Gavin Howe
The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are government-sponsored enterprises that buy and sell mortgages in the secondary mortgage market. In the years leading up to the 2008 Financial Crisis, Fannie Mae and Freddie Mac contributed to a housing bubble by investing in riskier loans, inflating the housing market, and making bad loans. This led to a government bailout and conservatorship. While there have been attempts to regulate these enterprises, their role in the 2008 crisis and the subsequent fallout highlight the impact of their financial practices on the wider economy.
| Characteristics | Values |
|---|---|
| Year | 2008 |
| Companies | Fannie Mae, Freddie Mac |
| Cause | Investing in riskier loans, purchasing large volumes of Alt-A mortgages, buying private-label MBS collateralized by subprime mortgages |
| Losses | Billions of dollars |
| Government Intervention | Housing and Economic Recovery Act, bailout of $116 billion |
| Congressional Leaders | Democratic senators Charles Schumer and Christopher Dodd, Congressman Barney Frank |
| Impact | Junk mortgage collapse, home prices plunging, insolvency |
| Role | Secondary mortgage market, buying and securitizing mortgages, ensuring steady flow of mortgage credit |
| Sponsors | Finance, insurance, and real estate (FIRE) sectors |
| Function | Make housing increasingly unaffordable, inflate asset prices with credit |
| Regulatory Reform | Federal Housing Enterprise Regulatory Reform Act |
| Sponsors | Senator Chuck Hagel, Senators Elizabeth Dole, John McCain, and John Sununu |
| Conservatorship | Federal Housing Finance Agency (FHFA) |
| Stock Performance | Down more than 99%, 20-30 cents a share |
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What You'll Learn
The role of Fannie Mae and Freddie Mac in the 2008 financial crisis
In the years leading up to the 2008 Financial Crisis, Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs), started investing in riskier loans, contributing to a housing bubble. They purchased large volumes of Alt-A mortgages, which often lacked full documentation of borrowers' incomes. They also bought private-label mortgage-backed securities (MBS) collateralized by subprime mortgages, i.e. loans issued to borrowers with poor credit ratings.
As the housing market started to decline in 2007, defaults surged, and the MBS market collapsed. Fannie Mae and Freddie Mac lost billions of dollars, and investor confidence in them eroded. As their stock prices plummeted, the federal government intervened to prevent a wider economic fallout.
In July 2008, Congress passed the Housing and Economic Recovery Act, establishing the Federal Housing Finance Agency (FHFA) to oversee Fannie Mae and Freddie Mac and expand regulatory authority over them. However, the new regulator still lacked the full mandate, authority, or discretion over safety, soundness, and systemic risk.
By September 2008, the FHFA announced that it would take over Fannie Mae and Freddie Mac as they had become illiquid due to the collapse of the market for their bonds in the subprime mortgage crisis. The FHFA established conservatorships to reduce losses and develop a new operating structure for the enterprises to return to self-management.
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The bailout of Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs) that play a pivotal role in the secondary mortgage market. They buy residential mortgages on this market to hold or bundle and sell as mortgage-backed securities (MBS) to investors. This process injects liquidity, stability, and affordability into the housing market. However, in the years leading up to the 2008 Financial Crisis, they started investing in riskier loans, contributing to a housing bubble. They purchased large volumes of Alt-A mortgages, which often lacked full documentation of borrowers' incomes, and bought private-label MBS collateralized by subprime mortgages. When the housing bubble burst, they lost billions of dollars, and investor confidence eroded.
The bailout gave Fannie Mae and Freddie Mac the financial liquidity they needed to survive. The Federal Housing Finance Agency (FHFA) placed them into government conservatorship, infusing them with billions of dollars to back their ailing home mortgage portfolios. As part of the deal, they had to pay the Treasury a 10% dividend. This bailout turned out to be profitable for the US government. As of 2018, profits from Fannie Mae and Freddie Mac are still being sent to the Treasury Department.
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The Federal Housing Finance Agency's (FHFA) conservatorship
The Federal Housing Finance Agency (FHFA) is an independent federal agency in the United States. It was created as the successor regulatory agency of the Federal Housing Finance Board (FHFB), the Office of Federal Housing Enterprise Oversight (OFHEO), and the U.S. Department of Housing and Urban Development government-sponsored enterprise mission team. The FHFA has expanded legal and regulatory authority, including the ability to place government-sponsored enterprises (GSEs) into receivership or conservatorship.
The FHFA regulates Fannie Mae, Freddie Mac, and the 11 Federal Home Loan Banks (FHLBanks, or FHLBank System). It is wholly separate from the Federal Housing Administration, which largely provides mortgage insurance. The FHFA's mission is to ensure that Fannie Mae and Freddie Mac (the Enterprises) and the FHLBanks (together, "the regulated entities") fulfill their mission by operating in a safe and sound manner to serve as a reliable source of liquidity and funding for housing finance and community investment.
In the years leading up to the 2008 Financial Crisis, Fannie Mae and Freddie Mac started investing in riskier loans, contributing to a housing bubble. They purchased large volumes of Alt-A mortgages, which often lacked full documentation of borrowers’ incomes. When home values collapsed in 2007, defaults surged, and investor confidence in them eroded. As their stock prices plummeted and insolvency loomed, the federal government intervened to prevent a wider economic fallout.
On September 7, 2008, FHFA director Lockhart announced that he had put Fannie Mae and Freddie Mac under the conservatorship of the FHFA. The FHFA established conservatorships in which each enterprise's management works under the FHFA's direction to reduce losses and to develop a new operating structure that will allow a return to self-management. As part of the conservatorship, the FHFA assumed the power of the Board and management. The then-present CEOs were dismissed, but they stayed on to help with the transition. Herb Allison, former Vice Chairman of Merrill Lynch, was appointed CEO for Fannie Mae, and David M. Moffett, former Vice Chairman and CFO of US Bancorp, was appointed CEO for Freddie Mac. Their compensation was significantly lower than that of the outgoing CEOs.
As of 2024, Fannie Mae and Freddie Mac remain under conservatorship. After repaying their Treasury loans, they are building capital reserves for an expected eventual exit.
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The impact of the housing bubble on Fannie and Freddie's stock prices
The housing bubble had a significant impact on the stock prices of Fannie Mae and Freddie Mac, leading to a substantial decline in their value.
In the years leading up to the 2008 Financial Crisis, both enterprises started investing in riskier loans, contributing to the housing bubble. They purchased Alt-A mortgages, which often lacked proper documentation of borrowers' incomes, and bought private-label mortgage-backed securities (MBS) collateralized by subprime mortgages. As a result, when home values collapsed in 2007, defaults surged, and these institutions lost billions of dollars.
The stock prices of Fannie Mae and Freddie Mac plummeted as they faced significant losses and erosion of investor confidence. This decline in stock prices led to the federal government's intervention to prevent a wider economic fallout. The government bailout and conservatorship were implemented, with the Federal Housing Finance Agency (FHFA) taking over in September 2008.
The aftermath of the housing bubble and the subsequent financial crisis had lasting effects on Fannie Mae and Freddie Mac's operations. They remained under conservatorship for an extended period, and despite repaying their Treasury loans, they continued to send profits to the Treasury Department. The enterprises' ability to raise capital and manage debt remained a concern, impacting their prospects for returning to self-management.
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The government's response to the collapse of the housing bubble
The US housing bubble collapse of 2008, also known as the global financial crisis (GFC), was a significant event that led to a worldwide financial crisis. The crisis was caused by a combination of factors, including a housing bubble, risky mortgage lending, complex financial products, and inadequate regulation. In response to the growing crisis, governments around the world took several measures to address the situation and prevent further economic fallout.
In the years leading up to the 2008 financial crisis, Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs), started investing in riskier loans, contributing to the housing bubble. They purchased mortgages with higher loan-to-value (LTV) and debt-to-income (DTI) ratios and often lacked proper documentation of borrowers' incomes. As a result, when home values collapsed in 2007, defaults surged, and the GSEs lost billions of dollars.
To address the crisis, the US government intervened with a bailout of Fannie Mae and Freddie Mac, providing $116 billion to Fannie Mae alone in 2008. Additionally, in July 2008, Congress passed the Housing and Economic Recovery Act, establishing the Federal Housing Finance Agency (FHFA) to regulate Fannie Mae and Freddie Mac and expand oversight of the housing market. The FHFA established conservatorships to reduce losses and develop a new operating structure for the GSEs.
The Federal Reserve also played a role in responding to the crisis. After the dot-com bubble burst in 2000, the Federal Reserve, under Chairman Alan Greenspan, lowered the federal funds rate, leading to an increase in high-risk loans to low-income homebuyers. However, as interest rates rose from 2004 to 2006, mortgage costs increased, and demand for housing fell. The Federal Reserve also provided financing for the sale of Bear Stearns, the fifth-largest US investment bank, to JPMorgan Chase in a fire sale in March 2008.
The 2008 financial crisis had a significant impact on the housing market, with home prices plummeting and foreclosure rates rising, particularly in cities like Cape Coral, Florida. The recovery process was slow, with home prices taking until 2012 to fully recover. The crisis highlighted the dangers of excessive risk-taking and the importance of proper oversight and regulation in the financial industry.
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Frequently asked questions
The laws that led to the bubble were created by the US Congress and President George W. Bush.
These laws were the Housing and Economic Recovery Act of 2008, the Emergency Home Finance Act of 1970, and the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989.
The Housing and Economic Recovery Act of 2008 expanded regulatory authority over Fannie Mae and Freddie Mac. The Emergency Home Finance Act of 1970 established the Federal Home Loan Mortgage Corporation (FHLMC) or “Freddie Mac”, and allowed both Fannie Mae and Freddie Mac to buy and sell non-government-backed mortgages for the first time. FIRREA of 1989 restructured Freddie Mac as a for-profit corporation, leading to its listing on the NYSE.
The laws contributed to the bubble by allowing Fannie Mae and Freddie Mac to invest in riskier loans, inflating the housing market, and making bad loans.
As a result of the bubble, Fannie Mae and Freddie Mac collapsed in 2008, and their stock prices plummeted. The US government intervened to prevent a wider economic fallout and took over the two companies.
