Fannie Mae and Freddie Mac - Who Needs Them?
Why do we need Fannie Mae and Freddie Mac in the first place? And why have they been in the news so much lately? In this writer's opinion, both organizations should be left alone to sink or swim of their own accord. But I'll try to remain objective as we investigate the world of Fannie and Freddie ...
While they may sound like the distant aunt and uncle you never knew you had, Fannie Mae and Freddie Mac are actually big corporations. They are also big players in the secondary mortgage market. In fact, Fannie Mae essentially created the secondary mortgage market. So let's start with "her."
Fannie Mae (formally the Federal National Mortgage Corporation, or FNMA) was created by a congressional mandate back in 1938. That's right, history buffs ... at the tail end of the Great Depression. Fannie Mae was — and sort of still is — a program designed to extend home loans to a greater number of Americans by (A) providing federal funding to banks and (B) creating a secondary market where mortgage loans could be sold off to investors.
During and after the Depression, the U.S. housing market essentially collapsed. As a result, mortgage lenders became stricter with their lending practices, only offering loans to the best qualified of applicants. Does this sound familiar? But when Fannie Mae came onto the scene, lenders were able to offer mortgage loans to people who would never have qualified before.
For about the first 30 years of its existence, Fannie Mae was a federal institution with no competition whatsoever. It had basically created the secondary mortgage market, so there were no other institutions to compete with it in that arena.
In 1968, Lyndon B. Johnson privatized Fannie Mae to get it off the "government books." So now you had a private company that received federal support and monopolized a certain area of the American economy. Oops. Well, Americans historically do not like monopolies (unless you're part of the monopoly), so the federal government created Freddie Mac to perform the same basic function as Fannie Mae ... thus preventing the monopoly.
If you think this is a little bizarre, you're not alone. In a sense, Fannie Mae and Freddie Mac are like two government-created Frankenstein's monsters. We created the first monster, but it got too powerful. So we did the only logical thing — we created another monster to compete with the first. The Bride of Frankenstein revisited.
The "Freddie" of this equation is the Federal Home Loan Mortgage Corporation (FHLMC), which for some reason is called Freddie Mac for short. So what does this bloated organization with questionable accounting practices do? Basically, they do the same thing as Fannie Mae (see notes about monopoly and Frankenstein above).
Today, Fannie and Freddie both buy mortgages from lending institutions, "package" those mortgages with other financial products, and then sell them to investors throughout the world, from Europe to Asia and most points in between.
What's the purpose of this, you ask? Good question!
As touched on above, the purpose behind Freddie Mac and Fannie Mae is to extend homeownership to more Americans. You see, if Freddie and Fannie weren't there to purchase mortgage loans from lending institutions, there wouldn't be much of a secondary mortgage market. In that case, mortgage lenders would be a lot stricter about who they gave money to.
So without Freddie and Fannie, a person with bad credit and a shaky financial history would be turned away by mortgage lenders. No house for you today. Sorry. Better go play the lottery. But with Freddie Mac and Fannie Mae, mortgage lenders can offer loans to a wider range of people, even the ones they deem a credit risk. That's because they know there's a good chance they can sell off the loan to Freddie Mac.
Obviously, this liberates the mortgage lender from any concerns they might have had about getting their money back. For example, if they sell the loan to Freddie Mac, who in turn sells it off to some Asian bank ... what does the lender care if the borrower defaults on the loan? That's right, they don't care. So, because of Freddie Mac and Fannie Mae, the lenders can offer mortgage loans to people they wouldn't normally consider. Make the loan. Sell it to the secondary market. Wipe your hands clean of any future repercussions or defaults. Nice and neat!
Oh yeah, and during this process, the folks at Freddie Mac and Fannie Mae make a ton of money! In addition to their government sponsorship (and sometimes complete bailouts), these organizations make millions each year from selling off the loans. Witness — the CEO of Freddie Mac made nearly $20 million in 2007 (while the company itself was dropping stock value like a bad habit).
So what does all of this have to do with a person buying a home these days? Well, suffice it to say that if Freddie and Fannie went belly-up, it would be even tougher to obtain a mortgage loan. It's already tougher in the wake of the subprime crisis that came to a boil last year. Buyers need much higher credit scores these days in order to qualify for the lowest rates on a mortgage loan. Without a secondary mortgage market, that could tighten even more.
Some people in the government feel that homeownership should be made available to just about everyone. Hence, we have organizations like Fannie and Freddie to encourage lending to a larger pool of Americans.
But the hard truth is that some people just cannot afford to own a home. Period. If a person has a low credit score as the result of a bad financial history, the last thing they should do is buy a home. Especially a home they know they can't afford. They're only going to make their financial situation worse, because they will pay incredibly high interest rates on the new mortgage loan (as a result of having bad credit).
This is part of the reason we have record numbers of home foreclosures across the United States right now. Banks are giving mortgages to people who have no business taking on a mortgage.
So let's take a quick tally of who really benefits from the existence of Freddie Mac and Fannie Mae. Well, the people running these companies certainly benefit. They make millions in salary each year. The foreign investors certainly benefit -- at least in the beginning.
But do U.S. consumers benefit? Well, if you are one of the people who got into a new home courtesy of the secondary mortgage market, and you subsequently lost that home when the adjustable interest rate skyrocketed ... you might not feel so lucky. You may have wished somebody told you, "No, you should not own a home right now. You should fix your finances and your credit score first."
And if you've been paying attention, the federal government is more interested in bailing out private organizations and lenders these days. But they don't care much about the millions of Americans who have lost their homes.
What about the country as a whole? How do we benefit from the existence of Freddie Mac and Fannie Mae? In reality, not very much. As a result of the secondary mortgage market and money pits like the war in Iraq, we are more indebted to foreign banks now than we ever have been. In fact, these organizations harm our economy in the long run, by encouraging lenders to offer mortgage loans to poorly qualified borrowers ... the kinds of borrowers who become foreclosure statistics later on.
So, should we pump additional tax dollars into Fannie Mae and Freddie Mac to keep them afloat? Should we keep giving mortgage loans to people who simply cannot afford them? Should we plant the seeds for the next mortgage crisis and recession?
I say no. I say the hell with Freddie and Fannie. In the long run, we are much better off without them.
Who the Heck Are Fannie and Freddie?
While they may sound like the distant aunt and uncle you never knew you had, Fannie Mae and Freddie Mac are actually big corporations. They are also big players in the secondary mortgage market. In fact, Fannie Mae essentially created the secondary mortgage market. So let's start with "her."
Fannie Mae is Born
Fannie Mae (formally the Federal National Mortgage Corporation, or FNMA) was created by a congressional mandate back in 1938. That's right, history buffs ... at the tail end of the Great Depression. Fannie Mae was — and sort of still is — a program designed to extend home loans to a greater number of Americans by (A) providing federal funding to banks and (B) creating a secondary market where mortgage loans could be sold off to investors.
During and after the Depression, the U.S. housing market essentially collapsed. As a result, mortgage lenders became stricter with their lending practices, only offering loans to the best qualified of applicants. Does this sound familiar? But when Fannie Mae came onto the scene, lenders were able to offer mortgage loans to people who would never have qualified before.
For about the first 30 years of its existence, Fannie Mae was a federal institution with no competition whatsoever. It had basically created the secondary mortgage market, so there were no other institutions to compete with it in that arena.
In 1968, Lyndon B. Johnson privatized Fannie Mae to get it off the "government books." So now you had a private company that received federal support and monopolized a certain area of the American economy. Oops. Well, Americans historically do not like monopolies (unless you're part of the monopoly), so the federal government created Freddie Mac to perform the same basic function as Fannie Mae ... thus preventing the monopoly.
If you think this is a little bizarre, you're not alone. In a sense, Fannie Mae and Freddie Mac are like two government-created Frankenstein's monsters. We created the first monster, but it got too powerful. So we did the only logical thing — we created another monster to compete with the first. The Bride of Frankenstein revisited.
And Freddie Mac Too
The "Freddie" of this equation is the Federal Home Loan Mortgage Corporation (FHLMC), which for some reason is called Freddie Mac for short. So what does this bloated organization with questionable accounting practices do? Basically, they do the same thing as Fannie Mae (see notes about monopoly and Frankenstein above).
Today, Fannie and Freddie both buy mortgages from lending institutions, "package" those mortgages with other financial products, and then sell them to investors throughout the world, from Europe to Asia and most points in between.
What's the purpose of this, you ask? Good question!
As touched on above, the purpose behind Freddie Mac and Fannie Mae is to extend homeownership to more Americans. You see, if Freddie and Fannie weren't there to purchase mortgage loans from lending institutions, there wouldn't be much of a secondary mortgage market. In that case, mortgage lenders would be a lot stricter about who they gave money to.
So without Freddie and Fannie, a person with bad credit and a shaky financial history would be turned away by mortgage lenders. No house for you today. Sorry. Better go play the lottery. But with Freddie Mac and Fannie Mae, mortgage lenders can offer loans to a wider range of people, even the ones they deem a credit risk. That's because they know there's a good chance they can sell off the loan to Freddie Mac.
Obviously, this liberates the mortgage lender from any concerns they might have had about getting their money back. For example, if they sell the loan to Freddie Mac, who in turn sells it off to some Asian bank ... what does the lender care if the borrower defaults on the loan? That's right, they don't care. So, because of Freddie Mac and Fannie Mae, the lenders can offer mortgage loans to people they wouldn't normally consider. Make the loan. Sell it to the secondary market. Wipe your hands clean of any future repercussions or defaults. Nice and neat!
Oh yeah, and during this process, the folks at Freddie Mac and Fannie Mae make a ton of money! In addition to their government sponsorship (and sometimes complete bailouts), these organizations make millions each year from selling off the loans. Witness — the CEO of Freddie Mac made nearly $20 million in 2007 (while the company itself was dropping stock value like a bad habit).
What About Home Buyers?
So what does all of this have to do with a person buying a home these days? Well, suffice it to say that if Freddie and Fannie went belly-up, it would be even tougher to obtain a mortgage loan. It's already tougher in the wake of the subprime crisis that came to a boil last year. Buyers need much higher credit scores these days in order to qualify for the lowest rates on a mortgage loan. Without a secondary mortgage market, that could tighten even more.
But Who Really Benefits?
Some people in the government feel that homeownership should be made available to just about everyone. Hence, we have organizations like Fannie and Freddie to encourage lending to a larger pool of Americans.
But the hard truth is that some people just cannot afford to own a home. Period. If a person has a low credit score as the result of a bad financial history, the last thing they should do is buy a home. Especially a home they know they can't afford. They're only going to make their financial situation worse, because they will pay incredibly high interest rates on the new mortgage loan (as a result of having bad credit).
This is part of the reason we have record numbers of home foreclosures across the United States right now. Banks are giving mortgages to people who have no business taking on a mortgage.
So let's take a quick tally of who really benefits from the existence of Freddie Mac and Fannie Mae. Well, the people running these companies certainly benefit. They make millions in salary each year. The foreign investors certainly benefit -- at least in the beginning.
But do U.S. consumers benefit? Well, if you are one of the people who got into a new home courtesy of the secondary mortgage market, and you subsequently lost that home when the adjustable interest rate skyrocketed ... you might not feel so lucky. You may have wished somebody told you, "No, you should not own a home right now. You should fix your finances and your credit score first."
And if you've been paying attention, the federal government is more interested in bailing out private organizations and lenders these days. But they don't care much about the millions of Americans who have lost their homes.
What about the country as a whole? How do we benefit from the existence of Freddie Mac and Fannie Mae? In reality, not very much. As a result of the secondary mortgage market and money pits like the war in Iraq, we are more indebted to foreign banks now than we ever have been. In fact, these organizations harm our economy in the long run, by encouraging lenders to offer mortgage loans to poorly qualified borrowers ... the kinds of borrowers who become foreclosure statistics later on.
So, should we pump additional tax dollars into Fannie Mae and Freddie Mac to keep them afloat? Should we keep giving mortgage loans to people who simply cannot afford them? Should we plant the seeds for the next mortgage crisis and recession?
I say no. I say the hell with Freddie and Fannie. In the long run, we are much better off without them.
Labels: Home loans
posted by Brandon at
9:09 AM
