Fannie Mae and Freddie Mac

Fannie Mae and Freddie Mac are federally backed home mortgage companies created by the U.S. Congress. Neither institution originates or services its own mortgages. Instead, they buy and guarantee mortgages issued through lenders in the secondary mortgage market.

The two entities virtually monopolized the secondary mortgage market until the 1990s. That’s when growing federal regulation and new legislation that allowed banks and other financial companies to merge sparked more competition from conventional companies. Still, Fannie Mae and Freddie Mac continue to dominate the secondary mortgage market in the U.S. today, despite concerns about being two of the largest “too big to fail” companies.

Together, these agencies make the mortgage market more liquid, stable, and affordable by providing liquidity and guarantees to thousands of banks, savings and loans, and mortgage companies in the U.S. Here’s a look at how the two work, their roles in the 2008 financial crisis, and what they’re doing today to help homeowners and renters during the COVID-19 pandemic.

What Is Fannie Mae?

In the early 20th century, homeownership was out of reach for many people in the United States. Unless you could pay cash for an entire home (which few people could), you were looking at a prohibitively large down payment and a short-term loan that would culminate in a big balloon payment.

During the Great Depression, nearly one in four homeowners lost their homes to foreclosure, the banks didn’t have any money to lend, and the nation faced a real housing crisis.

In response, Congress in 1938 created the Federal National Mortgage Association (FNMA), better known as Fannie Mae, to provide a reliable, steady source of funding for housing. It brought a new type of mortgage to the market: the long-term, fixed-rate loan with an option to refinance at any time.

For decades, Fannie Mae was the dominant buyer and seller of government-insured mortgages in the nation. Eventually, Congress did two things to boost competition in the secondary mortgage market:

1.  It privatized Fannie Mae in 1968, making it a shareholder-owned company funded entirely with private capital.
2.  It created Freddie Mac in 1970.

Fannie Mae was created as a federal government agency in 1938 as part of an amendment to the National Housing Act. Fannie Mae initially bought mortgages insured by the Federal Housing Administration (FHA) and later added loans guaranteed by the Veterans Administration (VA) to the mix.

In 1954, Fannie Mae was converted into a public-private, mixed ownership corporation under the Federal National Mortgage Association Charter Act. It became privately owned in 1968 and two years later become authorized to buy conventional mortgages in addition to FHA and VA loans.

In the 1980s, Fannie Mae started to issue mortgage-backed securities (MBS) to provide more liquidity in the mortgage investment market. It gets the money to buy mortgage-related assets by issuing assorted debt securities in the U.S. and international capital markets.

What Is Freddie Mac?

Freddie Mac is the unofficial name of the Federal Home Loan Mortgage Corporation. It was established in 1970 under the Emergency Home Finance Act to expand the secondary mortgage market and reduce interest rate risk for banks. In 1989, it was reorganized and turned into a shareholder-owned company as part of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA).

Freddie Mac’s charter is quite similar to that of Fannie Mae, in the sense that it expands the secondary market for mortgages and mortgage-backed securities by buying loans made by banks, savings and loans, and other lending institutions. However, unlike Fannie Mae, which buys mortgages from major retail and commercial banks, Freddie Mac buys its loans from smaller banks (i.e., “thrift” banks) that focus on providing banking services to communities.

What Do Fannie Mae and Freddie Mac Do?

Fannie Mae and Freddie Mac have similar charters, mandates, and regulatory structures. Each buys mortgages from lenders to either hold in their portfolios or repackage as mortgage-backed securities that can be sold. In turn, lenders use the money they get from selling mortgages to originate more loans. This helps individuals, families, and investors access a continuous and stable supply of mortgage funding.

According to their charters, Fannie Mae and Freddie Mac “establish secondary market facilities for residential mortgages [and] provide that the operations thereof shall be financed by private capital to the maximum extent feasible.” Both entities are mandated to do the following:

• Maintain stability in the secondary market for residential mortgages
• Respond appropriately to the private capital market
• Offer ongoing support to the secondary market for residential mortgages by increasing the liquidity of mortgage investments and making more money available for residential mortgage financing
• Promote access to mortgage credit by increasing the liquidity of mortgage investments and making more money available for residential mortgage financing

Fannie Mae has one additional responsibility according to its charter: to manage and liquidate federally owned mortgage portfolios to minimize any adverse effects on the residential mortgage market and minimize losses to the federal government.

Who Regulates Fannie Mae and Freddie Mac?

According to Fannie Mae and Freddie Mac’s congressional charters, which gave them government-sponsored enterprise (GSE) status, they operate with certain ties to the U.S. federal government that provide a financial backstop. For instance, in September 2008, during the height of the financial crisis, they were placed under the direct supervision of the federal government.

During normal times, the government ties remain a bit more hidden, but nonetheless important. According to their congressional charters:

• The president of the United States appoints five of the 18 members of the organizations’ boards of directors.
• The secretary of the Treasury is authorized to buy up to $2.25 billion of securities from each company to support its liquidity.
• Both companies are exempt from state and local taxes.
• Both companies are regulated by the Department of Housing and Urban Development (HUD) and the Federal Housing Finance Agency (FHFA).

The FHFA regulates, enforces, and monitors Fannie and Freddie’s capital standards, and limits the size of their mortgage investment portfolios. HUD is responsible for the general housing missions of Fannie and Freddie.

An Implicit Guarantee

Fannie and Freddie’s GSE status has created certain perceptions in the marketplace of safety. One was that the federal government would step in and bail out these organizations if either firm ever ran into financial trouble, as was seen in the lead up to the Great Recession. This is known as an implicit guarantee. 

Because the market believed in this implicit guarantee, Fannie Mae and Freddie Mac were allowed to borrow money in the bond market at lower yields than other financial institutions could.

The yield on Fannie Mae and Freddie Mac’s corporate debt, known as agency debt, has been historically about 35 basis points higher than U.S. Treasury bonds. AAA-rated financial firm debt, in comparison, has historically yielded about 70 basis points more than U.S. Treasury bonds. Thirty-five basis points may not seem like much, but it made a huge difference because of the trillions of dollars involved.

Role in the Financial Crisis of 2008

With a funding advantage over their Wall Street rivals, Fannie Mae and Freddie Mac made sizable profits for more than two decades throughout the 1990s and early 2000s. Over this time period, there was frequent debate about Fannie and Freddie among economists, financial market professionals, and government officials.

Did the implied government backing of Fannie and Freddie actually benefit U.S. homeowners? Or was the government just helping the companies and their investors while creating a moral hazard?

Fannie Mae and Freddie Mac were given a government-sponsored monopoly in a large segment of the U.S. secondary mortgage market. This monopoly—combined with the government’s implicit guarantee to keep these firms afloat—would later contribute to the mortgage market’s collapse.

In 2007, Fannie Mae and Freddie Mac began to experience large losses on their retained portfolios, especially on their Alt-A and subprime investments. In 2008, the sheer size of their retained portfolios and mortgage guarantees led the FHFA to conclude that they would soon be insolvent.

On March 19, federal regulators allowed the two firms to take on another $200 billion in debt in the hopes of stabilizing the economy. However, by September 6, 2008, it was clear that the market believed the firms were in financial trouble, and the FHFA put the companies into conservatorship. They received $190 billion in bailout funding and have since paid it back, but are still in conservatorship.

Of course, a long list of missteps led to the Great Recession. However, critics say Fannie and Freddie created an enormous amount of debt and credit guarantees in the years leading up to 2007, and that Congress should have recognized the systematic risks to the global financial system that these firms posed.

Role in the COVID-19 Pandemic

If you have been impacted by the COVID-19 pandemic, you may have concerns about paying your mortgage or rent. One way to get help is through your state’s unemployment insurance program.

The CARES (Coronavirus Aid, Relief, and Economic Security) Act temporarily boosted unemployment insurance benefits through three programs: Federal Pandemic Unemployment Compensation (FPUC), Pandemic Emergency Unemployment Compensation (PEUC), or Pandemic Unemployment Assistance (PUA).

The CARES Act also offers protections for homeowners who have Fannie Mae and Freddie Mac mortgages. Under the CARES Act, lenders and loan services are prohibited from starting a judicial or non-judicial foreclosure against you—or finalizing a foreclosure judgment or sale until Jan. 31, 2020, according to the FHFA.

You can request a mortgage forbearance for up to 180 days (and potentially extend it another 180 days) if you have a financial hardship due to the COVID-19 pandemic.

Additionally, the FHFA also put in place more flexible lending and appraisal standards to make sure that homebuyers can close on loans during the pandemic and that all parties involved can maintain social distancing throughout the process.

Mortgage Relief Program

If you have a Fannie Mae mortgage and can’t make your payment due to a COVID-19-related job loss, income reduction, or illness, your mortgage servicer can help with mortgage relief options, including:

• A forbearance plan that lowers or suspends your mortgage payments for up to 12 months
• No late fees during the forbearance period
• Repayment options after the forbearance period, which include a repayment plan to catch up gradually or a loan modification plan to maintain or lower your monthly payment
• Foreclosure and eviction relief

Fannie Mae has another program—the Disaster Response Network—that can help with the broader financial implications of the COVID-19 emergency. The Disaster Response Networks provides access to HUD-approved housing counselors for homeowners with Fannie Mae-owned loans and renters in Fannie Mae-financed properties. The counselors can create personalized plans, provide financial coaching and budgeting, and support you for up to 18 months.

Freddie Mac Mortgage Forbearance

If you have a Freddie Mac-owned mortgage, you may be eligible for help if you have been directly or indirectly impacted by the COVID-19 pandemic. There are currently several mortgage relief options if you can’t make your mortgage payment due to a loss or decline in income, including:

• Up to 12 months of mortgage forbearance
• Waived penalties and late fees
• Halt on all foreclosure actions and evictions until Jan. 31, 2021 (extended from Dec. 31 2020)
• Loan modification options to lower payments or keep payments the same after the forbearance period

More Flexible Lending and Appraisal Standards

The easing of lending and appraisal standards for homebuyers applying for a mortgage backed by Fannie Mae and Freddie Mac during the pandemic has been extended by the FHFA to Jan. 31, 2021 from Dec. 31, 2020. They allow: 

• Alternative appraisals on purchase and refinance loans (conducting drive by and online appraisals versus on site)
• Alternative methods for documenting income and verifying employment before loan closing (for example, employment verification via email)
• Expanding the use of power of attorney to assist with loan closings (for example, e-signatures)

The Bottom Line

Fannie Mae and Freddie Mac are charged with keeping the U.S. mortgage market running smoothly. Both companies buy mortgages from various lenders, which helps maintain a steady and reliable source of mortgage funding for individuals, families, and investors.

Today, the housing industry is keeping a watchful eye on the COVID-19 situation—and how it could impact Fannie and Freddie and the 28 million homeowners that have a mortgage backed by them. The FHFA estimates that an additional $1.1 billion to $1.7 billion in expenses will be shouldered by Fannie Mae and Freddie Mac due to the existing foreclosure moratorium and its extension, on top the $6 billion in costs already incurred by the two.