The Federal National Mortgage Association Essay Example

in the mortgage market, government affiliations, and significance. This discourse gained more prominence after the housing market crash and subprime mortgage crisis in 2007. However, Fannie Mae, Ginnie Mae, and later Freddie Mac have been instrumental in shaping the world's most prosperous mortgage market and facilitating accessible homeownership for U.S. citizens.

The United States boasts one of the world's highest rates of homeownership. During the Clinton administration in 1999, Fannie Mae was urged to enhance mortgage loans for individuals with low and moderate incomes. At the same time, lenders in the primary mortgage market asked Fannie Mae to relax credit requirements on mortgages they planned to buy. This enabled them to lend at higher interest rates to subprime borrowers compared to conventional loans. Additionally, Fannie Mae encountered shareholder pressure to maintain its remarkable profits.

In 2000, the Department of Housing and Urban Development (HUD) implemented regulations to prevent inclusion of risky and costly loans in affordable housing goals. However, these regulations were later removed in 2004, allowing high-risk loans to once again contribute towards affordable housing objectives. The purpose behind this change was for Fannie Mae to utilize their strict underwriting standards, typically employed for standard conforming mortgages, to offer secure lending options for buyers with less-than-prime credit.

Nonetheless, Daniel Mudd, the President and CEO of Fannie Mae at that time, testified in 2007 that these responsible underwriting requirements unintentionally led borrowers towards the private mortgage industry. These industry players aggressively marketed products without considering future consequences. Mudd explained: "We also established conservative underwriting standards for loans we finance to ensure that homebuyers can afford their loans over a long period. Our main goal was to extend our

services to underserved families by applying the same standards we use in prime markets to the subprime market through collaborations with our industry partners."

Unfortunately, the subprime market did not embrace Fannie Mae-quality safe loans as the norm, causing the lending market to veer away from us. Instead, borrowers were presented with a variety of loans that added teaser rates, interest-only payments, negative amortization, and low-documentation requirements to floating-rate loans. In early 2005, we began expressing concerns about this risky approach to lending. For instance, Tom Lund, the head of our single-family mortgage business, publicly voiced our unease about placing more homebuyers into programs that fostered higher risk. These products were better suited for more sophisticated buyers.

Should borrowers take on unknown risks? Are we setting them up for failure? As a result, our competitors gained a significant market share. Early warnings: In 1999, The New York Times reported that Fannie Mae was entering the subprime market, thus increasing their risk significantly. This heightened risk may not be problematic during prosperous economic times. However, in an economic downturn, this government-supported corporation could encounter difficulties and require a government rescue similar to the savings and loan industry in the 1980s. Alex Berenson of The New York Times also emphasized in 2003 that Fannie Mae's risk is much greater than commonly believed. Nassim Taleb highlighted in his book The Black Swan that Fannie Mae, as a government-sponsored institution, seems highly susceptible to even minor disruptions due to their extensive exposure to risk. Despite these concerns, their team of scientists dismisses such occurrences as 'unlikely'.

Fannie Mae is located at 3900 Wisconsin Avenue, NW in Washington, D.C. They specialize in obtaining

loans from mortgage originators and reorganizing them as mortgage-backed securities. These securities are then sold to investors in the secondary mortgage market, with Fannie Mae providing a guarantee for timely payments of both principal and interest. Additionally, they have the option to keep some of these mortgages within their own portfolio. This process injects fresh funds into banks and other financial institutions, enabling them to issue new loans. As a result, Fannie Mae and Freddie Mac's flexibility and liquidity have a positive impact on the housing and credit markets in the United States. To qualify for Fannie Mae's guarantee on their mortgage-backed securities, loans must meet specific criteria known as "conforming" loans.

"Non-conforming" loans, also known as "jumbo" mortgages, deviate from lending guidelines and are typically larger than the maximum mortgage that Fannie Mae and Freddie Mac will purchase.

In early 2008, it was determined that TBA-eligible MBS (Mortgage-Backed Securities) could include up to 10% of these "jumbo" mortgages.

The mortgage crisis in late 2007 led GSE's (Government-Sponsored Enterprises) like Fannie Mae, Freddie Mac, and the Federal Home Loan Banks (FHLBanks) to fulfill HUD's housing goals. These goals aim to enhance home ownership for low and middle-income families, underserved areas, and promote affordable methods such as enabling individuals to obtain a 30-year fixed-rate mortgage with a low down payment. It also ensures continuous access to mortgage credit under different economic conditions.

According to the HUD 2002 Annual Housing Activities Report, the subprime mortgage crisis began in 2007. This had a negative impact on borrowers with poor credit and adjustable rate mortgages (ARM), causing difficulties with mortgage payments and resulting in a rise in home foreclosures. As a result, there

was an increase in inventory due to the growing number of foreclosed homes, leading to a decrease in home prices. Moreover, stricter lending standards made it more difficult for borrowers to obtain mortgages. Consequently, GSEs (government-sponsored enterprises), which handle most US mortgages, experienced significant losses as home prices depreciated. To address concerns within the market, the government reaffirmed in July 2008 that Fannie Mae and Freddie Mac play a crucial role within the US housing finance system.The Treasury Department and the Federal Reserve took steps to restore confidence in corporations by implementing measures. These measures included providing low-interest loans from the Federal Reserve to corporations at rates similar to those offered by commercial banks. They also lifted the prohibition on the Treasury Department's purchase of GSEs' stock. However, despite these efforts, Fannie Mae and Freddie Mac's shares experienced a drastic decline of over 90% by August 2008 compared to their levels one year earlier.

Fannie Mae generates income through various sources, such as the positive difference between the interest rate paid for funding mortgage investments and the return earned on retained mortgage investments. By August 2008, Fannie Mae's mortgage portfolio had surpassed $700 billion.

In addition, a significant portion of Fannie Mae's revenue is derived from guaranty fees received for assuming credit risk associated with single-family mortgage loans underlying its Fannie Mae MBS (Mortgage-Backed Securities), as well as those held in its retained portfolio. Investors who hold Fannie Mae MBSs allow them to retain this fee while taking on credit risk themselves. As a result, even if borrowers default, Fannie Mae ensures payment of scheduled principal and interest on underlying loans.

Fannie Mae and Freddie Mac provide conforming

loans, which have a maximum loan size called the "conforming loan limit." The Office of Federal Housing Enterprise Oversight (OFHEO), the regulatory body for both government-sponsored enterprises (GSEs), determines this limit annually based on changes in mean home price from October to October.

If a mortgage exceeds this limit, it becomes a non-conforming jumbo loan. These loans are not purchased by the GSEs for sale in the secondary market, causing challenges for lenders in selling them. Consequently, consumers face increased costs (typically 1/4 to 1/2 of a percent).

In Alaska and Hawaii, the conforming loan limit is 50% higher than in other states. However, in 2008, there was minimal demand for bonds that lacked Fannie Mae or Freddie Mac guarantees. This led to non-conforming loans being nearly nonexistent and resulted in an approximately 1% cost difference compared to conforming loans.

During the subprime mortgage crisis, there were discussions about guarantees and subsidies that hinted at the rescue of Fannie Mae by the U.S. government. It should be noted that this hypothesis had not been examined before.

S. On July 11, 2008, the New York Times reported that U.S. government officials were discussing a potential strategy for the U.

S. government may assume control of Fannie Mae and/or Freddie Mac if their financial conditions deteriorate as a result of the U.S. housing crisis.

Government officials have announced plans to enact a law that would establish a $5 trillion explicit government guarantee on debt held or guaranteed by Fannie Mae and Freddie Mac. This declaration had a significant impact on the stock market, causing substantial decreases in the share prices of both companies on Friday, July 11, 2008. Investors speculated that the government

was preparing to take over the companies in order to address their funding problems. The uncertainty surrounding FNMA's financial stability also contributed to declines in its share prices.

S. Treasury Secretary Henry M. Paulson and the White House made a televised appearance to ensure the financial stability of Fannie Mae, which along with Freddie Mac, has control or guarantee over nearly half of all residential mortgages in the U.S. These institutions are facing substantial losses amounting to billions of dollars and may need additional funds to navigate through the current economic downturn.

Government assistance is expected to be provided for mortgage obligations in the United States housing market, despite ongoing challenges, given that the entire U.S. economy depends on it.

The mortgage market collapse would impede and raise the cost of obtaining mortgages. U.S. Treasury Secretary Henry Paulson has stressed the government's main objective of aiding Fannie Mae and Freddie Mac in their present state. It is crucial to acknowledge that Fannie Mae does not receive direct government funding or support, and their securities lack a guarantee from the government for repayment. This absence of government endorsement is explicitly mentioned in the legislation granting authority to GSEs, as well as in multiple public communications by Fannie Mae.

The United States government does not guarantee the certificates or payments of principal and interest on them. These certificates are not considered a debt or obligation of the United States or its agencies, except for Fannie Mae. However, Fannie Mae and Freddie Mac have benefited from lower borrowing costs because investors believe they are backed by the government. The Congressional Budget Office and the Treasury Department estimate that this savings amounts

to about $2 billion annually. Many investors believe that FNMA securities have an implied federal guarantee and that the government would intervene to prevent a catastrophic default. Vernon L.

In 2002, Smith, the recipient of the Nobel Prize in economics, described FHLMC and FNMA as agencies that indirectly receive support from taxpayers. The Economist also acknowledged the government's implied guarantee of these two agencies. During testimonies to the House and Senate Banking Committee in 2004, Alan Greenspan highlighted that Fannie Mae's financial vulnerability was a result of the market's belief that the U.S. Government would always prevent its collapse. While not directly assisted by the federal government, it is widely believed that both FNMA and its issued securities are implicitly backed by the U.S. Government.

In 1996, the Congressional Budget Office stated that government-sponsored enterprises (GSEs) do not receive federal appropriations or guarantee subsidies from the U.S. government, but they do enjoy significant unpriced benefits. For instance, Fannie Mae and Freddie Mac benefit from holding less capital than other financial institutions, which is an expensive arrangement for both the government and taxpayers.

The FDIC Bank Holding Company Act mandates that financial institutions must maintain a capital/asset ratio of 3% or more to ensure their financial stability. However, mortgage-backed securities can be sold with only half the amount of capital support compared to other institutions. Fannie Mae and Freddie Mac, known as GSEs, are exempt from this requirement and often have a capital/asset ratio below 3%.

The additional leverage enables companies to generate higher returns during prosperous times, but also exposes them to increased risk during downturns, such as the ongoing subprime mortgage crisis. FNMA is exempt from state and

local taxes and SEC filing requirements; however, both GSEs voluntarily submit their SEC 10-K and 10-Q filings. FNMA uses derivatives like interest rate swaps and options for entering interest rate swaps (including "pay-fixed swaps," "receive-fixed swaps," "basis swaps," "interest rate caps and swaptions," and "forward starting swaps") to hedge its cash flow. The accounting for FNMA is discussed in an article by Barron's titled "Fannie Mae faces more income issues - Banks - Financial - Real Estate - Financial Services - General". Duration gap, a term used in finance and accounting, refers to the difference between the duration of assets and liabilities. It is commonly employed by banks, pension funds, or other financial institutions to assess their risk due to fluctuations in interest rates. An update reveals that Fannie Mae's average duration gap widened in April.

In April, the company reported that its average duration gap increased to plus 3 months, up from zero in March. The company's goal is to maintain a duration gap ranging from minus 6 months to plus 6 months. Prior to March, the gap has fluctuated between plus and minus one month since September 2003. This information is related to the federal takeover of Fannie Mae and Freddie Mac, which occurred on September 7, 2008 and led the companies to enter conservatorship under the Federal Housing Finance Agency (FHFA) Director James B.

Lockhart III implemented the conservatorship of Fannie Mae and Freddie Mac on behalf of the FHFA based on financial analysis, assessments, and statutory authority. The FHFA has clarified that there are no intentions to liquidate the company. This decision came after reports indicated that the Federal government was planning to

intervene and held abrupt meetings with the CEOs of both entities. On September 7, 2008, the Federal Housing Finance Agency took control of Fannie Mae and Freddie Mac, dismissing their CEOs and boards of directors. Additionally, the Treasury received new senior preferred stock and warrants for common stock equivalent to 79% of each government-sponsored enterprise (GSE). The value of common and preferred stock for pre-conservatorship holders declined significantly due to the suspension of future dividends on existing stock. This measure aimed to maintain the value of company debt and mortgage-backed securities. The U.S. authorities held the responsibility for this action.

According to the law passed on July 30, 2008, the Treasury is authorized to provide funds to stabilize Fannie Mae and Freddie Mac, as long as it does not exceed the federal government's debt limit. This law increased the national debt ceiling by US$800 billion, bringing the total to US$10.7 trillion. The purpose of this increase was to allow the Treasury to support the federal home loan banks if needed. In 2004, Fannie Mae was investigated for its accounting practices, with the Office of Federal Housing Enterprise Oversight reporting widespread accounting errors on September 20, 2004. To rectify these errors and comply with regulations, Fannie Mae was projected to spend over $1 billion in 2006 alone.

The restatement was anticipated to cost $10.8 billion but ended up being $6.3 billion according to Fannie Mae's Annual Report on Form 10-K. Worries regarding business and accounting practices at Fannie Mae can be traced back before the scandal. On June 15, 2000, the House Banking Subcommittee On Capital Markets, Securities And Government Sponsored Enterprises conducted hearings on Fannie Mae.

On December

18, 2006, regulators in the United States filed 101 civil charges against the chief executive, Franklin Raines; the chief financial officer, J. Timothy Howard; and the former controller, Leanne G. Spencer. The accusations state that they manipulated Fannie Mae earnings in order to maximize their bonuses.

The lawsuit aimed to recover over $115 million in bonus payments earned by three individuals between 1998 and 2004, as well as around $100 million in penalties for their involvement in the accounting scandal. In addition, it was revealed that two former CEOs of Fannie Mae, James A. Johnson and Franklin Raines, had received loans below market rate from Countrywide Financial, which Fannie Mae was the largest purchaser of its mortgages. Both Fannie Mae and Freddie Mac strategically made contributions to lawmakers who served on committees responsible for regulating their industry, such as the House Financial Services Committee, Senate Banking, Housing & Urban Affairs Committee, or Senate Finance Committee. Other lawmakers who received contributions either held seats on powerful committees like Appropriations or Ways ; Means, held positions in congressional leadership, or ran for president. Barney Frank has served on the House Financial Services Committee since 1991 and currently serves as its chair.

The HFSC is one of two government entities responsible for oversight over Fannie Mae. From 1991 to 1998, Barney Frank had a lover, Herb Moses, who was an executive at Fannie Mae. While at Fannie Mae, Moses helped develop many of Fannie Mae’s affordable housing and home improvement lending programs. Other lawmakers have called this a "clear conflict of interest. " In 2003, the Bush administration recommended a significant regulatory overhaul in the housing finance industry. However,

many Democrats opposed that regulation fearing that tighter regulation could sharply reduce financing for low-income housing, both low and high risk.

Treasury Secretary John W. Snow called for Congress to eliminate the president's authority to appoint directors to Fannie Mae. Senator John McCain became a co-sponsor of the Federal Housing Enterprise Regulatory Reform Act of 2005, initially introduced by Sen. Charles Hagel. The act highlighted findings from Fannie Mae's regulator, stating that the company's senior management intentionally and systematically fabricated profits.

However, many Democrats also opposed this regulation, leading to repeated Democratic resistance against Republican efforts to reform Fannie Mae and Freddie Mac. Notably, Franklin Raines, former Clinton Budget Director and CEO from 1999 to 2004; James Johnson, former aide to Democratic Vice-President Walter Mondale and ex-head of Obama's Vice-Presidential Selection Committee, CEO from 1991 to 1998; and Jamie Gorelick, former Clinton Deputy Attorney General, Vice-Chair from 1998 to 2003 all served as top executives at Fannie Mae. In their respective roles, Johnson made an estimated $21 million; Raines made an estimated $90 million; and Gorelick made an estimated $26 million. Additionally, all three executives were implicated in mortgage-related financial scandals.

Senator Barack Obama, in his first campaign, received a total of $105,849 in campaign contributions from Fannie Mae employees and PACs. This amount was the third highest received between 1989 and 2008. Additionally, he received $16,000 in campaign contributions specifically from Fannie Mae and Freddie Mac.