Decoding The Secondary Mortgage Market
No, Fannie Mae and Freddie Mac are not politicians. Nor are they CEOs or leaders of organizations of any kind. Rather, they are the driving force behind the secondary mortgage market. It’s a system that most average home buyers will never have any direct contact with but which nevertheless helps fuel the entire home-loan industry.
The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are two government-sponsored-enterprises (GSE) that serve very similar purposes. Fannie Mae was founded in 1938 as part of President Franklin Roosevelt’s “New Deal” program for social and economic reform. Freddie Mac was founded in 1970 by President Richard Nixon, with many of the same goals and mandates. Having two GSEs doing much the same thing meant more competition, which in turn benefited home buyers, albeit in a roundabout way.
What They Do
Fannie Mae and Freddie Mac purchase mortgages from lenders, repackage them into guaranteed securities, and then resell them to investors. Fannie Mae tends to focus on mortgages from retail banks, while Freddie Mac purchases more from smaller “thrift” banks.
Their intended purpose is to free up more lending capital and stabilize the markets. In the 1950s, before Fannie Mae was started, all mortgage lending was done by private entities, and it was a very volatile market. Mortgages often required at least 50% down payment, and generally had short terms of just a few years — nothing like the 30-year, fixed-rate terms most home buyers enjoy today. Because of that, home ownership was out of reach for the middle and lower classes, and even finding affordable rental properties could be difficult in some parts of the country.
With the government backing those loans, investors were more willing to put cash into the system. This in turn meant lenders could work with a much wider range of home buyers and offer them more time to repay.
What About The Bubble?
You might be asking, if these companies are so instrumental in keeping the mortgage market stable, does that mean they were the cause of the housing bubble? Well, their directors may be blamed for making some poor decisions. But those came near the end of the bubble, and in response to it, not as the cause.
In the mid- to late-2000s, some in the private lending market found a way around Fannie Mae and Freddie Mac. They began offering their own version of purchased and bundled securities to investors. Only instead of the very strict lending guidelines that the two government-backed firms employed, private investors accepted much riskier mortgages. Some belonged to subprime borrowers and others were “Alt-A” mortgages, which required good credit but little proof of income. (Lenders that were trying to inflate their numbers put Alt-A mortgages to good use.)
This private lending strategy drove the secondary mortgage market to greater heights, which in turn led to banks offering increasingly risky loans to increasingly credit-challenged buyers. In response, because they were losing market share — and, unlike many private firms, neither Fannie Mae nor Freddie Mac have any other products they can use to offset losses — their directors began to relax their own standards and started accepting Alt-A loans as well.
This proved to be a bad decision.
When the market collapsed, Fannie and Freddie lost a combined $265 billion between January 2008 and March 2012. This compelled the George W. Bush administration to place them in what is called “conservatorship,” subjecting them to increased oversight in exchange for government backing. In recent years, both entities have begun to recover, and have started to show a profit again. It remains to be seen how long they will remain under conservatorship.
What This Means For You
Mortgages are bought and sold every day, and this activity has no bearing on any homeowner’s credit rating. As long as you keep your mortgage payment current, it doesn’t matter who owns your actual mortgage or which investors are betting on you.
A collapse of the system would have far greater implications. Most (but not all) experts agree that, if Fannie Mae and Freddie Mac were to fail, the housing market would take a severe hit. It might not regress to a 1950s model overnight, but the robust mortgage trading market would likely dry up in a matter of years, taking with it much of the available credit.
It would also become much harder to get a loan. Those who did qualify would have to have much larger down payments, with much shorter terms, leading to much higher average monthly housing costs.
There is no need to panic just yet, however. As it stands, with Fannie Mae and Freddie Mac in conservatorship, the government has ensured their survival as they get back on their proverbial feet. Bush- and Obama-era changes to the banking system and Wall Street have slowly allowed the market to recover. The mortgage industry is in no danger of evaporating overnight, and products such as home loan refinancing are still viable options if you are looking to lower your interest rate or reduce your monthly payment.
Knowing that you have a place to call your own, where you can raise a family and feel safe, can be a powerful driving force. Fannie Mae and Freddie Mac seek to make that dream possible for far more people by ensuring the market has enough free capital to ensure loans are available to those who want them.