Origins
Fannie Mae (the Federal National Mortgage Association) was established in 1938 as part of the New Deal to provide a secondary market for FHA-insured loans, helping to revive the housing market after the Great Depression. In 1968, to move its debt off the federal budget during the Vietnam War, Fannie was split into a government entity (Ginnie Mae) and a private, shareholder-owned corporation (Fannie Mae). Freddie Mac (the Federal Home Loan Mortgage Corporation) was created in 1970 to provide competition and expand the market for conventional mortgages.
These institutions were unique “odd creatures”: half-government, half-private entities with a social mandate to expand homeownership while maintaining high profitability for shareholders. They solved the problem of the “broken funding mechanism” of the 1970s, where local savings and loans lacked the capital to meet housing demand. By creating the first mortgage-backed securities (MBS) in 1970–71, they enabled local lenders to sell their loans and replenish their cash to make new ones.
Structure & Function
As Government-Sponsored Enterprises (GSEs), Fannie and Freddie operated with an “implicit guarantee” from the U.S. government, allowing them to borrow money at lower interest rates than any purely private competitor. They utilized this “big, fat gap” to buy higher-yielding mortgages for their own massive portfolios, generating outsized profits for their employees and shareholders. Their core function was to establish standards for conforming mortgages—standardized 30-year fixed-rate loans that were then bundled into securities and sold to global investors.
They acted as the “enablers” of the modern mortgage market, guaranteeing the payment of principal and interest on securities to remove default risk for investors. This status made them so powerful that Wall Street dealers treated them as “sovereign credits.” Under leaders like David Maxwell and Jim Johnson, they built a formidable political machine, opening “partnership offices” in congressional districts to ensure that any threat to their privileges was met with “bare-knuckled politics.”
Historical Significance
The legacy of the GSEs is deeply controversial; they were “Michelangelo” turnarounds that became “systemic risks.” In the late 1990s, they dominated the market for conforming loans, but as private Wall Street firms began to securitize riskier subprime mortgages, the GSEs felt pressured to enter the subprime space to maintain their market share and meet government-mandated affordable housing goals. By 2004, they were the world’s largest purchasers of the safest “triple-A” tranches of subprime securities, inadvertently helping to inflate the housing bubble.
Their aggressive pursuit of profit led to massive accounting scandals in 2003–2004, forcing CEOs like Franklin Raines to resign. As the housing market crashed in 2008, the GSEs were overwhelmed by credit losses on their $5 trillion in mortgage holdings. To prevent a global financial meltdown, the U.S. government took them into conservatorship in September 2008, effectively nationalizing the risk they had spent decades trying to distribute.
Key Developments
- 1938: Founding of Fannie Mae as a government agency.
- 1968: Fannie Mae becomes a private, shareholder-owned corporation; Ginnie Mae splits off.
- 1970: Freddie Mac is founded to provide competition.
- 1970–1971: First securitization of modern mortgages by Ginnie and Freddie.
- 1981–1991: David Maxwell transforms Fannie from an insolvent entity into a profit machine.
- c. 1992: Expansion of the “big, fat gap” strategy, buying mortgages with low-cost government-backed debt.
- 2003–2004: Major accounting scandals lead to the ouster of top management at both GSEs.
- 2004: GSEs purchase $175 billion in triple-A subprime securities to meet housing goals.
- 2007: Credit losses begin to mount as housing prices decline.
- 2008: Fannie and Freddie are placed into government conservatorship after credit losses threaten their solvency.
- 2010: The Dodd-Frank Act notably omits reform of the GSEs, leaving them in a “limbo state” as wards of the government.