Mortgage Confidential: Fannie and Freddie, What's Up With These Guys?
Mortgage expert David Reed invites WalletPop readers to ask him questions about real estate financing. Leave your questions in the comment section of this post.
Fannie Mae is the nickname given to the Federal National Mortgage Association (FNMA). First established as a government agency in 1938 by Franklin D. Roosevelt then later re-chartered in 1968 as a publicly traded and government sponsored enterprise. Fannie's job is to provide liquidity in the mortgage market. Freddie Mac, or the Federal Home Loan Corporation (FHMLC) was created in 1970 as a government sponsored private entity just like Fannie Mae with a similar mission, to provide liquidity and add stability in the housing market using private funds.
So how do they do that? How do they provide liquidity and stability in the mortgage market? Let's first look at liquidity and why that's important. When a mortgage company wants to make a home loan it can do so from it's vault of cash or it can be issued from the lender's credit line it has established for the sole purpose of making home loans. Let's say a lender has $100 million in available funds to place mortgages. Now let's say that same lender was successful in its endeavor and lent out everything it had. Zero bank balance. Okay, they've got a lot of real estate in their portfolio but they've run out of cash. Remember, they call lenders "lenders" for a reason, if there's no money to lend, they won't be lenders for very much longer. So what to do?
The mortgage company sells the mortgages they own to Fannie Mae or Freddie Mac, as long as those loans meet the underwriting requirements previously set by Fannie and Freddie. Fannie and Freddie now own the notes and collect the interest on those loans while the mortgage company now has replenished its credit line and is back in the lending business.
Next, stability. By establishing universal guidelines, mortgages become some sort of a commodity, which can be bought and sold to not only Fannie or Freddie but to other lending institutions. Lenders can sell loans individually or lenders can package them up and sell mortgages in bulk. Having a universal lending standards that lenders adhere to provides a stable platform and cash when needed to mortgage companies across the United States.
But Fannie and Freddie aren't making headlines today because of their "stability." Because these institutions are publicly traded they can issue stock to raise cash when they need it. But paranoia has crept in and Fannie and Freddie's stock has gotten hammered. Now there are questions that wonder if either have enough money on hand to cover losses through bad real estate loans. When the stock price is high, either can sell shares and raise cash, but if the stock is trading low, as it is now, simply selling stock (to those who would buy it) might not be enough.
That's why the Fed stepped in and allowed for either Fannie or Freddie to borrow money from the Fed in the same fashion banks do when they need some extra cash. If Fannie or Freddie fail, the entire real estate industry would come to a complete halt. Beaten with a Tonya Harding crow bar. Okay, it would only come to a complete halt for those who needed a home loan and couldn't pay cash for a new house.
What is being overlooked in all this is that our current mortgage "crisis" was caused not by lenders who made mortgage loans using Fannie and Freddie guidelines but by those in the sub prime and alternative markets. It was these two types of mortgage loans, rife with fraud and loose credit guidelines, that started this whole mess. Fannie Mae and Freddie Mac are not sub prime lenders, alternative lenders. Yes, they had some similar product, a very small part of their portfolio of loans, but nothing near what was being laid out by the now-defunct sub prime industry.
Lenders like to see their borrowers have unique things that subprime or alternative lenders didn't require such as a job, a paycheck, a down payment and decent credit. If Fannie and Freddie were awash in bad-credit, no income mortgages I'd be concerned but since they don't, I'm not.
The Fed did a good thing if only to let the world know that Fannie and Freddie are here to stay. This will all wash out and investors will find that these two government sponsored corporations are solid again. Once that happens, I think our little "mortgage mess" will soon be viewed in the rear view mirror.
Real estate finance expert David Reed is president of CD REED Mortgage Bankers in Austin, TX and author of Mortgage Confidential: What You Need to Know That Your Lender Won't Tell You and Mortgages 101: Quick Answers to over 250 Critical Questions About Your Home Loan.