Note: Window to Wall Street is not endorsing or blaming any political party for the Freddie and Fannie failure and billions in lost shareholder value. We are providing these videos for educational information. They show the debate that arose over these entities back in 2004 when a financial reporting scandal made national news.
U.S. government seized control of the two government sponsored mortgage giants
In September 2008, the U.S. government seized control of the mortgage giants Fannie Mae (FNM: 0.66, -0.05, -7.01%) and Freddie Mac (FRE: 0.74, -0.06, -7.50%) wiping-out the remaining $7 stock values of shareholders -which included many small banks. Our government placed the liabilities of more than $5 trillion of mortgages onto the backs of the U.S. taxpayer. Like AIG it was believed they were "to big to allow to fail".
Both companies have now been placed into a government conservatorship under the recently created Federal Housing Finance Agency, in a plan announced by Treasury Secretary Henry Paulson and FHFA Director Jim Lockhart.
The Federal National Mortgage Association, nicknamed Fannie Mae, and the Federal Home Mortgage Corporation, nicknamed Freddie Mac, have operated since 1968 as government sponsored enterprises (GSEs). This means that, although the two companies are privately owned and operated by shareholders, they are protected financially by the support of the Federal Government. These government protections include access to a line of credit through the U.S. Treasury, exemption from state and local income taxes and exemption from SEC oversight. A recent accounting scandal at Freddie Mac that resulted in the replacement of three of the company's top executives has led to mounting concerns over the privileged status these GSEs enjoy in the marketplace.
A 2004 investigation by the Justice Department and the SEC into the accounting practices at Freddie Mac revealed accounting errors in the amount of many billion dollars and resulted in the termination of three of the company's top executives who were paid millions in bonuses based upon manipulated accounting.
Fannie Mae was created in 1938 as part of Franklin Delano Roosevelt's New Deal. The collapse of the national housing market in the wake of the Great Depression discouraged private lenders from investing in home loans. Fannie Mae was established in order to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing.
Initially, Fannie Mae operated like a national savings and loan, allowing local banks to charge low interest rates on mortgages for the benefit of the home buyer. This lead to the development of what is now known as the secondary mortgage market. Within the secondary mortgage market, companies such as Fannie Mae are able to borrow money from foreign investors at low interest rates because of the financial support that they receive from the U.S. Government. It is this ability to borrow at low rates that allows Fannie Mae to provide fixed interest rate mortgages with low down payments to home buyers. Fannie Mae makes a profit from the difference between the interest rates homeowners pay and foreign lenders charge.
For the first thirty years following its inception, Fannie Mae held a veritable monopoly over the secondary mortgage market. In 1968, due to fiscal pressures created by the Vietnam War, Lyndon B. Johnson privatized Fannie Mae in order to remove it from the national budget. At this point, Fannie Mae began operating as a GSE, generating profits for stock holders while enjoying the benefits of exemption from taxation and oversight as well as implied government backing. In order to prevent any further monopolization of the market, a second GSE known as Freddie Mac was created in 1970. Currently, Fannie Mae and Freddie Mac control about 90 percent of the nation's secondary mortgage market.
GSEs such as Fannie Mae and Freddie Mae, with their combination of private enterprise and public backing have experienced a period of unprecedented financial growth over the past few decades. The current assets of these two companies combine for a total that is 45 percent greater than that of the nation's largest bank.