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Message: Making Sense of Problems at Fannie and Freddie
July 11, 2008
Making Sense of Problems at Fannie and Freddie
An examination of how Fannie Mae works, the current problems and some proposed actions.
How Does Fannie Mae Work?
Fannie Mae was originally formed by the federal government in 1938 in order to supply liquidity to the mortgage market. Since 1968, it has been a private corporation. Here is how it works:
Fannie Mae takes mortgage loans from banks, in order to repackage them in the form of mortgage-backed securities. There are limits on the types and size of loans it can guarantee.
Those mortgage-backed securities are sold to investors, and Fannie Mae guarantees that the loans will be repaid.
Fannie Mae also borrows money from the debt markets, traditionally at a rate much lower than other banks, and uses it to buy mortgages it holds as its own investments. By buying these loans, Fannie injects new money into the housing economy.
What Are the Problems It Is Facing?
Guaranteed Mortgages
Fannie Mae's exposure to the housing market has soared. Its outstanding guaranteed mortgages tripled from 1998 to 2007.
Delinquency Rates
The delinquency rate on Fannie Mae mortgages is rising. This increases the chance that the company will have to make good on its guarantees.
Borrowing Costs
Borrowing costs are volatile and rising, reflecting investor concerns about Fannie Mae's health.
What Is the Reach of the Problems?
Fannie Mae and Freddie Mac own or guarantee about half of the nation's $12 trillion mortgage market.
Housing Markets
They provide the capital that banks use to write new loans. If Fannie and Freddie stop buying loans, banks may stop making new loans, freezing the United States housing market.
Fannie and Freddie provide stability and liquidity to the mortgage market. If it is harder for them to borrow money, mortgage interest rates will rise.
Financial Markets
Virtually every Wall Street bank and many overseas financial institutions, central banks and investors do business with Fannie and Freddie.
What Are the Consequences of a Government Bailout?
Paying for Losses
A bailout would potentially put taxpayers on the hook for billions to offset Fannie's and Freddie's losses.
National Debt
It would most likely make it more expensive for the United States government to borrow money in the future, since the government's potential obligations, which currently stand at about $9 trillion, would rise by an additional $5 trillion.
Investors Suffer
Shares of Fannie and Freddie would probably be worth little or nothing,
Sources: Fannie Mae; Office of Federal Housing Enterprise Oversight; Bloomberg
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