When the recession struck huge bailouts were given to Fannie Mae and Freddie Mac, and in an instant, these unknown entities became household names. Even after this instant change, many don’t know the exact difference between the two and what they each actually do.
Fannie Mae is a U.S. government-sponsored enterprise that purchases loans from the commercial banks that issue those loans to homeowners. Fannie Mae would then package bundles of loans into securities and re-sell them as mortgage-backed bonds.
The company was created in 1938 and has been a publicly-traded company since 1968.
While this may seem like an odd process it is crucial to support home purchases and to make sure that banks in the U.S. have the funds they need to continue issuing home loans. Fannie Mae buys the mortgages from the bank, providing them with the cash they need, before turning the bundled securities into investment products for investors.
The recession was largely triggered by the fact that the degree of risk in many of the bundled mortgage-backed bonds was badly misunderstood. This resulted in mortgage-backed securities held by many investors defaulting at a rate that far exceeded what was expected, and these toxic securities couldn’t be sold to anyone. Since they made up such a significant percentage of many institutions’ investment portfolios this sudden loss shocked the investment community and caused a significant downward spiral.
Freddie Mac is nearly identical to Fannie Mae but with one key distinction. Freddie Mac purchases loans from smaller ‘thrift’ banks as opposed to the large commercial banks that Fannie Mae deals with. Besides that, Freddie Mac performs the exact same job and experienced identical repercussions during the recession. Freddie Mac was created in 1970 to further support the secondary market in mortgage securities already being operated in by Fannie Mae.
Both companies were stuck holding extensive toxic securities when the recession struck in 2007 and required extensive bailouts from the federal government ($187 billion +). The reason the federal government bailed them out is largely due to the central role they held in the home mortgage and security issuing industry. If either company were to fail the legal entanglements and implications to investors and homeowners would have taken a decade to work out. Additionally, without the ability to re-sell mortgages to these entities commercial banks would have greatly slowed the pace at which mortgages were given, disastrously slowing the economy.
Since then, however, the bailouts have been repaid and as the government took ownership of the companies during the bailout they are now generating a significant profit for the U.S. government. While the government is expected to sell their interest in the two companies at some point in the future they have not done so yet.