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Secondary Housing Market

Fannie Mae and Freddie Mac
by

Hari Raja

on 29 April 2010

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Transcript of Secondary Housing Market

A Brief Historical Look at Fannie Mae Who are Fannie Mae and Freddie Mac? WHAT are Fannie Mae and Freddie Mac? Fannie Mae and Freddie Mac are governement sponsored enterprises (GSE) that buy mortgages on the secondary market, pool them, and sell them back as a mortgage-backed security to investors on the open market. By grouping together many loans and selling them as securities (collateralized mortgage obligations), the supply of money available for mortgage lending increases, thereby increasing the money available to purchase new homes, and reducing the risk of the individual loans. A brief look at the history of these
Government Sponsored Enterprises 1938:
The Federal National Mortgage Association (Fannie Mae) was founded as a means to make mortgages more readily available to low income families. The program began with just $1 Billion in purchasing power
At the time that it was created: 4 out of 10 Americans owned homes and standard mortgage lasted 5-10 years with an interest as high as 8 %.
It was then added to the Federal Home Mortgage Association to provide more liquidity within the mortgage market. 1968:
Fannie Mae grew so large that, with the fiscal pressures of the Vietnam War straining the national budget, the Johnson Administration took Fannie Mae's debt portfolio off of the government balanace sheet by converting it into a mixed-ownership corporation. This split Fannie Mae into a private shareholder corporation and a public corporation. PRIVATE:
The private corporation was still called Fannie Mae and it was converted as such so that its activities could be removed from the annual balance sheet of the federal budget. Fannie Mae continued to support the purchase of mortgages from savings and loan associations but without explicitly guaranteeing the value of the mortgages. Public:
Authority to grant government-issued mortgages was then transferred to the publicly financed portion named Government National Mortgage Association (Ginnie Mae) which explicitly guaranteed the repayments of securities backed by mortgages made to government employees or veterans. 1970:
“Emergency Home Finance Act of 1970:” Under this act, the Federal Home Loan Mortgage Company (Freddie Mac) was established as a means to end Fannie Mae’s monopoly of the secondary mortgage market, thus attempting to make the market more efficient. 1971:
Freddie Mac introduced its first mortgage-related security 1979:
Fannie Mae began buying Adjustable-Rate Mortgages (ARMs) to help cushion the interest-rate risk it faced. 1981:
Fannie Mae began to sell Mortgage-Backed Securities (MBS) to help finance its mortgage purchases and to generate fee income.

More attractive investments due to greater liquidity. MBS "Swap Program" allowed lending institutions to trade loans directly for the more liquid securities on which were the timely payment of interest and principal were guaranteed. By 1982, Fannie Mae funded one out of every seven home mortgages made in the United States 1983
Fannie Mae begins purchasing conventional multifamily housing loans 1984
With the abolishion of the 30% withholding tax on foreign investments, Fannie Mae entered foreign capital markets by issuing its first debenture in the overseas Euromarket
1987
Fannie Mae issues its first Real Estate Mortgage Conduit (REMIC)

REMICS can be tailored to an investor's needs in terms of maturity dates, allowing Fannie Mae to attract investors that would normally not be interest in mortgage-related investment products 1988 (50 years!)
Fannie Mae stock is added to the S&P500

-$345 million in first three quarters alone.

-Of the $400 Billion that Fannie Mae had pumped into the nation's mortgage industry in its 50 years, over $300 came after 1980
1991
"Opening Doors to Affordable Housing"

-Produced $10 Billion in purchases for low income, moderate income, and special needs housing.

-This is later expanded to become the "Trillion Dollar Commitment," which, together with the Partnership Office Initiative, brought together lenders, local governments, nonprofits, builders and developers to work toward expanding affordable rental and homeownership opportunities
1996:
10th consecutive year of record earnings 1998:
Fannie Mae reaches $1 Trillion mark in mortgage books of business outstanding 1999
Fannie Mae changes its mission statement to: "Our Mission is to tear down barriers, lower costs, and increase the opportunities for home ownership and affordable rental housing for all Americans. Because having a safe place to call home strengthens families, communities, and our nation as a whole."

-Conventional loan limit increases to $240,000 "Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s."
- New York Times, 1999 2000: Conventional loan limit increases to $252,700
2001: Conventional loan limit increases to $275,000
2002: Conventional loan limit increases to $300,700
2003: Conventional loan limit increases to $322,700
2001
American Dream Commitment is launched
-10 yr, $2T pledge to increase home ownership rates
-18 Million American Families
2002
-President Bush signs the Single-Family Affordable Housing Tax Credit Act

-Gave $2.4 Billion in tax credits over the next 5 years to investors/builders who develop affordable single-family housing in distressed areas 2003
-Persident Bush recommends an agency within the Treasury Department to assume supervision of Fannie Mae
-Agency would have authority to determine whether a Fannie Mae is adequately managing risks of its portfolios 2003 (cont)
US policy interest rates hit a low of 1% - further stoking the booming US housing market 2004
Office of Federal Housing Enterprise Oversight released a report alleging of widespread accounting errors, eventually resulting in 101 civil charges being filed against the chief executives at Fannie


Following the accounting scandal, Ofheo (Fannie and Freddie's regulator) requires the companies to raise their core capital 30% above previous levels - capping their abilities to purchase mortgages 2005
Federal Housing Enterprise Regulatory Reform Act of 2005:
-Senate legislation was introduced in an effort to reform existing GSE regulatory structure, but was never considered by the full Senate for a vote.


Federal Housing Finance Reform Act of 2005:
-House Financial Services Committee produced a Committee Report to the legislation and it passed the House in October. However, it met with opposition in the Senate and was never taken up for consideration afterwards. 2006
Steep rise in rate of subprime mortgage defaults/foreclosures lead to the failure of a great number of subprime mortgage lenders.

-Prices in the mortgage-backed securities market begin to slip July 2008
Government attempted to ease market fears by reiterating the importance of Fannie and Freddie's role in the U.S. housing finance system. They did so by allowing the Treasury Department to purchase the GSE's stock as well as giving Fannie and Freddie access to Federal Reserve low-interest loans. Shares in Fannie and Freddie plummet amid speculation that a bailout of the GSE mortgage financiers may be required.

Shares fell 90% from one year prior "Includes seriously delinquent conventional single-family loans as a percent of the total number of conventional single-family loans. These rates are based on conventional single-family mortgage loans and exclude reverse mortgages and non-Fannie Mae mortgage securities held in our portfolio. A measure of credit performance and indicator of future defaults for the single-family ... credit books. We include single-family loans that are three months or more past due or in the foreclosure process ... We include conventional single-family loans that we own and that back Fannie Mae MBS in our single-family delinquency rate, including those with substantial credit enhancement." On September 7, 2008, the director of the Federal Housing Finance Agency, James B. Lockhart III, announced his decision to place Fannie Mae and Freddie Mac, into conservatorship run by the FHFA Many government agencies stepped in to assist in increasing liquidity within Fannie and Freddie Federal Reserve purchases of $23 billion in GSE debt (out of a potential $100 billion) and $53 billion in GSE-held mortgage backed securities (out of a potential $500 billion).

Treasury Department purchases of $14 billion in GSE stock (out of a potential $200 billion).

Treasury Department purchases of $71 billion in mortgage backed securities

Federal Reserve extends primary credit rate for loans to the GSEs
Why were Fannie and Freddie taken over by the Federal Government? Conditions Prior to Takeover:

98% of Fannie's loans were paying in a timely manner in 2008
Fannie and Freddie had a positive net worth before the takeover
Fannie had a leverage ratio of 20:1
BiggFreddie had a leverage ratio of 70:1 Government's biggest concern: Fannie and Freddie's could not handle growing delinquency rates. Failure to step-in would cause emminent insolvency. Public knowledge of this situation would result in an immediate failure due to investors refusing to purchase debt from Fannie and Freddie.
In laymans terms: if the government didn't step in and the word leaked that Fannie/Freddie could not handle growing delinquency rates... everyone would freak out and the GSEs would collapse due to mere lack of confidence, alone. So where do we stand with the U.S. Housing Market today? Learn more from Econ 571! Discuss: Was it really necessary for a federal takeover of Fannie Mae and Freddie Mac?
What warning signs were overlooked?
How did our former presidents warn against or inflate the problem?
Where would we be today if proper regulatory overheads were put into place a decade ago?
What would you have done differently as the CEO of Fannie Mae in 2008 More Resources It works like this: Suppose you get a mortgage on your new home from Persky Bank.
Persky Bank, like any other bank, has limitations on how much money it can lend as a function of its asset base. If your loan sits on Persky's books, it constricts how much the bank can loan. But if Persky Bank sells the rights of that loan to Fannie Mae, it essentially turns that loan back into cash which, in turn, Persky Bank can go out and loan again. The person who received the loan makes loan payments to Persky Bank while Perskey Bank turns around passes these funds on to Fannie Mae. Fannie Mae makes money by borrowing funds at a lower interest rate than you can. So basically instead of a single loan tying up much of Persky Bank's capital, it can turn around and make multiple loans all from the same original capital base. In theory, this increases the bank's willingness to loan in good times and in bad so what happens now? Fannie just holds on to these mortgages? Nope. Fannie bundles it up with hundreds of other mortgages and markets them to investors as Mortgage-Backed Securities. These investors include insurance companies, pension funds, etc. They trust Fannie because Fannie provides a guarantee to these investors that they will receive timely principal and interest payments, regardless of what happens with the underlying mortgages. Even though Fannie Mae was not entirely a government owned company, the financial marketts believed that Fannie Mae's status as a GSE implied that the government would provide full backing of Fannie's debt. Thereby giving Fannie Mae an AAA credit rating.
(Note: in the mid 2000s, Fannie had a 78:1 debt-to-equity ratio... Wah wah)
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