Why Did Freddie Mac And Fannie Mae Go Under?

By Author: Lawrence Roberts
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The Federal Home Loan Mortgage Corporation, also known as Freddie Mac, was created by Congress in 1970 to make possible a secondary mortgage market to provide greater liquidity to banks and other lending institutions to facilitate home mortgage lending. The Federal National Mortgage Corporation, also known as Fannie Mae, was originally created by the Federal Housing Authority (FHA) in 1938. In the beginning, Fannie Mae would securitize FHA loans, and it was the first to create a secondary mortgage market.

In 1968, the company was privatized to remove its debt from the balance sheet of the Federal Government. Fannie Mae's role in purchasing FHA loans was replaced by the Government National Mortgage Association, also known as Ginnie Mae. Both Freddie Mac and Fannie Mae are private corporations that have the implied backing of the Federal Government even though their activities are explicitly not guaranteed (until they were taken into conservatorship in September 2008). Collectively Freddie Mac, Fannie Mae and Ginnie Mae are known as Government Sponsored Entities or GSEs, and they are responsible for maintaining a secondary ...
... market for mortgage backed securities.

Fannie Mae and Freddie Mac buy and sell mortgage loans to create a secondary market. Mortgage originators bring groups of loans to the two companies which will either buy the loans to hold in their own portfolios, or they will bundle these loans together into securities in a process known as a "swap." In a swap program, the originator provides the group of loans, and Fannie Mae and Freddie Mac promise the originator they will receive payments from the pool, whether Fannie Mae and Freddie Mac receive said payments or not. This guarantee is tantamount to insurance as the two companies are taking on all risk of default for a small annual "guarantee fee," usually equal to 20 basis points (0.2% of the guarantee amount).

Fannie Mae and Freddie Mac have strict loan origination guidelines because of the insurance they are providing. In the terms of the mortgage industry, "conforming" loans are those loans that meet the underwriting standards of Fannie Mae and Freddie Mac. In the later stages of the rally in the Great Housing Bubble, more and more mortgage loans were being originated that did not conform to Fannie Mae's and Freddie Mac's standards. The asset-backed securities (ABS) market packages these non-conforming loans into collateralized debt obligations and garnered significant market share.

Despite their more conservative lending standards, Fannie Mae and Freddie Mac guaranteed many loans that performed poorly in the fallout of the Great Housing Bubble. They guaranteed many exotic loan types with inflated appraisals and committed many of the same errors as asset-backed securities (ABS) issuers during the bubble. When these loans started to go bad, Fannie Mae and Freddie Mac faced enormous losses, so the government had to assume conservatorship in 2008.
About Author:
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author's daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/ Visit Why did Freddie Mac and Fannie Mae Go Under?.