Meet Fannie Mae, Freddie Mac in the recovery room
Meet Fannie Mae, Freddie Mac in the recovery room

By Richard Mize

Published: August 2, 2008

Fannie Mae? Freddie Mac?

Who? Here's who, since they've been in the news so much lately, especially this week after the president signed the big housing bill. Among a gozillion other things, it extends more credit to Fannie and Freddie and lets the U.S. Treasury buy stock in them to prop them up.

Congress chartered the Federal National Mortgage Association — known by the nickname Fannie Mae — in 1938 to issue bonds and use the proceeds to buy mortgages from lenders backed by the still-new Federal Housing Administration.

In 1934, about 10 percent of the nation's homes were in foreclosure, construction jobs were halved from the pre-Depression peak and credit was as scarce as hen's teeth because the banking system was about to collapse. Think George Bailey, Bailey Bros. Building & Loan and "It's a Wonderful Life.”

Creating the FHA and insurance for mortgage lenders led to loans with easier terms. By the 1950s, most loans were for 30 years, not the previously typical 10 years with a balloon payment at the end and the requirement of a 50-percent down payment. (Think Henry Potter, George Bailey's fat-cat slumlord nemesis).

Fannie Mae, by buying mortgages from lenders, would put money back in lenders' hands to be loaned again, increasing mortgage credit. By selling those government-insured mortgages to institutional investors on a secondary market, Fannie Mae helped level out credit availability and loan terms across regions.

Outside the New Deal programs, the mortgage markets operated with pre-Depression business as usual — but the newer longer-term 30-year mortgages were being financed based on short-term deposits. So, when the Federal Reserve took steps to influence short-term interest rates, it had a kind of whipsaw effect on the mortgage system, causing booms and busts in lending and housing into the 1970s.

Congress created the Federal Home Loan Mortgage Corp. — known by the nickname Freddie Mac — in 1970. Freddie Mac came amid a cluster of reforms that included privatizing Fannie Mae and allowing it to operate in a secondary market for conventional loans as well as government-back mortgages. Freddie Mac soon also started issuing mortgage-backed securities.

Those reforms linked mortgage lending more to capital markets and detached it from short-term deposits and the wide fluctuation in lending — and housing — that came with ticks up and down in short-term interest rates.

That's who Freddie and Fannie are and, more or less, why they are. (Many details from Federal Reserve Chairman Ben Bernanke's introduction to a symposium sponsored by the Federal Reserve Bank of Kansas City a year ago in Jackson Hole, Wyo. It's available online at www.KansasCityFed.org.)

So, why this week's lifelines, which could cost We, the People, $25 billion dollars?

In a nutshell, while Fannie and Freddie didn't suffer much from the subprime mortgage mess, big trouble in housing as a whole on a national basis caused stockholders to freak out and sell, sell, sell. Fannie's and Freddie's capitalization plummeted. If they collapsed, it could cripple the whole banking system, since so many banks have their securities in their own investment portfolios. Not good.

Not everyone thinks Fannie and Freddie are still needed. Others think they've gotten too big for their britches. Legitimate arguments can be made on all sides. What the government did this week was keep the two huge mortgage finance ships afloat.

What now? Keep them going? Break them up? Something else? Doing anything now, obviously, will be easier and less expensive for all of us than trying to decide what to do with two sunken ships loaded with ruined treasure — some $5 trillion, and that is a T, in liabilities at last count.

Your thoughts!