Fannie Mae Versus Freddie Mac, Their Similarities and Differences

In 1938, Congress established Fannie Mae through the Federal Home Loan Bank Act. It purchased mortgages insured by the FHA. President Roosevelt wanted Fannie Mae to help realize the American Dream of homeownership. When Fannie Mae bought the loans from banks, it gave them more money to lend.

Congress transformed Fannie Mae into a company in 1968. Instead of using tax dollars to fund it, the government allowed Fannie to sell stocks to shareholders in an initial public offering. Congress needed the funding to finance the Vietnam War. 

Like Fannie, Freddie Mac is a government-owned corporation that buys mortgages and packages them into mortgage-backed securities.Freddie Mac focused on encouraging banks to create 30-year mortgages to avoid keeping the loans in their books for thirty years. That tied up too much money and was risky for the banks.

Fannie Mae, Freddie Mac, and the FHLB made housing affordable for most Americans for decades. But they functioned as government-sponsored entities. This meant they had to be profitable for the shareholders while creating the secondary market that made the resale of mortgages feasible.

According to the Office of Federal Housing Enterprise Oversight, Fannie Mae, Freddie Mac, and FHLB provided 90 percent of the financing for new mortgages by the end of 2007. This was more than double their share of the mortgage market revealing the extent to which private mortgage financing had dried up.

In early 2008, Fannie Mae and Freddie Mac stepped in to guarantee more subprime mortgages to reassure the housing market. As the subprime mortgage meltdown continued, the Federal government had to intervene to rescue Fannie Mae and Freddie Mac themselves.

Once the banks panicked, the two GSEs were the only ones making loans. After the recession, most banks would not give anyone a loan without Fannie Mae and Freddie Mac guarantees. 

Both Fannie and Freddie are under the conservatorship of the Federal Housing Finance Agency. The U.S. Department of the Treasury owns all their senior preferred stock. That means all of their profits go to the U.S. Treasury. Investors can still buy common stock and junior preferred stock. The conservatorship doesn't allow them to pay dividends.

Fannie and Freddie buy their mortgages from different sources. Fannie buys them from large commercial banks. Freddie buys them from smaller banks.

They also offer different programs for those who can only make low down payments. Fannie Mae offers the Home Ready loan. Applicants can't earn more than 80 percent of the area's median income. Freddie offers the Home Possible program. It requires that applicants live in the home and no more than the area's average income.

Fannie and Freddie origins and original purposes were also different. Fannie was created in 1938 to allow banks to create more mortgages. It bought the loans from banks, but then was more likely to keep them on its books. Freddie was created in 1970 as competition for Fannie. It also was the first to resell loan packages on the secondary market .

In August 2007, the Economist warned that Fannie's and Freddie's ability to pump liquidity in the market could be compromised. Fannie announced it would withdraw a debt offering. At that time, everyone thought that Fannie had enough cash to enable it to wait until the market improved. But in November 2007, Fannie declared a $1.4 billion quarterly loss and announced it would seek $500 million in new funds. Freddie then disclosed a $2 billion loss, sending its stock price down 23 percent.

Freddie held $120.8 billion in subprime mortgages. Experts believed it was too small a percentage of its overall portfolio to threaten the agency's viability. By Q4 2007, Freddie reported a $2 billion loss. In response, the agency raised $6 billion in new capital through the sale of preferred stock to shore up its reserves. It wasn't enough.

Fannie Mae and Freddie Mac did not cause the subprime mortgage crisis. Their portfolios held a lower percentage of subprime loans than that of commercial and investment banks. Nonetheless, they did increase their acquisition of these loans to keep their shareholders happy in what had become a very competitive marketplace.

Before the financial crisis, they owned or guaranteed $1.4 trillion, or 40 percent, of all U.S. mortgages. Of that, only $168 billion was in subprime mortgages.

The government spent at least $150 billion to keep Fannie Mae and Freddie Mac mortgage companies functioning. It has been managing the two since September 2008, when the Federal Housing Finance Agency put them into receivership. This was supposed to be a temporary arrangement, but Congress has not taken action to change Fannie's and Freddie's status.