Fannie, Freddie central to US housing market

WASHINGTON - You can't get a mortgage from Fannie Mae and Freddie Mac, the huge US housing finance companies whose financial health has rattled markets and raised the specter of a government bailout this week.

Nor can you walk into a branch office or open an account with either firm.

But invisible though the companies may be to the typical borrower, they are central to US housing markets and very influential financial institutions. Their debt is held around the world and considered to be only slightly below gold-standard US Treasury securities in quality. They own or guarantee nearly half of all US mortgages.

Congress created the companies to ensure a deep and steady flow of funds to mortgages for home buyers of moderate incomes. The firms have strong political support among US lawmakers of both political parties.

The two companies are also expected to play an integral role in pulling the US housing market out of its worst downturn since the Great Depression -- if they can weather their current difficulties.

To some, they represent an ideal marriage of the private sector with the public interest.

To others, they create dangerous capital market distortions that put taxpayers at risk and crowd out other institutions from lucrative mortgage markets. Former Federal Reserve Chairman Alan Greenspan has told Congress he believes the companies could grow to the point that they would cause risk to the financial system.

Lower Homeownership Costs

The companies argue that they lower interest rates on the 30-year fixed rate mortgages they guarantee, reducing the costs of homeownership for many Americans.

By buying mortgages from lenders and repackaging them as securities for investors, Fannie Mae and Freddie Mac provide lenders more funds to make further loans. Their automated underwriting systems have standardized mortgage lending and evened out regional US credit disparities.

Chartered by Congress but privately owned, the companies are in a gray area between government and the private sector.

Their charters entitle them to $2.25 billion lines of credit to the Treasury that each firm could draw on in an emergency, lending them a stamp of government approval in the eyes of many. Yet they are privately held for-profit companies whose shares trade on the New York Stock Exchange.

The assumption by financial markets that the government would bail them out in a crisis means Fannie Mae and Freddie Mac can borrow more cheaply than purely private financial institutions.

At the same time, the companies are limited from lending directly to home buyers or from pursuing any other business line than mortgage finance. There are also upper limits to the size of mortgages they can buy.

Boom and Bust

Fannie Mae, originally called the Federal National Mortgage Association, was created in 1938 as part of a campaign to expand the US secondary mortgage market and boost homeownership. Congress launched Freddie Mac, christened as the Federal Home Loan Mortgage Corp., in 1970 to further expand home loan finance.

The companies have grown steadily alongside the housing expansion since the early 1990s.

Fannie Mae had assets of $843 billion as of March, while Freddie Mac had $802 billion in assets. Including the mortgage bonds it guarantees, Fannie Mae's total book of business topped $3 trillion in May, while Freddie Mac had $2.2 trillion in investments and mortgage-backed securities, meaning the companies have a hand in nearly half the US mortgage market.

But last week, investors began to worry that the companies would finally be pinched by the deep US housing slump and the credit crunch. Reports that the Bush administration was considering how to handle a failure at either company pummeled the firms' share prices.

Treasury Secretary Henry Paulson said on Friday his goal is for the companies to continue in their current form.

But continued pressure may prompt the government to act to strengthen the firms, for example by opening the Federal Reserve's emergency borrowing discount window to them.

One benefit from access to the discount window is that just under 30 percent of each company's debt is short-term.

The government could also seek to raise the companies' Treasury line of credit to a level that would provide stronger implicit backing for their debt.

The Wall Street Journal reported on Saturday that another option would be for the government to buy a block of the companies' preferred stock on terms that dilute the equity of common shareholders.

The companies themselves could seek to raise more capital, although this would be hard given the recent sharp drops in their stock prices. The two have raised $20 billion through preferred or common stock offerings since last fall.

One approach might be for them to issue a new class of preferred stock.