EXPLAINING FANNIE & FREDDIE

Over the past year I've been asked about the role of Fannie Mae and Freddie Mac in the housing market collapse many times. It's obvious from the discussions we see in the media that there are not too many people that understand what either one does. I discuss their history and describe what both do in my book.

Still, this brief overview of both entities from Richard's Real Estate (hat tip to Economist's View) is about as succinct and on point as I've run across.

Back in 1987, when I started working on housing finance issues, I wondered this very thing. So I spoke with the person in charge of secondary market business for a Wisconsin Savings and Loan called First Financial (I wish I could remember his name now).

He had a crisp explanation: Fannie Mae was a Savings and Loan for Mortgage Bankers ... This was in fact the reason for their original existence. Fannie has been around since 1938, and it became private in 1968, and its purpose was to raise money from capital markets to fund mortgages originated by mortgage bankers. Between 1938-68, its business was entirely FHA and VA loans; thereafter it could fund private sector loans.

Freddie was chartered in 1970 at least in part in response to regional differences in the availability of mortgage credit. At that time, around 60 percent of mortgages were held by Savings and Loan Associations. These S&Ls were local businesses, who could not lend outside of their communities (I will need to double check, but my recollection is that they could not lend more then 150 miles away from their front door).

As young people migrated from the Northeast and Midwest to the sunbelt, leaving their parents and grandparents behind, there was a geographic mismatch between the location of deposits and the demand for mortgage credit. Freddie was invented to buy loans from S&Ls, turn them into securities, and sell them in the secondary market. This allowed money to flow where it was needed.

The distinction between the two institutions disappeared in 1992, with the passage of the Federal Housing Enterprises Financial Safety and Soundness Act (FHEFSSA). I am guessing that the reason we kept two around was to have some competition in the MBS issuance market.

I'll discuss this on the program after our discussion with Professor Thoma.

- Mark