Working Paper 2009-13
Abstract: Fannie Map and Freddie Mac are government-sponsored enterprises that play a central role in U.S. residential mortgage markets. In recent years, policymakers became increasingly concerned about the size and risk-taking incentives of these two institutions. In September 2008, the federal government intervened to stabilize Fannie Map and Freddie Mac in an effort to ensure the reliability of residential mortgage finance in the wake of the subprime mortgage crisis. This paper describes the sources of financial distress at Fannie Mae and Freddie Mac, outlines the measures taken by the federal government, and presents some evidence about the effectiveness of these actions. Looking ahead, policymakers will need to consider the future of Fannie Mae and Freddie Mac as well as the appropriate scope of public sector activities in primary and secondary mortgage markets.
JEL classification: G21, G28
Key words: government-sponsored enterprises, mortgages, securitization, conservatorship
Fannie Mae and Freddie Mac are enormous government-sponsored enterprises, or GSEs, that play a central role in U.S. secondary mortgage markets. (1) Together, as of midyear 2008, the two institutions held or guaranteed about $5.5 trillion in U.S. residential mortgage debt--slightly more than the $5.3 trillion in publicly held U.S. Treasury debt at that time.
Both Fannie Mae and Freddie Mac have been the subject of a great deal of attention and controversy in recent years. Each GSE has: faced accounting scandals; been criticized for not sufficiently targeting their activities toward low-and-moderate income communities and households; and had policymakers voice concerns that they posed a systemic risk to the global financial system. (2)
At the heart of these (and other) issues is the GSEs' incentive structure. Fannie Mae and Freddie Mac are publicly traded financial institutions that were created by Acts of Congress in order to fulfill a public mission. These charter Acts imbue the two GSEs with important competitive advantages (most notably, implied public-sector support for their obligations) and define the scope of their permissible activities. (3) Over time, Fannie Mae and Freddie Mac became exceptionally large, profitable, and politically powerful.
Recently, however, Fannie Mae's and Freddie Mac's singular exposure to U.S. residential mortgages--coupled with a thin capital base--resulted in both of these GSEs facing financial distress. U.S. housing markets became increasingly stressed through 2007 and resulted in severe disruption to mortgage markets. Secondary market liquidity for mortgages not backed by Fannie Mae and Freddie Mac almost entirely dried-up; and GSE-backed mortgages saw liquidity pressure as evidenced by unusually wide yield spreads. These developments resulted in a significant reduction in the availability and cost of mortgage credit for homeowners.
As a result of these developments, the federal government was compelled to intervene to stabilize both GSEs and mortgage markets more generally. On September 7, 2008, Fannie Mae and Freddie Mac were placed into conservatorship by their federal regulator: the Federal Housing Finance Agency (FHFA). Concurrent with this action, the U.S. Treasury entered into "senior preferred stock agreements" with each institution obligating the federal government to inject up to as much as $100 billion each in Fannie Mac and Freddie Mac. The Treasury also established a mortgage-backed securities purchase facility and a standing credit facility in order to support the residential mortgage market.
The actions of the FHFA and the Treasury last September stabilized Fannie Mae and Freddie Mac by effectively guaranteeing their debt and mortgage-backed obligations. (4) A subsequent announcement by the Federal Reserve that it would purchase substantial quantities of Fannie Mae and Freddie Mac debt and mortgage-backed securities during 2009 has further acted to improve liquidity in those markets and bring yield spreads back to historical norms. …