Fannie Mae and Freddie Mac: Key Players in Housing Finance

Fannie Mae and Freddie Mac are the leading figures in the U.S. housing finance sector, making up the largest credit market after government bonds. Their combined assets reach a staggering $7.8 trillion.

Originally, Fannie and Freddie were government-sponsored enterprises. This unique status, combined with significant political power, contributed to their considerable financial success. Fannie Mae, in particular, was known for its dominating presence in Washington.

However, during the Great Housing Bubble, these entities took on excessive credit risks and ultimately collapsed in 2008. They were then placed under government conservatorship, which meant they were fully controlled and bailed out by the government, totaling around $190 billion in U.S. Treasury stock purchases. This made the government the primary investor in these companies.

Now, Fannie and Freddie are no longer classified as government-sponsored entities since 2008; they are fully owned and operated by the government.

Former Congressman JJ Pickles (D-Texas) highlighted that the crucial idea behind Fannie and Freddie—and similar government-sponsored entities—is, “The risk is 99%, and the profit is 100% private.”

This arrangement is not advisable from an economic standpoint but remains very appealing to politicians and investors. They stand to gain when government subsidies are at play.

The substantial subsidies come from structuring a company with private shareholders who reap the benefits while being backed with protections offered at no cost by the U.S. Treasury—and, by extension, taxpayers.

When crises arise, the advantages of utilizing government credit flow to the shareholders, leaving the Treasury and taxpayers to shoulder the risks and expenses. It’s a lucrative opportunity for investors.

Thus, it’s no surprise that some major investors are advocating for Fannie and Freddie to revert to their former status as government-sponsored enterprises. These investors would benefit immensely from the government-backed profits.

The Trump administration has shown support for this initiative, with direct involvement from the president regarding government guarantees. Some equity in Fannie and Freddie still appears to be in private hands.

Nevertheless, those pushing to re-establish Fannie and Freddie as government-sponsored enterprises face complexities. Global investors in mortgage securities need to have complete trust in these guarantees.

At the same time, the Treasury wants to keep Fannie and Freddie off the government’s books. Can they strike a balance?

A solution to this dilemma was found during the Johnson administration in 1968, which sought to limit rising debt while expanding mortgage credit. The approach involved allowing private investors to hold Fannie’s shares, while subtly providing government support that would ensure market acceptance of guarantees without issuing explicit ones. According to a memorandum from that time, this setup “is indirect, but not expressly, a federal guarantee.”

This concept successfully transitioned Fannie into a government-sponsored entity, leading to the creation of Freddie in 1970.

Thus, the idea that guarantees were “not expressly direct” became a requirement for Fannie and Freddie’s offerings. It’s crucial to note that “securities, along with their interest, are not guaranteed by the United States and do not constitute a U.S. debt or obligation.”

It seems apparent, yet many did not buy into it, allowing the Johnson administration’s strategy to work.

Fannie and Freddie, along with their debts, remained off the budget until the downfall in 2008. That event starkly revealed the reality of guarantees as all creditors, including subordinate debt holders, were completely shielded from the failing corporation.

So what’s next? The least desirable outcome would be to reinstate Fannie and Freddie as government-sponsored entities, allowing free government guarantees that subsidize investors.

Theoretically, the ideal scenario would be returning to private ownership, but that would require Fannie and Freddie to compensate adequately for government guarantees. Unfortunately, as demonstrated, this fair price is quite steep, making their stocks less attractive to investors.

Fannie and Freddie are considered too big to fail, which means the government can’t escape this “tap” guarantee. The best course of action now appears to be keeping them under government control while addressing the resulting distortions in the housing market, taxpayer risks, and rising home prices.