The
Federal National Mortgage Association (
FNMA; ), commonly known as
Fannie Mae, was founded in 1938 during the
Great DepressionThe Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
as part of the
New DealThe New Deal was a series of economic programs implemented in the United States between 1933 and 1936. They were passed by the U.S. Congress during the first term of President Franklin D. Roosevelt. The programs were Roosevelt's responses to the Great Depression, and focused on what historians call...
. It is a
government-sponsored enterpriseA government-sponsored enterprise is a financial services corporation created by the United States Congress. Their function is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient and transparent...
(GSE), though it has been a publicly traded company since 1968. The corporation's purpose is to expand the
secondary mortgage marketThe secondary mortgage market is the market for the sale of securities or bonds collateralized by the value of mortgage loans. The mortgage lender, commercial banks, or specialized firm will group together many loans and sell grouped loans as securities called collateralized mortgage obligations ....
by
securitizingSecuritization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or Collateralized mortgage obligation , to...
mortgageA mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
s in the form of
mortgage-backed securitiesA mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...
(MBS), allowing lenders to reinvest their assets into more lending and in effect increasing the number of lenders in the mortgage market by reducing the reliance on
thriftA savings and loan association , also known as a thrift, is a financial institution that specializes in accepting savings deposits and making mortgage and other loans...
s.
History
The Federal National Mortgage Association (FNMA), colloquially known as Fannie Mae, was established in 1938 by amendments to the
National Housing ActThe National Housing Act of 1934, , also called the Capehart Act, was part of the New Deal passed during the Great Depression in order to make housing and home mortgages more affordable. It created the Federal Housing Administration and the Federal Savings and Loan Insurance Corporation.It was...
after the
Great DepressionThe Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
as part of Franklin Delano Roosevelt's
New DealThe New Deal was a series of economic programs implemented in the United States between 1933 and 1936. They were passed by the U.S. Congress during the first term of President Franklin D. Roosevelt. The programs were Roosevelt's responses to the Great Depression, and focused on what historians call...
. Fannie Mae was established to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing. Fannie Mae created a liquid
secondary mortgage marketThe secondary mortgage market is the market for the sale of securities or bonds collateralized by the value of mortgage loans. The mortgage lender, commercial banks, or specialized firm will group together many loans and sell grouped loans as securities called collateralized mortgage obligations ....
and thereby made it possible for banks and other loan originators to issue more housing loans, primarily by buying
Federal Housing AdministrationThe Federal Housing Administration is a United States government agency created as part of the National Housing Act of 1934. It insured loans made by banks and other private lenders for home building and home buying...
(FHA) insured mortgages. For the first thirty years following its inception, Fannie Mae held a monopoly over the secondary mortgage market. In 1954, an amendment known as the Federal National Mortgage Association Charter Act made Fannie Mae into "mixed-ownership corporation" meaning that federal government held the preferred stock while private investors held the common stock; in 1968 it converted to a privately held corporation, to remove its activity and debt from the federal budget. In the 1968 change, Fannie Mae's predecessor (also called Fannie Mae) was split into the current Fannie Mae and the
Government National Mortgage AssociationThe Government National Mortgage Association , or Ginnie Mae, was established in the United States in 1968 to promote home ownership. As a wholly owned government corporation within the Department of Housing and Urban Development , Ginnie Mae’s mission is to expand affordable housing in the U.S. by...
("Ginnie Mae").
Ginnie Mae, which remained a government organization, supports FHA-insured mortgages as well as Veterans Administration (VA) and
Farmers Home AdministrationIn 1946 Farmers Home Administration replaced the Farm Security Administration which superseded the Resettlement Administration. Its mission and programs involved extending credit for agriculture and rural development. Direct and guaranteed credit went to individual farmers, low-income families,...
(FmHA) insured mortgages. As such Ginnie Mae is the only home-loan agency explicitly backed by the full faith and credit of the United States government.
In 1970, the federal government authorized Fannie Mae to purchase private mortgages, i.e. those not insured by the FHA, VA, or FmHA, and created the
Federal Home Loan Mortgage CorporationThe Federal Home Loan Mortgage Corporation , known as Freddie Mac , is a public government sponsored enterprise , headquartered in the Tyson's Corner CDP in unincorporated Fairfax County, Virginia....
(FHLMC), colloquially known as Freddie Mac, to compete with Fannie Mae and thus facilitate a more robust and efficient secondary mortgage market.
In 1981, Fannie Mae issued its first mortgage passthrough and called it a
mortgage-backed security. The Fannie Mae laws did not require the Banks to hand out subprime loans in any way. Ginnie Mae had guaranteed the first mortgage passthrough security of an approved lender in 1968 and in 1971 Freddie Mac issued its first mortgage passthrough, called a
participation certificate, composed primarily of private mortgages.
1990s
In 1992, President George H.W. Bush signed the Housing and Community Development Act of 1992. The Act amended the charter of Fannie Mae and Freddie Mac to reflect Congress' view that the
GSEsA government-sponsored enterprise is a financial services corporation created by the United States Congress. Their function is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient and transparent...
"... have an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families in a manner consistent with their overall public purposes, while maintaining a strong financial condition and a reasonable economic return;" For the first time, the GSEs were required to meet "affordable housing goals" set annually by the Department of Housing and Urban Development (HUD) and approved by Congress. The initial annual goal for low-income and moderate-income mortgage purchases for each GSE was 30% of the total number of dwelling units financed by mortgage purchases and increased to 55% by 2007.
In 1999, Fannie Mae came under pressure from the
Clinton administrationThe United States Presidency of Bill Clinton, also known as the Clinton Administration, was the executive branch of the federal government of the United States from January 20, 1993 to January 20, 2001. Clinton was the first Democratic president since Franklin D. Roosevelt to win a second full term...
to expand mortgage loans to low and moderate income borrowers by increasing the ratios of their loan portfolios in distressed inner city areas designated in the CRA of 1977. Because of the increased ratio requirements, institutions in the primary mortgage market pressed Fannie Mae to ease credit requirements on the mortgages it was willing to purchase, enabling them to make loans to subprime borrowers at interest rates higher than conventional loans.
In 1999,
The New York TimesThe New York Times is an American daily newspaper founded and continuously published in New York City since 1851. The New York Times has won 106 Pulitzer Prizes, the most of any news organization...
reported that with the corporation's move towards the subprime market "Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s." Alex Berenson of
The New York Times reported in 2003 that Fannie Mae's risk is much larger than is commonly held.
Nassim TalebNassim Nicholas Taleb is a Lebanese American essayist whose work focuses on problems of randomness and probability. His 2007 book The Black Swan was described in a review by Sunday Times as one of the twelve most influential books since World War II....
wrote in
The Black Swan: "The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deem these events 'unlikely'".
Mike StathisMike Stathis Mike Stathis the chief investment strategist of AVA Investment Analytics, a financial research firm catering to financial institutions.He also serves as the managing principal of Apex Venture Advisors....
also warned about the risks of Fannie Mae, triggering the financial crisis in America’s Financial Apocalypse. “With close to $2 trillion in debt between Freddie Mac and Fannie Mae alone, as well as several trillion held by commercial banks, failure of just one GSE or related entity could create a huge disaster that would easily eclipse the Savings & Loan Crisis of the late 1980s. This would certainly devastate the stock, bond and real estate markets. Most likely, there would also be an even bigger mess in the derivatives market, leading to a global sell-off in the capital markets. Not only would investors get crushed, but taxpayers would have to bail them out since the GSEs are backed by the government. Everyone would feel the effects. At its bottom, I would estimate a 30 to 35 percent correction for the average home. And in ‘hot spots’ such as Las Vegas, selected areas of Northern and Southern California and Florida, home prices could plummet by 55 to 60 percent from peak values.”
2000s
In 2000, because of a re-assessment of the housing market by HUD, anti-predatory lending rules were put into place that disallowed risky, high-cost loans from being credited toward affordable housing goals. In 2004, these rules were dropped and high-risk loans were again counted toward affordable housing goals.
The intent was that Fannie Mae's enforcement of the underwriting standards they maintained for standard conforming mortgages would also provide safe and stable means of lending to buyers who did not have prime credit. As
Daniel MuddDaniel H. Mudd is the former President and CEO of Fannie Mae, a post he held from 2005-2008.He is the son of TV anchor, Roger Mudd. He holds a B.A. degree in American history from the University of Virginia and an M.P.A. from the John F. Kennedy School of Government at Harvard University...
, then President and CEO of Fannie Mae, testified in 2007, instead the agency's underwriting requirements drove business into the arms of the private mortgage industry who marketed aggressive products without regard to future consequences: "We also set conservative underwriting standards for loans we finance to ensure the homebuyers can afford their loans over the long term. We sought to bring the standards we apply to the prime space to the subprime market with our industry partners primarily to expand our services to underserved families.
"Unfortunately, Fannie Mae-quality, safe loans in the subprime market did not become the standard, and the lending market moved away from us. Borrowers were offered a range of loans that layered
teaser rateA teaser rate is a low, adjustable introductory interest rate advertised for a loan, credit card, or deposit account in order to attract potential customers to obtain the service. The teaser rates are normally too good to be true for the long term, and are far below the common realistic rate for...
s, interest-only,
negative amortizationIn finance, negative amortization, also known as NegAm, deferred interest or graduated payment mortgage, occurs whenever the loan payment for any period is less than the interest charged over that period so that the outstanding balance of the loan increases...
and payment options and low-documentation requirements on top of floating-rate loans. In early 2005 we began sounding our concerns about this "layered-risk" lending. For example, Tom Lund, the head of our single-family mortgage business, publicly stated, "One of the things we don't feel good about right now as we look into this marketplace is more homebuyers being put into programs that have more risk. Those products are for more sophisticated buyers. Does it make sense for borrowers to take on risk they may not be aware of? Are we setting them up for failure? As a result, we gave up significant market share to our competitors."
Congress, controlled by Republicans during this period, did not introduce any legislation aimed at bringing this proposal into law until the
Federal Housing Enterprise Regulatory Reform Act of 2005, which did not proceed out of committee to the Senate.
On January 26, 2005, the
Federal Housing Enterprise Regulatory Reform Act of 2005 (S.190) was first introduced in the Senate by Sen.
Chuck HagelCharles Timothy "Chuck" Hagel is a former United States Senator from Nebraska. A member of the Republican Party, he was first elected in 1996 and was reelected in 2002...
. The Senate legislation was an effort to reform the existing GSE regulatory structure in light of the recent accounting problems and questionable management actions leading to considerable income restatements by the GSE's. After being reported favorably by the Senate's Committee on Banking, Housing, and Urban Affairs in July 2005, the bill was never considered by the full Senate for a vote. Sen. John McCain's decision to become a cosponsor of S.190 almost a year later in 2006 was the last action taken regarding Sen. Hagel's bill in spite of developments since clearing the Senate Committee. Sen. McCain pointed out that Fannie Mae's regulator reported that profits were "illusions deliberately and systematically created by the company's senior management" in his floor statement giving support to S.190.
At the same time, the House also introduced similar legislation, the
Federal Housing Finance Reform Act of 2005 (H.R. 1461), in the Spring of 2005. The House Financial Services Committee had crafted changes and produced a Committee Report by July 2005 to the legislation. It was passed by the House in October in spite of President Bush's statement of policy opposed to the House version. The legislation met with opposition from both Democrats and Republicans at that point and the Senate never took up the House passed version for consideration after that.
The mortgage crisis from late 2007
Following their mission to meet federal Housing and Urban Development
(HUD)The United States Department of Housing and Urban Development, also known as HUD, is a Cabinet department in the Executive branch of the United States federal government...
housing goals, GSEs such as Fannie Mae, Freddie Mac and the Federal Home Loan Banks (FHLBanks) have striven to improve home ownership of low and middle income families, underserved areas, and generally through special affordable methods such as "the ability to obtain a 30-year fixed-rate mortgage with a low down payment... and the continuous availability of mortgage credit under a wide range of economic conditions."
(HUD 2002 Annual Housing Activities Report) Then in 2003-2004, the
subprime mortgage crisisThe U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
began. The market shifted away from regulated GSEs and radically toward Mortgage Backed Securities (MBS) issued by unregulated private-label securitization conduits, typically operated by investment banks.
As mortgage originators began to distribute more and more of their loans through private label MBS, GSEs lost the ability to monitor and control mortgage originators. Competition between the GSEs and private securitizers for loans further undermined GSEs power and strengthened mortgage originators. This contributed to a decline in underwriting standards and was a major cause of the financial crisis.
Investment bank securitizers were more willing to securitize risky loans because they generally retained minimal risk. Whereas the GSEs guaranteed the performance of their MBS, private securitizers generally did not, and might only retain a thin slice of risk. Often, banks would offload this risk to insurance companies or other counterparties through credit default swaps, making their actual risk exposures extremely difficult for investors and creditors to discern.
The shift toward riskier mortgages and private label MBS distribution occurred as
financial institutionIn financial economics, a financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries...
s sought to maintain earnings levels that had been elevated during 2001-2003 by an unprecedented refinancing boom due to historically low interest rates. Earnings depended on volume, so maintaining elevated earnings levels necessitated expanding the borrower pool using lower underwriting standards and new products that the GSEs would not (initially) securitize. Thus, the shift away from GSE securitization to private-label securitization (PLS) also corresponded with a shift in mortgage product type, from traditional, amortizing,
fixed-rate mortgagesA fixed-rate mortgage is a mortgage loan first developed by the Federal Housing Administration where the interest rate on the note remains the same through the term of the loan, as opposed to loans where the interest rate may adjust or "float." Other forms of mortgage loan include interest only...
(FRMs) to nontraditional, structurally riskier, nonamortizing, adjustable-rate mortgages (ARMs), and in the start of a sharp deterioration in mortgage underwriting standards. The growth of PLS, however, forced the GSEs to lower their underwriting standards in an attempt to reclaim lost market share to please their private shareholders. Shareholder pressure pushed the GSEs into competition with PLS for market share, and the GSEs loosened their guarantee business underwriting standards in order to compete. In contrast, the wholly public FHA/Ginnie Mae maintained their underwriting standards and instead ceded market share.
The growth of private-label securitization and lack of regulation in this part of the market resulted in the oversupply of underpriced housing finance that led, in 2006, to an increasing number of borrowers, often with poor credit, who were unable to pay their mortgages - particularly with adjustable rate mortgages (ARM), caused a precipitous increase in home foreclosures. As a result, home prices declined as increasing foreclosures added to the already large inventory of homes and stricter lending standards made it more and more difficult for borrowers to get mortgages. This depreciation in home prices led to growing losses for the GSEs, which back the majority of US mortgages. In July 2008, the government attempted to ease market fears by reiterating their view that "Fannie Mae and Freddie Mac play a central role in the US housing finance system". The US Treasury Department and the Federal Reserve took steps to bolster confidence in the corporations, including granting both corporations access to Federal Reserve low-interest loans (at similar rates as commercial banks) and removing the prohibition on the Treasury Department to purchase the GSEs' stock. Despite these efforts, by August 2008, shares of both Fannie Mae and Freddie Mac had tumbled more than 90% from their one-year prior levels.
On Oct 21, 2010 FHFA estimates revealed that the bailout of Freddie Mac and Fannie Mae will likely cost taxpayers $224–360 billion in total, with over $150 billion already provided.
2008 - Crisis and Conservatorship
On July 11, 2008, the
New York Times reported that U.S. government officials were considering a plan for the U.S. government to take over Fannie Mae and/or Freddie Mac should their financial situations worsen due to the U.S. housing crisis. Fannie Mae and smaller Freddie Mac own or guarantee a massive proportion of all home loans in the United States and so were especially hard hit by the slump. The government officials also stated that the government had also considered calling for explicit government guarantee through legislation of $5 trillion on debt owned or guaranteed by the two companies.
Fannie stock plunged. Some worried that Fannie lacked capital and might go bankrupt. Others worried about a government seizure. U.S. Treasury Secretary Henry M. Paulson as well as the White House went on the air to defend the financial soundness of Fannie Mae, in a last ditch effort to prevent a total financial panic. Fannie and Freddie underpinned the whole U.S. mortgage market. As recently as 2008, Fannie Mae and the
Federal Home Loan Mortgage CorporationThe Federal Home Loan Mortgage Corporation , known as Freddie Mac , is a public government sponsored enterprise , headquartered in the Tyson's Corner CDP in unincorporated Fairfax County, Virginia....
(Freddie Mac) had owned or guaranteed about half of the U.S.'s $12 trillion mortgage market. If they were to collapse, mortgages would be harder to obtain and much more expensive. Fannie and Freddie
bondIn finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
s were owned by everyone from the
Chinese GovernmentAll power within the government of the People's Republic of China is divided among three bodies: the People's Republic of China, State Council, and the People's Liberation Army . This article is concerned with the formal structure of the state, its departments and their responsibilities...
, to
Money MarketThe money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit,...
funds, to the retirement funds of hundreds of millions of people. If they went bankrupt, all those investments would go to 0, and there would be mass upheaval on a global scale.
The Administration PR effort was not enough, by itself, to save the GSEs. Their investments were simply too rotten, their managements had been too incompetent, and the market was tanking too quickly. Paulson knew that
Lehman BrothersLehman Brothers Holdings Inc. was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth largest investment bank in the USA , doing business in investment banking, equity and fixed-income sales and trading Lehman Brothers Holdings Inc. (former NYSE ticker...
and other banks were in trouble and would soon require his attention; this meant that he would not have the staff or the time to deal with a long, drawn out Fannie and Freddie conflict. Paulson's plan was to go in swiftly and seize the two GSEs; he told president Bush that "the first sound they hear will be their heads hitting the floor".
On September 7, 2008, James Lockhart, director of the
Federal Housing Finance AgencyThe Federal Housing Finance Agency is an independent federal agency created as the successor regulatory agency resulting from the statutory merger of the Federal Housing Finance Board , the Office of Federal Housing Enterprise Oversight , and the U.S...
(FHFA), announced that Fannie Mae and Freddie Mac were being placed into
conservatorshipConservatorship is a legal concept in the United States of America, where an entity or organization is subjected to the legal control of an external entity or organization, known as a conservator. Conservatorship is established either by court order or via a statutory or regulatory authority...
of the FHFA. The action was "one of the most sweeping government interventions in private financial markets in decades". Lockhart also dismissed the firms' chief executive officers and boards of directors, and caused the issuance to the Treasury new senior preferred stock and common stock warrants amounting to 79.9% of each GSE. The value of the common stock and preferred stock to pre-conservatorship holders was greatly diminished by the suspension of future dividends on previously outstanding stock, in the effort to maintain the value of company debt and of mortgage-backed securities. FHFA stated that there are no plans to liquidate the company.
The authority of the U.S. Treasury to advance funds for the purpose of stabilizing Fannie Mae, or Freddie Mac is limited only by the amount of debt that the entire federal government is permitted by law to commit to. The July 30, 2008 law enabling expanded regulatory authority over Fannie Mae and Freddie Mac increased the national debt ceiling US$ 800 billion, to a total of US$ 10.7 Trillion in anticipation of the potential need for the Treasury to have the flexibility to support the federal home loan banks.
2010 - Delisting
On June 16, 2010, Fannie Mae and Freddie Mac announced their stocks would be delisted from the NYSE. The Federal Housing Finance Agency directed the delisting after Fannie's stock traded below $1 a share for over 30 days. Their stocks will continue to trade on the Over-the-Counter Bulletin Board as long as there is trader interest. Reports from the finance agency specified that the delisting had nothing to do with current or future company performance.
Business
Fannie Mae made money partly by borrowing for low rates, and lending at higher rates. It borrowed by selling bonds, and lent by creating mortgages and mortgage backed securities which it held on its own books. Since its implied government guarantee meant it could borrow at very low rates, it earned a higher profit than did the non-government companies doing the same work. This was called "The big, fat gap" by Alan Greenspan. By August, 2008, Fannie Mae's mortgage portfolio was in excess of $700 billion.
Fannie Mae also earned a significant portion of its income from guaranty fees it received as compensation for assuming the credit risk on the mortgage loans underlying its single-family Fannie Mae MBS and on the single-family mortgage loans held in its retained portfolio. Investors, or purchasers of Fannie Mae MBSs, are willing to let Fannie Mae keep this fee in exchange for assuming the credit risk; that is, Fannie Mae's guarantee that the scheduled principal and interest on the underlying loan will be paid even if the borrower defaults.
Fannie Mae's charter has historically prevented it from guaranteeing mortgages with a loan-to-values over 80% without
mortgage insuranceMortgage insurance is an insurance policy which compensates lenders or investors for losses due to the default of a mortgage loan. Mortgage insurance can be either public or private depending upon the insurer...
or a repurchase agreement with the lender; however, in 2006 and 2007 Fannie Mae did purchase
subprimeIn finance, subprime lending means making loans to people who may have difficulty maintaining the repayment schedule...
and
Alt-AAn Alt-A mortgage, short for Alternative A-paper, is a type of U.S. mortgage that, for various reasons, is considered riskier than A-paper, or "prime", and less risky than "subprime," the riskiest category. Alt-A interest rates, which are determined by credit risk, therefore tend to be between...
loans as investments.
Business mechanism
Fannie Mae buys loans from approved mortgage sellers, either for cash or in exchange for a mortgage-backed security that comprises those loans and that, for a fee, carries Fannie Mae's guarantee of timely payment of interest and principal. The mortgage seller may hold that security or sell it. Fannie Mae may also securitize mortgages from its own loan portfolio and sell the resultant mortgage-backed security to investors in the
secondary mortgage marketThe secondary mortgage market is the market for the sale of securities or bonds collateralized by the value of mortgage loans. The mortgage lender, commercial banks, or specialized firm will group together many loans and sell grouped loans as securities called collateralized mortgage obligations ....
, again with a guarantee that the stated principal and interest payments will be timely passed through to the investor. By purchasing the mortgages, Fannie Mae and Freddie Mac provide banks and other financial institutions with fresh money to make new loans. This gives the United States housing and credit markets flexibility and liquidity.
In order for Fannie Mae to provide its guarantee to mortgage-backed securities it issues, it sets the guidelines for the loans that it will accept for purchase, called "conforming" loans. Mortgages that don't meet the guidelines are called "nonconforming". Fannie Mae produced an automated underwriting system (AUS) tool called Desktop Underwriter (DU) which lenders can use to automatically determine if a loan is conforming; Fannie Mae followed this program up in 2004 with Custom DU, which allows lenders to set custom underwriting rules to handle nonconforming loans as well. The
secondary marketThe page applies to the finanical term; For the merchandising concept, see Aftermarket .The secondary market, also called aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold....
for nonconforming loans includes jumbo loans, which are mortgages larger than the maximum mortgage that Fannie Mae and Freddie Mac will purchase. In early 2008, the decision was made to allow TBA (To-be-announced)-eligible mortgage-backed securities to include up to 10% "jumbo" mortgages.
Conforming loans
Fannie Mae and Freddie Mac have a limit on the maximum sized loan they will guarantee. This is known as the "conforming loan limit." The conforming loan limit for Fannie Mae, along with Freddie Mac, is set by Office of Federal Housing Enterprise Oversight (OFHEO), the regulator of both GSEs. OFHEO annually sets the limit of the size of a
conforming loanIn the United States, a conforming loan is a mortgage loan that conforms to GSE guidelines.In general, any loan which does not meet guidelines is a non-conforming loan...
based on the October to October changes in mean home price, above which a mortgage is considered a non-conforming jumbo loan. The conforming loan limit is 50 percent higher in
AlaskaAlaska is the largest state in the United States by area. It is situated in the northwest extremity of the North American continent, with Canada to the east, the Arctic Ocean to the north, and the Pacific Ocean to the west and south, with Russia further west across the Bering Strait...
and Hawaii. The GSEs only buy loans that are conforming to repackage into the secondary market, lowering the demand for non-conforming loans. By virtue of the law of supply and demand, then, it is harder for lenders to sell these loans in the secondary market; thus these types of loans tend to cost more to borrowers (typically 1/4 to 1/2 of a percent). Indeed, in 2008, since the demand for bonds not guaranteed by GSEs was almost non-existent, non-conforming loans were priced nearly 1% to 1.5% higher than conforming loans.
Implicit Guarantee and Government Support
Originally, Fannie had an 'explicit guarantee' from the government; if it got in trouble, the government promised to bail it out. This changed in 1968. Ginnie Mae was split off from Fannie. Ginnie retained the explicit guarantee. Fannie, however, became a private corporation, charted by congress and with a direct line of credit to the US Treasury. It was its nature as a Government Sponsored Enterprise (GSE) that provided the 'implied guarantee' for their borrowing. The charter also limited their business activity to the mortgage market. In this regard, although they were a private company, they could not operate like a regular private company.
Fannie Mae received no direct government funding or backing; Fannie Mae securities carried no actual explicit government guarantee of being repaid. This was clearly stated in the law that authorizes GSEs, on the securities themselves, and in many public communications issued by Fannie Mae. Neither the certificates nor payments of principal and interest on the certificates were explicitly guaranteed by the United States government. The certificates did not officially constitute a debt or obligation of the United States or any of its agencies or instrumentalities other than Fannie Mae. Every sub-prime era Fannie Mae prospectus read in bold, all-caps letters: "The certificates and payments of principal and interest on the certificates are not guaranteed by the United States, and do constitute a debt or obligation of the United States or any of its agencies or instrumentalities other than Fannie Mae." (Verbiage changed from all-caps to standard case for readability).
However, the implied guarantee, as well as various special treatments given to Fannie by the government, greatly enhanced its success.
For example, the implied guarantee allowed Fannie Mae and Freddie Mac to save billions in borrowing costs, as their credit rating was very good. Estimates by the Congressional Budget Office and the Treasury Department put the figure at about $2 billion per year. Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA "implicitly taxpayer-backed agencies". The Economist has referred to "the implicit government guarantee" of FHLMC and FNMA. In testimony before the House and Senate Banking Committee in 2004, Alan Greenspan expressed the belief that Fannie Mae's (weak) financial position was the result of markets believing that the U.S. Government would never allow Fannie Mae (or Freddie Mac) to fail.
Fannie Mae and Freddie Mac were allowed to hold less capital than normal financial institutions: e.g., they were allowed to sell mortgage-backed securities with only half as much capital backing them up as would be required of other financial institutions. Regulations exist through the FDIC Bank Holding Company Act that govern the solvency of financial institutions. The regulations require normal financial institutions to maintain a capital/asset ratio greater than or equal to 3%. The GSEs, Fannie Mae and Freddie Mac, are exempt from this capital/asset ratio requirement and can, and often do, maintain a capital/asset ratio less than 3%. The additional leverage allows for greater returns in good times, but put the companies at greater risk in bad times, such as during the current
subprime mortgage crisisThe U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
. FNMA is not exempt from state and local taxes. In addition, FNMA and FHLMC are exempt from SEC filing requirements; they SEC 10-K and 10-Q reports, but many other reports, such as certain reports regarding their REMIC mortgage securities, are not filed.
Lastly, Money market funds have diversification requirements, so that not more than 5% of assets may be from the same issuer. That is, a worst-case default would drop a fund not more than five cents. However, these rules do not apply to Fannie and Freddie. It would not be unusual to find a fund that had the vast majority of its assets in Fannie and Freddie debt.
In 1996, the
Congressional Budget OfficeThe Congressional Budget Office is a federal agency within the legislative branch of the United States government that provides economic data to Congress....
wrote "there have been no federal appropriations for cash payments or guarantee subsidies. But in the place of federal funds the government provides considerable unpriced benefits to the enterprises... Government-sponsored enterprises are costly to the government and taxpayers... the benefit is currently worth $6.5 billion annually.".
Accounting
FNMA is a financial corporation which uses
derivativesA derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...
to "hedge" its cash flow. Derivative products it uses include interest rate swaps and options to enter interest rate swaps ("pay-fixed swaps", "receive-fixed swaps", "basis swaps", "interest rate caps and
swaptionA swaption is an option granting its owner the right but not the obligation to enter into an underlying swap. Although options can be traded on a variety of swaps, the term "swaption" typically refers to options on interest rate swaps....
s", "forward starting swaps").
Duration gap is a financial and accounting term for the difference between the duration of assets and liabilities, and is typically used by banks, pension funds, or other financial institutions to measure their risk due to changes in the interest rate
"The company said that in April its average
duration gap-Definition:The difference between the duration of assets and liabilities held by a financial entity.-Overview:The duration gap is a financial and accounting term and is typically used by banks, pension funds, or other financial institutions to measure their risk due to changes in the interest rate...
widened to plus 3 months in April from zero in March." "The Washington-based company aims to keep its duration gap between minus 6 months to plus 6 months. From September 2003 to March, the gap has run between plus to minus one month."
All the Devils are Here
In
All the Devils Are HereAll the Devils Are Here: The Hidden History of the Financial Crisis is a nonfiction book by authors Bethany McLean and Joseph Nocera the 2008 financial crisis. It details account of how the financial crisis bubbled up from a volatile, and bipartisan, mixture of government meddling and laissez-faire...
, Bethany McLean and Joe Nocera paint an interesting portrait of the GSEs, including Fannie. Fannie had been aggressive in its political fights with Wall Street and Congress in the 1980s. In the 1990s Fannie ramped up the 'cut them off at the knees' strategy against political enemies. Tactics included a massive lobbying effort, neutering the OFHEO (its 1992-created regulator), creating a "partnership office" network to court the politically powerful with pork, giving high level employment to the well connected, giving out campaign contributions, creating a charity foundation, and threatening critics like FM Watch with retaliation. One of McLean & Nocera's sources even compared Fannie's activities to
Tammany HallTammany Hall, also known as the Society of St. Tammany, the Sons of St. Tammany, or the Columbian Order, was a New York political organization founded in 1786 and incorporated on May 12, 1789 as the Tammany Society...
.
McLean and Nocera also claim that Fannie 'gamed' its affordable housing numbers, with a process that was referred to internally as "stupid pet tricks". The National Community Reinvestment Coalition,
National Association of Affordable Housing LendersThe National Association of Affordable Housing Lenders is a U.S. trade organization representing financial institutions that provide financing and investing to low- and moderate-income communities...
, and studies by the Department of Housing and Urban Development all found the GSEs lacking in their actual, real support of affordable housing.
Accounting controversy
In late 2004, Fannie Mae was under investigation for its accounting practices. The
Office of Federal Housing Enterprise OversightThe Office of Federal Housing Enterprise Oversight was an agency within the Department of Housing and Urban Development. It was charged with ensuring the capital adequacy and financial safety and soundness of two government sponsored enterprises—the Federal National Mortgage Association and the...
released a report on September 20, 2004, alleging widespread accounting errors.
Fannie Mae was expected to spend more than $1 billion in 2006 alone to complete its internal audit and bring it closer to compliance. The necessary restatement was expected to cost $10.8 billion, but was completed at a total cost of $6.3 billion in restated earnings as listed in
Fannie Mae's Annual Report on Form 10-K.
Concerns with business and accounting practices at Fannie Mae predate the scandal itself. On June 15, 2000, the House Banking Subcommittee On Capital Markets, Securities And Government-Sponsored Enterprises held hearings on Fannie Mae.
On December 18, 2006, U.S. regulators filed 101 civil charges against chief executive
Franklin RainesFranklin Delano "Frank" Raines is an American business executive. He is the former chairman and chief executive officer of the Federal National Mortgage Association, commonly known as Fannie Mae, who served as White House budget director under President Bill Clinton...
; chief financial officer J. Timothy Howard; and the former controller Leanne G. Spencer. The three are accused of manipulating Fannie Mae earnings to maximize their bonuses. The lawsuit sought to recoup more than $115 million in bonus payments, collectively accrued by the trio from 1998–2004, and about $100 million in penalties for their involvement in the accounting scandal.
Conflict of interest
In June 2008, the Wall Street Journal reported that two former CEOs of Fannie Mae,
James A. JohnsonJames A. Johnson is a United States Democratic Party political figure, and the former CEO of Fannie Mae. He was the campaign manager for Walter Mondale's failed 1984 presidential bid and chaired the vice presidential selection committee for the presidential campaign of John Kerry...
and
Franklin RainesFranklin Delano "Frank" Raines is an American business executive. He is the former chairman and chief executive officer of the Federal National Mortgage Association, commonly known as Fannie Mae, who served as White House budget director under President Bill Clinton...
had received loans below market rate from
Countrywide FinancialBank of America Home Loans is the mortgage unit of Bank of America. Bank of America Home Loans is composed of:*Mortgage Banking, which originates purchases, securitizes, and services mortgages. In 2008, Bank of America purchased the failing Countrywide Financial for $4.1 billion...
. Fannie Mae was the biggest buyer of Countrywide's mortgages. The "Friends of Angelo" VIP Countrywide loan program included many people from Fannie Mae; lawyers, executives, etc.
Fannie Mae and Freddie Mac have given contributions to lawmakers currently sitting on committees that primarily regulate their industry: The House Financial Services Committee; the Senate Banking, Housing & Urban Affairs Committee; or the Senate Finance Committee. The others have seats on the powerful Appropriations or Ways & Means committees, are members of the congressional leadership or have run for president.
Leadership
- Michael Williams (2009– )
- Herbert M. Allison
Herbert M. Allison, Jr. is currently conducting a review of loans to energy companies, on behalf of the Obama administration. Mr. Allison served as Assistant Secretary of the Treasury for Financial Stability of the United States having been confirmed by the Senate onJune 19, 2009. He left the...
(2008–2009)
- Daniel Mudd
Daniel H. Mudd is the former President and CEO of Fannie Mae, a post he held from 2005-2008.He is the son of TV anchor, Roger Mudd. He holds a B.A. degree in American history from the University of Virginia and an M.P.A. from the John F. Kennedy School of Government at Harvard University...
(2005–2008)
- Franklin Raines
Franklin Delano "Frank" Raines is an American business executive. He is the former chairman and chief executive officer of the Federal National Mortgage Association, commonly known as Fannie Mae, who served as White House budget director under President Bill Clinton...
(1999–2004)
- James A. Johnson
James A. Johnson is a United States Democratic Party political figure, and the former CEO of Fannie Mae. He was the campaign manager for Walter Mondale's failed 1984 presidential bid and chaired the vice presidential selection committee for the presidential campaign of John Kerry...
(1991–1998)
- David Maxwell (1981-1991)
- Allan O. Hunter
Allan Oakley Hunter was an American lawyer and politician. Hunter, a Republican, served as the United States Representative for California's 9th congressional district from 1951 to 1953 and for California's 12th congressional district from 1953 to 1955...
(1970–1981)
See also
- Freddie Mac
- Ginnie Mae
- Canada Mortgage and Housing Corporation
Canada Mortgage and Housing Corporation is a Crown corporation, owned by the Government of Canada, founded after World War II to provide housing for returning soldiers...
– Canadian equivalent
External links