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The mortgage market: Understanding government-sponsored entities

Brent Nyitray, CFA

Imagining a post–Fannie Mae and post–Freddie Mac world (Part 2 of 6)

(Continued from Part 1)

Fannie Mae and Freddie Mac are government-sponsored entities in conservatorship

During the financial crisis, the government took over the government-sponsored entities (GSEs) Fannie Mae and Freddie Mac and effectively nationalized them. The stocks still trade, but the government owns 79.9% of both. The only reason there still is stock trading is that if the government holds less than 80%, it doesn’t have to recognize Fan and Fred’s $5 trillion worth of debt as sovereign debt. Fannie and Freddie are now profitable, and the government conveniently changed their status right before, so all of Fannie and Fred’s profit goes directly to the government and doesn’t “pay down” any of their obligations.

The role of the GSEs in the mortgage market

The GSEs act as a conduit between mortgage banks and investors like American Capital Agency (AGNC), Annaly (NLY), Hatteras (HTS), or CYS Investments (CYS). Fannie Mae and Freddie Mac purchase securities from the big banks like Wells Fargo (WFC) and JP Morgan (JPM) and issue mortgage-backed securities. The idea was to have the GSEs act as a back-up to the local banking system. Many small banks served only their small communities, and as the communities went, so went the banks. If there were a natural disaster or problems with a major employer leaving, the banks would be so overexposed that they would collapse as well, leaving communities with no banks. By employing securitization, the banks could sell their mortgages to investors anywhere and diversify their risk. Fannie and Fred made that happen.

A second role of Fannie Mae and Freddie Mac was to use their own balance sheet as a way to stabilize the mortgage market. If there were a dearth of credit in a locality, or if a bank were in trouble, the GSEs could buy those mortgages for their own book, relieving selling pressure on the local bank and the community.

Continue to Part 3

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