” plan would mean big profits for some shareholders.
The Reference Shelf
- The takeover of Fannie and Freddie was addressed in the U.S. Financial Crisis Inquiry Report and a study by the Federal Reserve Bank of New York.
- The terms of the bailout agreement between the U.S. Treasury Department and Fannie Mae and Freddie Mac.
- A 2014 Bloomberg story about an attempt at legislation to wind down the companies. The legislation died later that year.
- A Bloomberg article about Fannie and Freddie shareholders’ battle for a share of the companies’ profits
- A federal judge’s 2014 decision to dismiss shareholder complaints alleging the government illegally took Fannie Mae’s and Freddie Mac’s profits.
- An April 2016 audio recording of oral arguments of shareholders’ appeal of the dismissal.
First published Aug. 1, 2016
To contact the writer of this QuickTake:
Joe Light in Washington at firstname.lastname@example.org
To contact the editor responsible for this QuickTake:
John O'Neil at email@example.com