Federal
National Mortgage Association, commonly known as
Fannie Mae, was founded in 1938 during the Great Depression as part of
the New Deal. It is a government-sponsored enterprise (GSE), though it
has been a publicly traded company since 1968. The corporation's purpose
is to expand the secondary mortgage market by securitizing mortgages in
the form of mortgage-backed securities (MBS), allowing lenders to
reinvest their assets into more lending and in effect increasing the
number of lenders in the mortgage market by reducing the reliance on
thrifts.
Following
their mission to meet federal Housing and Urban Development (HUD)
housing goals, GSEs such as Fannie Mae, Freddie Mac and the Federal Home
Loan Banks (FHLBanks) have striven to improve home ownership of low and
middle income families, underserved areas, and generally through
special affordable methods such as "the ability to obtain a 30-year
fixed-rate mortgage with a low down payment... and the continuous
availability of mortgage credit under a wide range of economic
conditions." (HUD 2002 Annual Housing Activities Report) Then in
2003-2004, the subprime mortgage crisis began. The market shifted away
from regulated GSE's and radically toward Mortgage Backed Securities
(MBS) issued by unregulated private-label securitization conduits,
typically operated by investment banks.
As
mortgage originators began to distribute more and more of their loans
through private label MBS's, GSE's lost the ability to monitor and
control mortgage originators. Competition between the GSEs and private
securitizers for loans further undermined GSEs power and strengthened
mortgage originators. This contributed to a decline in underwriting
standards and was a major cause of the financial crisis.
Investment
bank securitizers were more willing to securitize risky loans because
they generally retained minimal risk. Whereas the GSE's guaranteed the
performance of their MBS's, private securitizers generally did not, and
might only retain a thin slice of risk. Often, banks would offload this
risk to insurance companies or other counterparties through credit
default swaps, making their actual risk exposures extremely difficult
for investors and creditors to discern.
The
shift toward riskier mortgages and private label MBS distribution
occurred as financial institutions sought to maintain earnings levels
that had been elevated during 2001-2003 by an unprecedented refinancing
boom due to historically low interest rates. Earnings depended on
volume, so maintaining elevated earnings levels necessitated expanding
the borrower pool using lower underwriting standards and new products
that the GSE's would not (initially) securitize. Thus, the shift away
from GSE securitization to private-label securitization (PLS) also
corresponded with a shift in mortgage product type, from traditional,
amortizing, fixed-rate mortgages (FRM's) to nontraditional, structurally
riskier, nonamortizing, adjustable-rate mortgages (ARM's), and in the
start of a sharp deterioration in mortgage underwriting standards. The
growth of PLS, however, forced the GSEs to lower their underwriting
standards in an attempt to reclaim lost market share to please their
private shareholders. Shareholder pressure pushed the GSEs into
competition with PLS for market share, and the GSEs loosened their
guarantee business underwriting standards in order to compete. In
contrast, the wholly public FHA/Ginnie Mae maintained their underwriting
standards and instead ceded market share.
The
growth of private-label securitization and lack of regulation in this
part of the market resulted in the oversupply of underpriced housing
finance that led, in 2006, to an increasing number of borrowers, often
with poor credit, who were unable to pay their mortgages - particularly
with adjustable rate mortgages (ARM), caused a precipitous increase in
home foreclosures. As a result, home prices declined as increasing
foreclosures added to the already large inventory of homes and stricter
lending standards made it more and more difficult for borrowers to get
mortgages. This depreciation in home prices led to growing losses for
the GSEs, which back the majority of US mortgages. In July 2008, the
government attempted to ease market fears by reiterating their view that
"Fannie Mae and Freddie Mac play a central role in the US housing
finance system". The US Treasury Department and the Federal Reserve took
steps to bolster confidence in the corporations, including granting
both corporations access to Federal Reserve low-interest loans (at
similar rates as commercial banks) and removing the prohibition on the
Treasury Department to purchase the GSEs' stock. Despite these efforts,
by August 2008, shares of both Fannie Mae and Freddie Mac had tumbled
more than 90% from their one-year prior levels.
On
Oct 21, 2010 FHFA estimates revealed that the bailout of Freddie Mac
and Fannie Mae will likely cost taxpayers $224–360 billion in total,
with over $150 billion already provided.
Business
Fannie
Mae made money partly by borrowing for low rates, and lending at higher
rates. It borrowed by selling bonds, and lent by creating mortgages and
mortgage backed securities which it held on its own books. Since its
implied government guarantee meant it could borrow at very low rates, it
earned a higher profit than did the non-government companies doing the
same work. This was called "The big, fat gap" by Alan Greenspan. By
August, 2008, Fannie Mae's mortgage portfolio was in excess of $700
billion.
Fannie
Mae also earned a significant portion of its income from guaranty fees
it received as compensation for assuming the credit risk on the mortgage
loans underlying its single-family Fannie Mae MBS and on the
single-family mortgage loans held in its retained portfolio. Investors,
or purchasers of Fannie Mae MBSs, are willing to let Fannie Mae keep
this fee in exchange for assuming the credit risk; that is, Fannie Mae's
guarantee that the scheduled principal and interest on the underlying
loan will be paid even if the borrower defaults.
Fannie
Mae's charter has historically prevented it from guaranteeing mortgages
with a loan-to-values over 80% without mortgage insurance or a
repurchase agreement with the lender; however, in 2006 and 2007 Fannie
Mae did purchase subprime and Alt-A loans as investments.
Business mechanism
Fannie Mae headquarters at 3900 Wisconsin Avenue, NW in Washington, D.C.
Fannie
Mae buys loans from approved mortgage sellers, either for cash or in
exchange for a mortgage-backed security that comprises those loans and
that, for a fee, carries Fannie Mae's guarantee of timely payment of
interest and principal. The mortgage seller may hold that security or
sell it. Fannie Mae may also securitize mortgages from its own loan
portfolio and sell the resultant mortgage-backed security to investors
in the secondary mortgage market, again with a guarantee that the stated
principal and interest payments will be timely passed through to the
investor. By purchasing the mortgages, Fannie Mae and Freddie Mac
provide banks and other financial institutions with fresh money to make
new loans. This gives the United States housing and credit markets
flexibility and liquidity.
In
order for Fannie Mae to provide its guarantee to mortgage-backed
securities it issues, it sets the guidelines for the loans that it will
accept for purchase, called "conforming" loans. Mortgages that don't
meet the guidelines are called "nonconforming". Fannie Mae produced an
automated underwriting system (AUS) tool called Desktop Underwriter (DU)
which lenders can use to automatically determine if a loan is
conforming; Fannie Mae followed this program up in 2004 with Custom DU,
which allows lenders to set custom underwriting rules to handle
nonconforming loans as well.The secondary market for nonconforming loans
includes jumbo loans, which are mortgages larger than the maximum
mortgage that Fannie Mae and Freddie Mac will purchase. In early 2008,
the decision was made to allow TBA (To-be-announced)-eligible
mortgage-backed securities to include up to 10% "jumbo" mortgages.
Conforming loans
Fannie
Mae and Freddie Mac have a limit on the maximum sized loan they will
guarantee. This is known as the "conforming loan limit." The conforming
loan limit for Fannie Mae, along with Freddie Mac, is set by Office of
Federal Housing Enterprise Oversight (OFHEO), the regulator of both
GSEs. OFHEO annually sets the limit of the size of a conforming loan
based on the October to October changes in mean home price, above which a
mortgage is considered a non-conforming jumbo loan. The conforming loan
limit is 50 percent higher in Alaska and Hawaii. The GSEs only buy
loans that are conforming to repackage into the secondary market,
lowering the demand for non-conforming loans. By virtue of the law of
supply and demand, then, it is harder for lenders to sell these loans in
the secondary market; thus these types of loans tend to cost more to
borrowers (typically 1/4 to 1/2 of a percent). Indeed, in 2008, since
the demand for bonds not guaranteed by GSEs was almost non-existent,
non-conforming loans were priced nearly 1% to 1.5% higher than
conforming loans.
