It's a snow storm, might as well meet Ginnie Mae, Freddie Mac and Fannie Mae.

Freddie Mac and Fannie Mae are the two biggest players in the US mortgage markets, dominating the market for loans under the conforming loan limit (currently $417,000) and ultimately purchasing about 2/3 of all single family mortgages between them. Ginnie Mae is a much smaller player, focused entirely on government guaranteed (FHA, VA, Agriculture Department) mortgages. I’ll get to their exact roles further on, but what’s really important to understand is that over 2/3 of the mortgage market would function much differently, if it functioned at all, without these three players. The second thing worth noting, and this is the timely part, is that these players have little involvement with the “subprime” or “jumbo” sections of the market and all three of them are functioning normally. (Freddie Mac and Fannie Mae do purchase some of the very top subprime mortgages, called “Alt-A” paper, that barely miss the requirements to be considered  “conventional” loans.)

Freddie Mac has a portfolio of $1.5 trillion in loans, more than the Gross Domestic Product of Russia, Canada, India or Mexico. Fannie Mae’s portfolio is even larger. Freddie Mac’s revenue, which is a fraction of a percent of the loans it underwrites, is over $40 billion a year and Fannie Mae’s is over $50 billion.
Fannie Mae was initially Federal National Mortgage Corporation, Freddie Mac was the Federal Home Loan Mortgage Corporation and Ginnie Mae was the Government National Mortgage Association. Fannie Mae and Freddie Mac are privately owned corporations chartered by Congress and have lines of credit with the US Treasury for $2.5 billion. Though there is a common perception that they have an implicit federal guarantee against failure, there is no legal guarantee and in fact the law authorizing them specifically disclaims any government guarantee. Ginnie Mae is a government agency and as such is legally backed by the full faith and credit of the US government.

But what do they actually do? Fannie Mae and Freddie Mac perform similar roles, while Ginnie Mae performs a bit different role. The typical mortgage loan is for a 15 or 30-year term. Bank deposits are mostly in checking accounts, savings accounts and certificates of deposit with terms of a few years. So, when a bank makes a mortgage loan, the bank may not want to actually hold the loan for its full life. This is where Fannie Mae, Freddie Mac and Ginnie Mae step in. Freddie Mac and Fannie Mae buy mortgage loans from the banks, package large numbers of loans into securities and then sell the securities, Mortgage Backed Securities, to investors and the banks get cash for the loans. (Technically, in most cases, the banks actually receive Fannie Mae, Freddie Mac or Ginnie Mae securities in exchange for the loans and the banks can then sell those securities to investors for cash or can use them in lieu of cash for some purposes.)

The function of the three agencies is to package loans for sale to investors so the banks can cash out. They make a market for the loans, called the secondary market. Because of their size and their relationship to the federal government, Fannie Mae and Freddie Mac are able to translate the demand for their securities into lower interest rates for mortgage borrowers and a more stable market for mortgage loans.

So, why three agencies instead of one? Each has a different purpose written into its charter.
Ginnie Mae has the narrowest charter of the three. Ginnie Mae doesn’t actually issue any securities or buy and sell any loans. Ginnie Mae does “guarantee investors the timely payment of principal and interest on MBS backed by federally insured or guaranteed loans.” These are insured or guaranteed by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the Department of Agriculture’s Rural Housing Service (RHS) and the Department of Housing and Urban Development’s Office of Public and Indian Housing (PIH). Ginnie Mae also provides a computer platform that allows Ginnie Mae approved lenders to package the mortgage backed securities that Ginnie Mae ultimately guarantees.
Fannie Mae was initially chartered to create and guarantee Mortgage Backed Securities for government loan programs and then for conventional mortgages. In 1968, Ginnie Mae was split off from Fannie Mae and Fannie Mae was privatized. From 1968, it’s purpose was to promote liquidity in mortgage markets by packaging conventional loans into securities for resale to investors.

In 1970, Congress chartered Freddie Mac. Part of the rationale was to provide competition for the newly private Fannie Mae, to avoid a mortgage market monopoly. Freddie Mac was also chartered specifically to promote “activities relating to mortgages on housing for low- and moderate-income families” and “to promote access to mortgage credit throughout the Nation (including central cities, rural areas, and under served areas).”

Freddie Mac and Fannie Mae are both regulated by the Department of Housing and Urban Development (HUD) and the Office of Federal Housing Enterprise Oversight (OFHEO).

For the home buyer or seller, what’s most important to understand is that Freddie Mac and Fannie Mae may ultimately end up owning your mortgage loan. As such, they have the right to set certain requirements on the lender who makes the loan. What this means for you is that it won’t matter how nice a tie you wear when you apply, whether you lose to your lender on purpose at golf or who you buy lunch for – if you and the house you are buying don’t meet the loan requirements set by Fannie Mae or Freddie Mac, you’re out of luck. If you’re getting a government guaranteed loan, Ginnie Mae won’t end up owning the loan, but the role of it and the government agencies involved will give them similar power to set requirements for the borrower and the property.

Investors should note a couple of things about Fannie Mae, Freddie Mac and Ginnie Mae securities. First, Fannie Mae and Freddie Mac securities are high quality debt securities backed by high quality mortgages. As private securities go, they are quite low risk. But, the market probably prices them as if they carried less risk than they do, because of the mistaken perception of a federal guarantee. By law, there is no federal guarantee on Fannie Maes or Freddie Macs. It’s also important to note that the capital requirement on Fannie Mae and Freddie Mac is 1/2 the required capital for other mortgage backed securities.

Ginnie Mae securities on the other hand are backed by the full faith and credit of the US government and are also backed by high quality mortgages making Ginnie Maes a very low risk fixed income security. (Arguably the backing by real estate makes them slightly less risky than even Treasury securities, though the distinction is trivial and for capital purposes they have a risk-weighting of zero.)

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