LIVE: What's a GSE? Fannie Mae, Freddie Mac Weren't the First

GSEs, Fannie Mae, Freddie Mac - before we choose their fate, understand their historyWhile the Treasury Department hosts today's conference about the future of the GSEs Fannie Mae and Freddie Mac, you may be wondering what is a GSE and how did we get into this mess in the first place?

For more conference-related coverage from AOL Real Estate, read these columns by housing experts Alyssa Katz, Jeff Corbett, and Patricia Orsini.

GSE is short for government-sponsored enterprise. These enterprises include a group of corporations in the financial services arena that were created by the U.S. Congress to enhance the flow of credit to particular markets. So they are hybrid corporations that raise private capital to fulfill their public mission.

Congress' intent in creating GSEs was to improve the flow of credit for particular segments of the capital markets, such a mortgages or student loans. They operate under the banner of the federal government as federally chartered institutions.
Fannie Mae and Freddie Mac were not the first GSEs. The first GSE was created by Congress in 1916 and called the Farm Credit System, which is a network of federally chartered cooperatives and related service organizations that lend to agricultural producers, rural homeowners, farm-related businesses, and public utility cooperatives in the U.S.

Next on the list of GSEs created by Congress was the Federal Home Loan Banks, which became GSEs in 1932. The banks are owned by the corporations that use their services. These banks do not lend to individuals only to other banks. Their role is to provide stable, low-cost funding to member institutions for home mortgages and small business loans. They also provide loans for rural, agricultural and economic development.

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Fannie Mae, officially called the Federal National Mortgage Association, was established in 1938 after the Great Depression to develop a secondary mortgage market, which buys up mortgages from their originators (mostly banks) and frees up new money for lending. Initially Fannie Mae bought up primarily federally insured mortgages of the Federal Housing Administration (FHA).

But in 1968 Fannie Mae was converted into a shareholder-owned corporation, so its activity could be removed from the balance sheet of the federal government. Fannie Mae was actually split in two government entities. Guaranteed loans, such as FHA, Veterans Administration (VA) and Farmers Home Administration (FmHA) fell under the new governmen-owned corporation -- the Government National Mortgage Association (GNMA). GNMA is wholly owned by the government and falls under the Department of Housing and Urban Development.

By 1970, Fannie Mae was authorized to buy private mortgages, not insured by the government. In the same year, Congress created Freddie Mac, officially called the Federal Home Loan Mortgage Corporation, to compete with Fannie Mae. Congress wanted to facilitate a more competitive and efficient secondary mortgage market.

Even though Fannie Mae and Freddie Mac mortgages and mortgage bonds weren't insured by the government, as are GNMA loans, the market assumed that the government would never let them fail, so they were always able to sell their mortgage bonds at a lower cost than private financial institutions. This gave them the edge to grow into two powerhouses in the mortgage marketplace. Today they own or securitize (package mortgages and sell them as bonds) about 70 percent of residential mortgage loans. Most of the rest of the mortgage market today are government insured loans. The private mortgage market is on its deathbed.

When the housing market crashed, Fannie Mae and Freddie Mac started losing billions. So far the two institutions have needed about $160 billion in taxpayer bailouts. In September 2008 the government took control of these two GSEs, and the meeting Tuesday will start discussions about their future.

That future is up in the air, but in prepared remarks for Tuesday's conference Treasury Secretary Timothy Geithner is expected to say, "We will not support a return to the system where private gains are subsidized by taxpayer losses."

Federal Reserve Chairman Ben Bernanke also gave Fannie and Freddie their last rites. His only hints, in writing, about next steps, were in a letter to Rep. Marcy Kaptur (D-Ohio): "There are a variety of organizational forms that might replace Fannie Mae and Freddie Mac that could likely provide mortgage credit without the systemic risks associated with these institutions in the past."

Congress certainly is letting the administration know that major changes are needed for the $12-trillion U.S. mortgage market. Many Democrats, hearing from affordable housing advocates, want the government to minimize its efforts to encourage homeownership and instead shift priorities toward rental housing for low-income people.

Republicans, who just a few years ago supported President George W. Bush's "ownership society," have introduced legislation to get rid of Fannie and Freddie completely. One thing both sides can agree on is that, whatever happens to Fannie and Freddie, the government must take taxpayers off the hook on future mortgage-funding schemes.

Folks who work for Fannie and Freddie are banned from political activity, so they won't have much to say in the new design, other than to pass their ideas on to their liaison with the Treasury Department.

Lita Epstein has written more than 25 books including "The 250 Questions Everyone Should Ask About Buying Foreclosures."

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