Fannie Mae: definition and meaning: Explained | TIOmarkets
BY TIO Staff
|July 8, 2024Fannie Mae, officially known as the Federal National Mortgage Association (FNMA), is a significant player in the United States' secondary mortgage market. This government-sponsored enterprise (GSE) plays an instrumental role in the nation's housing finance system, providing liquidity, stability, and affordability to the mortgage market.
Established in 1938 during the Great Depression, Fannie Mae's primary function is to buy mortgages from banks and other lenders, bundle them into mortgage-backed securities (MBS), and sell these securities to investors. This process frees up capital for lenders to issue more mortgages, thus promoting homeownership and rental housing.
Origins and History of Fannie Mae
The U.S. government established Fannie Mae as part of the New Deal in 1938. Its creation aimed to stimulate the housing market during the Great Depression by making more mortgages available to low- and moderate-income families. Initially, Fannie Mae was a government agency that purchased Federal Housing Administration (FHA) insured mortgages.
In 1968, Fannie Mae was restructured and privatized to remove its activity and debt from the federal budget. Despite its privatization, Fannie Mae retains a close relationship with the government, contributing to its perception as a quasi-governmental entity.
The Role of Fannie Mae in the Secondary Mortgage Market
Fannie Mae operates in the secondary mortgage market, which is where home loans and servicing rights are bought and sold between lenders and investors. The primary mortgage market is where borrowers and mortgage originators come together to negotiate terms and effectuate mortgage transaction.
By purchasing mortgages from lenders, Fannie Mae provides banks with the liquidity to make more loans. After purchasing these mortgages, Fannie Mae bundles them into mortgage-backed securities (MBS), which are then sold on the open market. The process of securitizing mortgages into MBS reduces risk and increases liquidity in the mortgage market.
Impact of Fannie Mae on the Housing Market
Fannie Mae's activities have a significant impact on the housing market. By purchasing and securitizing mortgages, Fannie Mae facilitates a continuous flow of credit in the housing market and creates liquidity for lenders. This process ultimately makes it possible for individuals to buy homes, even during times of economic uncertainty.
Furthermore, Fannie Mae's underwriting standards influence the types of loans that lenders make. Because Fannie Mae only buys mortgages that meet its underwriting criteria, lenders are incentivized to make loans that conform to these standards.
Fannie Mae's Business Model
Fannie Mae's business model is based on the spread between the interest rates homeowners pay on their mortgages and the interest rates Fannie Mae pays on the MBS it issues. Fannie Mae makes money from the difference, or spread, between these two rates.
Moreover, Fannie Mae charges a guarantee fee, or "g-fee," to lenders when it buys their mortgages. This fee is intended to cover the credit risk associated with the potential default of the underlying mortgages. The g-fee is typically passed on to the borrower in the form of a slightly higher interest rate.
Types of Mortgages Purchased by Fannie Mae
Fannie Mae purchases a variety of mortgage types, including fixed-rate, adjustable-rate, and government-insured mortgages. However, it only buys conforming loans, which are mortgages that meet specific criteria set by Fannie Mae and the Federal Housing Finance Agency (FHFA).
These criteria include loan limits, which are the maximum amounts that Fannie Mae will purchase for a single-family home. In 2021, the base conforming loan limit for a single-family home is $548,250, although it can be higher in areas with high-cost housing.
Fannie Mae's Relationship with Lenders
Fannie Mae's relationship with lenders is a crucial aspect of its business model. By buying mortgages from lenders, Fannie Mae provides them with the liquidity needed to make more loans. This relationship is beneficial for both parties: lenders can issue more mortgages, and Fannie Mae can generate revenue from the mortgages it purchases and securitizes.
However, this relationship also comes with risks. If a lender fails to adhere to Fannie Mae's underwriting standards when originating a mortgage, Fannie Mae can force the lender to buy back the loan. This risk of repurchase incentivizes lenders to carefully adhere to Fannie Mae's underwriting standards.
Fannie Mae and the 2008 Financial Crisis
Fannie Mae played a significant role in the 2008 financial crisis. Leading up to the crisis, Fannie Mae and its sister organization, Freddie Mac, took on significant risk by purchasing and securitizing a large number of subprime mortgages. When the housing market collapsed, many of these mortgages defaulted, leading to substantial losses for Fannie Mae.
In September 2008, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship, a legal process that allows the government to take control of a company to prevent its failure. Since then, Fannie Mae has been under the direct control of the FHFA, which has made efforts to stabilize the company and the broader housing finance system.
Reforms After the Financial Crisis
Following the financial crisis, Fannie Mae underwent significant reforms. These reforms aimed to reduce the risk associated with Fannie Mae's activities and to ensure the stability of the housing finance system. One of the most significant changes was the introduction of stricter underwriting standards for the mortgages Fannie Mae purchases.
Additionally, Fannie Mae and Freddie Mac have been required to reduce their mortgage portfolios. This requirement aims to limit the systemic risk associated with these entities and to encourage the return of private capital to the mortgage market.
Fannie Mae Today
Today, Fannie Mae continues to play a vital role in the U.S. housing finance system. Despite the reforms implemented after the financial crisis, Fannie Mae and Freddie Mac still dominate the secondary mortgage market, purchasing the majority of mortgages originated in the U.S.
However, the future of Fannie Mae is uncertain. There have been ongoing discussions about ending the conservatorship of Fannie Mae and Freddie Mac and restructuring the housing finance system. These discussions reflect the ongoing debate about the appropriate role of the government in the housing market.
Conclusion
In conclusion, Fannie Mae is a crucial component of the U.S. housing finance system. By purchasing and securitizing mortgages, Fannie Mae provides liquidity to lenders, promotes homeownership, and contributes to the stability of the housing market.
However, Fannie Mae's activities also come with risks, as demonstrated by its role in the 2008 financial crisis. As such, the future of Fannie Mae and the broader housing finance system remains a topic of ongoing debate and reform.
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