Aunt Fannie and Uncle Freddie

You may have noticed that two previously-sleepy companies have been in the news. The mammoth mortgage lenders Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) have come under severe pressure from the housing crisis. This prompted someone to ask me, “What’s up with Fannie and Freddie—I thought they were supposed to be safe!”

Before I go into the why, a brief overview of the companies is necessary. Fannie and Freddie are Government Sponsored Enterprises (GSEs), a group of corporations created by Congress that are intended to enhance the flow of credit to the housing market by maintaining an active secondary market for mortgages. Fannie and Freddie are publicly traded and are authorized to make loans and loan guarantees. However, they are not government agencies and Uncle Sam does not guarantee them. Although they are not directly backed by the full faith and credit of the US, GSE bonds have long been considered to be high credit quality and investors have assumed the government would bail them out in a crisis.

With Fannie’s stock down from over $70 in August to a low of $19.81 just a few days ago and Freddie’s from over $68 to a recent low of $17.52, some might say that the crisis is here. The stocks dropped over the past week as forced sales of securities by some distressed investors drove the yields on mortgage securities guaranteed by Fannie and Freddie to as much as about 3.5% Treasury securities, the highest since 1986. But over the course of the past year, Fannie and Freddie have been slammed as a result of the housing recession and anxieties that home-mortgage defaults will force the companies to raise more capital.

This may seem crazy, because GSEs mostly guarantee prime fixed-rate mortgages, not the more exotic subprime stuff. But even good borrowers have come under pressure as the housing market has continued to reel and the economy cools. Fannie says about 1% of the conventional single-family loans it owns or guarantees are 90 days or more overdue and that it expects credit, or default-related, losses equal to 0.11% to 0.15% of its mortgage portfolio this year, up from a previous forecast of 0.08% to 0.10%. Yes, these are teeny numbers, but considering that at the end of 2007, Fannie had guaranteed $2.55 trillion of mortgages, small numbers add up. Based on Fannie's estimate of 0.15% of losses, the total would be approximately $4 billion.

For this reason, the Federal Reserve stepped in yesterday to help. The US central bank said that it would lend up to $200 billion of Treasury securities and allow banks and dealers to pledge various flavors of mortgage-backed securities as collateral to help ease the strain on the credit market. That announcement helped Uncle Sam’s beleaguered cousins Aunt Fannie and Uncle Freddie tremendously, at least for the day, which judging by the reaction of investors (US stocks were up 3.5-4%), was necessary treatment.