In order to understand the relations between the Government Sponsored Enterprises and the Housing Market, it may be best to start with a little review of Fannie Mae and Freddie Mac's historical background. It all started when Franklin D. Roosevelt's New Deal came into effect. The federal government established the Federal National Mortgage Association, better known as Fannie Mae, in order to help reform the financial system during the Great Depression.
Fannie Mae's purchasing authority began with the Federal Housing Administration's (FHA's) insured mortgages. In 1944, it expanded to include loans guaranteed by the Veteran's Administration (VA). In 1968, the Vietnam War caused a strain in the national budget, which forced former president Lyndon B. Johnson to sign an amendment to Fannie Mae's Charter Act. This new Act was to free up space in the government's national budget by turning Fannie Mae into a private, shareholder-owned company. However, Fannie Mae was and is still currently a government sponsored enterprise (GSE). This means that Fannie Mae has the benefits of being privately owned, publicly traded, and operated by shareholders while also having the benefits of tax exemption and government support.
In 1970, the Federal Home Loan Mortgage Corporation (Freddie Mac) was established to control any further monopolization exercised by Fannie Mae. In the same year, Washington authorized the two GSEs to purchase conventional loans, which is currently comprised of prime and subprime loans. Prime mortgages are designed for borrowers with good credit who typically receive lower interest rates and more affordable mortgage options. Subprime mortgages are typically offered to borrowers who have low credit scores and/or fit into the lower income bracket. Fannie Mae and Freddie Mac were designed to open opportunities for homeownership. Therefore, they need to produce the business necessary to make homeownership affordable for borrowers. These two GSEs are not lending institutions and therefore do not lend money to borrowers directly. Instead, they provide funds to the lenders through their secondary market functions. The secondary market constitutes some of the highest buying authority with purchases being exchanged between lenders, banks, and savings institutions.
Foreign investors have helped Fannie Mae and Freddie Mac receive the necessary funds for the U.S. Housing Market in exchange for the guarantee that the principal and interest will be paid back regardless of borrower defaults. The added comfort for foreign investors came from the government backing that these two GSEs have. Fannie Mae and Freddie Mac have written guidelines that set the limit for conforming loans. These guidelines are set to minimize the credit risk of borrowers, who go through a series of paperwork and qualification process in order to determine their likelihood of mortgage default.
How do Fannie Mae and Freddie Mac make money? They charge lenders who in turn charge the borrowers a guarantee fee on loans that it has securitized into mortgage-backed security bonds. In addition, Fannie Mae and Freddie Mac profit from the difference between the interest rate they charge the homeowners and the rate their investors charge them.
Subprime lending turned into an avenue of increased possibilities for the two GSEs. Higher risk borrowers meant higher rates charged. The higher the rates charged the less likely the borrowers were able to qualify. Therefore, programs that increased the borrower's ability to qualify became more available. Such programs include adjustable rate mortgages, balloon mortgages, interest only, and increased amortization periods. The increased available programs produced more competition between the mortgage giants. In the 1990s, the two GSEs began their participation into subprime lending with A minus bond purchases. Over time, the competition within the subprime mortgages that were offered to high risk borrowers caused an increase in home values, which in turn caused an increase in equity available to borrowers. This led to equity liquidation, which provided temporary available funds for homeowners. Many high risk borrowers accepted adjustable or negatively amortizing programs in order for them to qualify for their mortgages. These programs made it temporarily affordable for borrowers to pay their mortgages. However, after a certain period of time (typically three to five years), the mortgage programs that were accepted by these borrowers forced them to find an alternative to their mortgage term as their mortgage's adjustable rate caused their payments to increase.
Today, subprime lending is almost nonexistent. Lesser programs have become available to borrowers who have had their equity reduced and debts increased. Increased delinquencies have caused lending institutions along with other mortgage giants to tighten their guidelines and minimize programs that were once created to increase homeownership across the country.
The GSE bonds backed with subprime loans may appear to be causing quite a stir, not only in domestic markets, but in foreign markets as well. As of the end of March, approximately $1.5 trillion in securities were held by foreign investors. There is speculation that the GSEs might be asking the U.S. government for additional help in the matter. Will the government come through for these two companies? What will the additional costs be to taxpayers? How will Americans cope with higher consumer prices and less income due to higher taxes? Is it possible for the government to help both the GSEs and their digressing economy?
Karlyn Katigbak has had years of experience working in different arenas of the mortgage industry from real estate and mortgage sales to processing, underwriting, and making due diligence decisions in the secondary market. She is currently one of the owners of a company that specializes in helping with the rehabilitation of properties during our current foreclosure crisis. In addition, Karlyn spend a lot of her free time helping borrowers find an alternative to foreclosure [http://www.myloannegotiator.net/] as well as finding homes for investors and future homeowners.
Karlyn invites you to please comment on her blog found in http://loanmods.blogspot.com/
Great Article !
ReplyDeleteCarlos Ruiz