Debt Consolidation

Fannie Mae and Freddie Mac Explained

Posted on: July 21, 2008
Written by: V. Ann Paulins, PhD

Government Sponsored Enterprises (GSEs) are financial services corporations, established by the United States government, that are intended to make credit available to consumers, specifically to fund agriculture, home mortgages, and education. The government is motivated to support GSEs because such activity stimulates the US economy and provides opportunities for Americans to invest in agriculture, homes, and educational pursuits.

Fannie Mae and Freddie Mac are two GSEs that are privately owned, but publicly chartered, and exist to offer credit for home financing. The Federal National Mortgage Association (FNMA; commonly called "Fannie Mae") was established by the US government in 1938, but became a private corporation in 1968. The Federal Home Loan Mortgage Corporation (FHLMC; commonly called "Freddie Mac") was created in 1970. Both are stockholder owned corporations authorized to make loans and loan guarantees.

Quick Facts

The mortgages offered by Fannie Mae and Freddie Mac exist on the secondary market; that is the securities (loans) that have already been issued to consumers are traded. When there is demand by speculators to trade in debt securities, the price of those securities go up (law of supply and demand), resulting in lower interest rates for long term mortgage loans. This is desirable for consumers seeking low rate mortgages. Conversely, when the demand decreases, the prices of the stocks go down, and the interest rates associated with those loans rises. This creates hardship for Americans who hold mortgages that are not offered at fixed rates, as the costs of their loans increase. This is the current situation that is causing problems for these companies.

In the past year, a declining market for mortgages has threatened the value of stocks held for Fannie Mae and Freddie Mac. The fact that the stocks are currently privately owned, rather than publicly traded, prevents investment by common stockholders. A common, public stock means that anyone who wishes to purchase shares may do so. Private stocks are issues only to investors selected by the company selling the shares as a method of raising money to finance the venture.

In the midst of a troubled economy and reduced demand for mortgages, the value of Freddy Mac shares fell 50% in early July 2008 as there was concern that the US government would take control of the company resulting in loss of equity for current shareholders. As a result, the Chairman of the Federal Reserve, Ben Bernanke, announced to the House of Representative Financial Services Committee that Fannie Mae and Freddie Mac were not in danger of failing. On Sunday July 13, 2008 the US Fed and the Treasury Department asked Congress to temporarily increase lines of credit to Fannie Mae and Freddy Mac and to let the government buy their stock.

On July 18, 2008, Freddie Mac filed with the Securities and Exchange Commission (SEC) in a step toward issuing common stock. This move would create the potential for more capital to be raised to support the enterprise, but could also dilute the value of its stock for current investors. The Federal Reserve offered emergency loans to both companies.

Ann Paulins is the director and professor of the School of Human and Consumer Sciences at Ohio University