Freddie Mac Essay ⋆ Business Essay Examples ⋆ EssayEmpire

Federal Home Loan Mortgage Corporation, or Freddie Mac, is a U.S. government–sponsored but privately owned corporation created for the purpose of increasing the supply of funds for home mortgages. The origin of Freddie Mac goes back to the Depression era when the U.S. government wanted to make it easier for potential homeowners to build and own their houses. In order to ease availability of funds to these individuals, the government created an organization that came to be known as Fannie Mae. In 1970 the U.S. Congress continued with the privatization of the mortgage market and legislated the creation of Freddie Mac.

Freddie Mac, along with other government-sponsored organizations like Fannie Mae and Ginnie Mae, increases the volume of funds available for mortgages while simultaneously lowering their cost by providing a secondary market for mortgages. In what is called the primary market, a financial institution approves a home-builder’s request for a mortgage, funds the mortgage through deposits it attracts and its equity. Without a secondary market, the total volume of mortgages would be limited to the share of their total deposits that the financial institutions would be willing to commit to mortgages.

A secondary market for mortgages is created when the financial institution sells the mortgage to an institution like Freddie Mac. Freddie Mac bundles a number of these mortgages together and creates one collective asset whose cash flows are derived from the collection of mortgage payments—interest as well as the principle repayments. This collection of mortgages is called a mortgage backed security or MBS. Freddie Mac sells all or parts of this MBS to investors. Since Freddie Mac can bundle mortgages from different types of borrowers and from different regions, the MBS portfolio becomes diversified across various risk categories and has higher return and lower risk than a portfolio of mortgages held by a particular financial institution. The improved risk-return profile makes these securities attractive for individual investors. Creation of this secondary market increases the volume of funds available for mortgages and competition between various providers of funds to this market lowers the cost at which home-builders can obtain mortgages.

Freddie Mac and Fannie Mae provide similar services but compete with each other. Ginnie Mae, on the other hand, provides guarantees on loans issued by government agencies and deals with smaller sized mortgages. In contrast to Ginnie Mae, Freddie Mac deals with mortgages that are not federally insured and can be of different sizes and different interest rates. Freddie Mac mortgages tend to be of larger sizes. Together these institutions are knows as Government Sponsored Enterprises, or GSEs, because government places looser restrictions on them relative to fully private companies. Although these enterprises are not fully backed by the government, they can raise funds in the market at advantageous rates because of the common perception that the government will not allow these institutions to default. The government sponsorship became very important in the summer of 2008 when problems with the housing market exploded into a full-blown financial crisis.

At the end of 2007, Freddie Mac held $710 billion worth of mortgage backed securities in its portfolio. The mortgage backed securities market has grown from about $200 billion in 1989 to more than $2 trillion in 2006. Till about 2001, Freddie Mac and other GSEs dominated this market, together maintaining a market share of about 80 percent. Private issuers held the remainder of the market. Since 2002, however, private issuers began offering what became known as subprime mortgages. The share of these subprime mortgages increased from about 20 percent in 2002 to about 55 percent in 2006. Private issuers resort to securitization—they hand over the administration of the mortgage contracts to suppliers of funds instead of holding the mortgages to maturity.

Crisis

Beginning in 2007, rates of defaults in the subprime sector of the mortgage market began to increase partly due to declines in house prices and partly due to the nature of the subprime borrowers. Financial institutions that had held the mortgage-backed securities based on subprime mortgages faced heavy losses resulting in bankruptcy or re-organizations of large investment banks like Lehman Brothers and Bear Stearns.

In July 2008 Freddie Mac along with Fannie Mae felt the full brunt of the emerging financial crisis. These two institutions either held or guaranteed about $5.2 billion worth of mortgages in the country—about half of the total U.S. market. Their portfolio included some mortgage-backed securities issued by other institutions ($267 billion at the end of 2007 with Freddie Mac). With their capital of $83.2 at the end of 2007, their leverage ratio of 65:1 was much higher than any other financial institution could support. Freddie Mac had lost $3.5 billion in 2007. With losses accumulating in 2008, share prices of Freddie Mac (as well as Fannie Mae) dropped from 65 in mid-2007 to less than 10 in July 2008.

The drop in share prices implied that these institutions would find it very difficult to raise new capital in the financial markets to continue supporting the housing mortgage market, which had become more important in mid-2008 due to withdrawal of private financial institutions. Their status as GSEs as well as their sizes required that the U.S. Treasury and Congress intervene to protect these institutions.

By the end of July 2008, the U.S. Senate and Congress approved a $300 billion package that would be used to guarantee mortgages issued by the two institutions—Freddie Mac and Fannie Mae. The implicit guarantee of the government thus became explicit. In turn, the government acquired preferred shares in the two organizations as well as rights to acquire some outstanding common shares, and placed a host of other minor restrictions on the activities of these two organizations. The two institutions were placed in conservatorship—a less offensive term than nationalization.

The era of unprecedented growth of these giants in the mortgage as well as the U.S. financial markets may have ended with the financial crisis that began in full earnest in 2008.

Bibliography:

David H. Carpenter and M. Maureen Murphy, Financial Institution Insolvency Federal Authority Over Fannie Mae, Freddie Mac, and Depository Institutions. CRS report for Congress, RL34657 (Congressional Research Service, Library of Congress, 2008);
Freddie Mac, www.freddiemac.com (cited March 2009);
Daniel J. McDonald and Daniel L. Thronton, “A Primer on the Mortgage Market and Mortgage Finance,” Federal Reserve Bank of St. Louis Review (January–February 2008).

This example Freddie Mac Essay is published for educational and informational purposes only. If you need a custom essay or research paper on this topic please use our writing services. EssayEmpire.com offers reliable custom essay writing services that can help you to receive high grades and impress your professors with the quality of each essay or research paper you hand in.