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Federal National Mortgage Association
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The Federal National Mortgage Association (FNMA) , commonly known as Fannie Mae, is a stockholder-owned corporation chartered by Congress in 1968 as a government sponsored enterprise (GSE), but founded in 1938 during the Great Depression. The corporation's purpose is to purchase and securitize mortgages in order to ensure that funds are consistently available to the institutions that lend money to home buyers.
On September 7, 2008, James Lockhart, director of the Federal Housing Finance Agency (FHFA), announced that Fannie Mae and Freddie Mac were being placed into conservatorship of the FHFA.
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Encyclopedia
The Federal National Mortgage Association (FNMA) , commonly known as Fannie Mae, is a stockholder-owned corporation chartered by Congress in 1968 as a government sponsored enterprise (GSE), but founded in 1938 during the Great Depression. The corporation's purpose is to purchase and securitize mortgages in order to ensure that funds are consistently available to the institutions that lend money to home buyers.
On September 7, 2008, James Lockhart, director of the Federal Housing Finance Agency (FHFA), announced that Fannie Mae and Freddie Mac were being placed into conservatorship of the FHFA. The action is "one of the most sweeping government interventions in private financial markets in decades". , Fannie Mae and the Federal Home Loan Mortgage Corporation (Freddie Mac) owned or guaranteed about half of the U.S.'s $12 trillion mortgage market.
History
Fannie Mae was established in 1938 as a mechanism to make mortgages more available to low-income families. It was added to the Federal Home Mortgage association, a government agency in the wake of the Great Depression in 1938, as part of Franklin Delano Roosevelt's New Deal in order to facilitate liquidity within the mortgage market. In 1968, the government converted Fannie Mae into a private shareholder-owned corporation in order to remove its activity from the annual balance sheet of the federal budget. Consequently, Fannie Mae ceased to be the guarantor of government-issued mortgages, and that responsibility was transferred to the new Government National Mortgage Association (Ginnie Mae). In 1970, the government created the Federal Home Loan Mortgage Corporation (FHLMC), commonly known as Freddie Mac, to compete with Fannie Mae and, thus, facilitate a more robust and efficient secondary mortgage market. Since the creation of the GSEs, there has been debate surrounding their role in the mortgage market, their relationship with the government, and whether or not they are indeed necessary. This debate gained relevance due to the collapse of the U.S. housing market and subprime mortgage crisis that began in 2007. Despite this debate, Fannie Mae, as well as Ginnie Mae and later Freddie Mac, has played an integral part in the development of what was the most successful mortgage market in the world which has allowed U.S. citizens to benefit from one of the highest home ownership percentages in the world.
In 1999, Fannie Mae came under pressure from the Clinton administration to expand mortgage loans to low and moderate income borrowers. At the same time, 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. Shareholders also pressured Fannie Mae to maintain its record profits.
In 2000, due to 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 Mudd, then President and CEO of Fannie Mae, testified in 2007, instead the agency's responsible 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 rates, interest-only, negative amortization 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. "
Contributing Factors and Early Warnings
In 1999, The New York Times 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 Taleb 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'".
In 2002, President George W. Bush signed the Single-Family Affordable Housing Tax Credit Act. Dubbed "Renewing the Dream," the program would give nearly $2.4 billion in tax credits over the next five years to investors and builders who develop affordable single-family housing in distressed areas.
In 2003, the Bush administration recommended significant regulatory overhaul of Fannie Mae and Freddie Mac. However, the Democrats opposed that proposal, fearing that tighter regulation could sharply reduce financing for low-income housing, both low and high risk. Under immense lobbying pressure from Fannie Mae in association with Congressional Democrats led by Rep. Barney Frank, the Republican controlled Congress did not introduce any legislation aimed at bringing this proposal into law until 2005.
On December 16, 2003, President George W. Bush signed the American Dream Downpayment Act, a new program that provided grants to help home buyers with downpayment and closing costs. The act authorized $200 million dollars per year for the program for fiscal years 2004-2007.
President Bush also tripled the funding for organizations like Habitat for Humanity that help families help themselves become homeowners through 'sweat equity' and volunteerism in their communities. Substantially increasing, by at least $440 billion, the financial commitment made by the government-sponsored enterprises involved in the secondary mortgage market specifically targeted toward the minority market.
In 2006, the (first put forward by Sen. Chuck Hagel) where he pointed out that Fannie Mae's regulator reported that profits were "illusions deliberately and systematically created by the company's senior management". However, this legislation too met with opposition from both Democrats and Republicans. This bill was passed by the House, but was never presented to the Senate for a vote.
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 now, for a fee, carries Fannie Mae's guaranty 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 market, 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 follow the guidelines are called "non-conforming"; typically the secondary market for non-conforming loans deals in mortgages larger (termed "jumbo") than the maximum mortgage that Fannie Mae and Freddie Mac will purchase. In early 2008, the decision was made to allow TBA-eligible MBS to include up to 10% "jumbo" mortgages.
The mortgage crisis from late 2007
Following their mission to meet federal Housing and Urban Development (HUD) housing goals , GSE's such as Fannie Mae, Freddie Mac and the Federal Home Loan Banks (FHLBanks) have strived 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." Then in 2007, the subprime mortgage crisis began. An increasing number of borrowers, often with poor credit that 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 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.
Business
One part of Fannie Mae's income is generated through the positive interest rate spread between the rate paid to fund the purchase of mortgage investments and the return it earns on those retained mortgage investments. Fannie Mae's mortgage portfolio was in excess of $700 billion as of August 2008. Fannie Mae also earns a significant portion of its income from guaranty fees it receives 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.
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 loan based on the October to October changes in mean home price, above which a mortgage is considered a non-conforming jumbo loan. 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 the loans, thus it would cost more to the consumers (typically 1/4 to 1/2 of a percent.) The conforming loan limit is 50 percent higher in Alaska and Hawaii. However, in 2008, since the demand for bonds not guaranteed by the corporations is almost non-existent, non-conforming loans are almost 1% to 1.5% higher than the conforming loans.
Guarantees and subsidies
Speculation that the U.S. government would bail out an insolvent Fannie Mae is a hypothesis that had never been tested until recently, when the subprime mortgage crisis hit the U.S.
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. 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.
Shares in U.S. mortgage finance firms Fannie Mae and Freddie Mac plunged on Friday, July 11, 2008, and market speculation mounted that the government was set to take them over to resolve their funding problems.
Shares continued to plummet as investors became unsure about the adequacy of the capital held by FNMA. 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.
Fannie Mae and smaller Freddie Mac own or guarantee almost half of all home loans in the United States. They face billions of dollars in potential losses, and may need to raise additional, potentially substantial, amounts of new capital as the current downturn in the U.S. housing market continues.
Markets assume that the taxpayer will if necessary take on the burden of all their mortgages because they underpin the whole U.S. mortgage market.
If they were to collapse, mortgages would be harder to obtain and much more expensive.
U.S. Treasury Secretary Henry Paulson has said the government's primary focus is in supporting Fannie Mae and Freddie Mac in their current form.
No actual guarantees
Fannie Mae receives no direct government funding or backing; Fannie Mae securities carry no government guarantee of being repaid. This is explicitly 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 are guaranteed by the United States government. The certificates do not constitute a debt or obligation of the United States or any of its agencies or instrumentalities other than Fannie Mae.
The perception of government guarantees has allowed Fannie Mae and Freddie Mac to save billions in borrowing costs. Estimates by the Congressional Budget Office and the Treasury Department put the figure at about $2 billion per year.
Assumed guarantees
There is a wide belief that FNMA securities are backed by some sort of implied federal guarantee, and a majority of investors believe that the government would prevent a disastrous default. Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA "implicitly taxpayer-backed agencies." The Economist has referred to "[t]he 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.
Federal subsidies
The FNMA receives no direct federal government aid. However, the corporation and the securities it issues are widely believed to be implicitly backed by the U.S. government. In 1996, the Congressional Budget Office 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.". Fannie Mae and Freddie Mac are allowed to hold less capital than normal financial institutions: e.g., it is allowed to sell mortgage-backed securities with only half as much capital backing them up as would be required of other financial institutions. Specifically, 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 crisis. FNMA is also exempt from state and local taxes. In addition, FNMA and FHLMC are exempt from SEC filing requirements; however, both GSEs voluntarily file their SEC 10-K and 10-Q.
Accounting
FNMA is a financial corporation which uses derivatives 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 swaptions", "forward starting swaps").
- FNMA's accounting is discussed in
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 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."
Conservatorship
On September 7, 2008, Federal Housing Finance Agency (FHFA) Director James B. Lockhart III announced pursuant to the financial analysis, assessments and statutory authority of the FHFA, he had placed Fannie Mae and Freddie Mac under the conservatorship of the FHFA. FHFA has stated that there are no plans to liquidate the company.
The announcement followed reports two days earlier that the Federal government was planning to take over Fannie Mae and Freddie Mac and had met with their CEOs on short notice.
Under plan announced September 7, 2008, the federal government, via the Federal Housing Finance Agency, placed the two firms into conservatorship, and for each entity, dismissed the chief executive officer, and dismissed the present board of directors, and caused the issuance to the Treasury new senior preferred stock and separately warrants for common stock 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.
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. Access to Legislative History: Library of Congress THOMAS:
White House pre-signing statement: (July 23, 2008 ). Executive office of the President, Office of Management and Budget, Washington DC.
Scandals
Accounting scandal
In late 2004, Fannie Mae was under investigation for its accounting practices. The Office of Federal Housing Enterprise Oversight 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 .
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 Raines; 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. Johnson and Franklin Raines had received loans below market rate from Countrywide Financial. Fannie Mae was the biggest buyer of Countrywide's mortgages.
Fannie Mae and Freddie Mac have strategically 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.
Barney Frank has been a member of the House Financial Services Committee since 1991 (and is currently the chair). The HFSC is one of two government entities responsible for oversight over Fannie Mae. From 1991 to 1998, Barney Frank was in a romantic relationship with Herb Moses, who was an executive at Fannie Mae. While at Fannie Mae, Moses helped develop many of Fannie Mae’s affordable housing and home improvement lending programs. Other lawmakers have called this a "clear conflict of interest."
Leadership
See also
External links
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