Freddie Mac, officially known as the Federal Home Loan Mortgage Corp. (FHLMC), is a government-sponsored enterprise (GSE) established by Congress in 1970. It plays a crucial role in supporting homeownership and rental housing for middle-income Americans. Freddie Mac purchases, guarantees, and securitizes home loans, making it a significant participant in the secondary mortgage market. In this article, we will delve into the history, functions, and criticism surrounding Freddie Mac, while also highlighting the key differences between Freddie Mac and its counterpart, Fannie Mae.
History of Freddie Mac
The Emergency Home Finance Act of 1970 paved the way for the creation of Freddie Mac. As a wholly owned subsidiary of the Federal Home Loan Bank System (FHLBS), Freddie Mac aimed to reduce interest rate risk for savings and loans associations and smaller banks. In 1989, it underwent a reorganization and became a publicly owned company, with shares traded on the New York Stock Exchange. However, during the financial crisis of 2008, triggered by the subprime mortgage meltdown, Freddie Mac came under the conservatorship of the Federal Housing Finance Agency (FHFA). While it is gradually moving towards independence, it remains under federal conservatorship.
Functions of Freddie Mac
Freddie Mac's primary objective is to facilitate the flow of credit to different sectors of the economy, particularly in the housing market. Unlike originating or servicing home mortgages, Freddie Mac purchases loans from banks and commercial mortgage lenders, providing these institutions with funds to finance more loans and mortgages. To ensure quality, these loans must adhere to the standards set by Freddie Mac. Subsequently, Freddie Mac holds these mortgages in its own portfolio or combines and sells them as mortgage-backed securities (MBS) to investors seeking a stable income stream.
By guaranteeing the timely payment of principal and interest on the loans, Freddie Mac provides an "insurance" that enhances the liquidity and credit rating of the securities it issues. The liquidity of these securities often rivals that of U.S. Treasuries, attracting investors seeking stable investments.
Criticism of Freddie Mac
Freddie Mac has faced criticism due to its advantageous borrowing rates, thanks to its government ties, which are lower than those available to other financial institutions. Leveraging this funding advantage, Freddie Mac issues substantial amounts of debt, referred to as "agency debt" or "agencies," and holds a sizable portfolio of mortgages known as its "retained portfolio."
Detractors argue that the sheer size of Freddie Mac's retained portfolio, coupled with the complexities of managing mortgage risk, poses systemic risks to the U.S. economy. Some have even attributed the uncontrolled growth of Freddie Mac, along with Fannie Mae, to be a primary driver behind the credit crisis of 2008 and the subsequent Great Recession. However, proponents of these enterprises contend that while they made poor business decisions and lacked sufficient capital during the housing bubble, their portfolios represented only a fraction of the total subprime loans.
Freddie Mac vs. Fannie Mae
Fannie Mae, also known as the Federal National Mortgage Association (FNMA), shares similarities with Freddie Mac. Both are publicly traded companies chartered to serve a public mission. However, the key distinction lies in the sources of the mortgages they acquire. Fannie Mae primarily purchases mortgage loans from major retail or commercial banks, while Freddie Mac obtains loans from smaller banks, often referred to as "thrift banks" or "savings and loan associations," which focus on providing banking services to local communities.
Summary
Freddie Mac is a government-sponsored company which purchases mortgages from banks and securitizes them for sales to investment banks or individuals. Freddie Mac is not a government organization, but was established by a congressional mandate in the 1970’s.
It’s proper name is the Federal Home Loan Mortgage Corporation (FHLMC). The company’s purpose is to make mortgage debts into marketable securities by purchasing the mortgage risk and cash flow from banks and dividing into tranches which are sold to or through investment banking institutions. The securitized mortgages are known as Collateralized Mortgage Obligations, or CMO’s.
By increasing the size of the secondary market for mortgages, it infuses the lending bank system with more liquidity to fund additional home purchases. The risk of the mortgage loan is effectively shifted from the lending bank to the investment bank with Freddie Mac as the conduit.
The incentive of the lending banks to make good loans to qualified individuals is lessened significantly through this arrangement, however, and the additional bad loans that this process brought into the economy, and the significant overweighting that many institutions had in this asset class, were a main cause of what came to be known as the Subprime Meltdown and the Great Recession that occurred between 2007 and 2009.
Freddie Mac and its sister organization, Fannie Mae, along with the eleven Federal Home Loan Banks were taken over in a conservatorship arrangement by the FHFA (Federal Housing Finance Agency) in 2008, effectively infusing bailout money from taxes into the enterprises to assist with the housing correction and restructuring of the businesses.
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