What are Fannie Mae and Freddie Mac, and why are they in trouble?

Fannie Mae and Freddie Mac: initialisms for the government-sponsored enterprises, short for Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC). The two have brought national attention to themselves when government officials were seen discussing the consequences of a possible falter.

Originally created to provide liquidity to the mortgage market, these shareholder-owned corporations are authorized to make loans and loan guarantees. As the nation’s largest buyers and insurers of mortgages (about $5 trillion, half the outstanding mortgage debt in the U.S.), the two companies have suffered heavy losses through the fast rate of default in mortgage. The losses have stretched to an enormous $5.1 billion as of 2007. Many have regarded the information of the large, government-backed companies failing as unsettling.

Says Gerard Baker of Times Magazine, “when the viability of two institutions that are central to the US housing market is called into doubt, it is potentially a personal and national calamity that threatens to undermine faith in the US economy itself.”

Both Fannie Mae and Freddie Mac have had cash or securities to fall back on over the years. However, losses have seen this financial cushion dwindling, forcing the companies to search for ways to raise new money. Many have argued that the companies are undercapitalized and need to find more efficient ways of raising money, while others have defended the strength of Fanny and Freddy, insisting that the companies are two big and too well-backed by the government to fail.

One may ask, how serious is the situation if the companies do fail?

“Every major bank, and many mutual funds and pension funds and foreign governments, hold significant amounts of securities issued by Fannie and Freddie… A default by either one of the companies could be catastrophic for the financial system,” says Stephen Labaton of New York Times.

So is there any rescue which lies in sight for Fanny or Freddie?

Fannie Mae and Freddie Mac: initialisms for the government-sponsored enterprises, short for Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC). The two have brought national attention to themselves when government officials were seen discussing the consequences of a possible falter.

Originally created to provide liquidity to the mortgage market, these shareholder-owned corporations are authorized to make loans and loan guarantees. As the nation’s largest buyers and insurers of mortgages (about $5 trillion, half the outstanding mortgage debt in the U.S.), the two companies have suffered heavy losses through the fast rate of default in mortgage. The losses have stretched to an enormous $5.1 billion as of 2007. Many have regarded the information of the large, government-backed companies failing as unsettling.

Says Gerard Baker of Times Magazine, “when the viability of two institutions that are central to the US housing market is called into doubt, it is potentially a personal and national calamity that threatens to undermine faith in the US economy itself.”

Both Fannie Mae and Freddie Mac have had cash or securities to fall back on over the years. However, losses have seen this financial cushion dwindling, forcing the companies to search for ways to raise new money. Many have argued that the companies are undercapitalized and need to find more efficient ways of raising money, while others have defended the strength of Fanny and Freddy, insisting that the companies are two big and too well-backed by the government to fail.

One may ask, how serious is the situation if the companies do fail?

“Every major bank, and many mutual funds and pension funds and foreign governments, hold significant amounts of securities issued by Fannie and Freddie… A default by either one of the companies could be catastrophic for the financial system,” says Stephen Labaton of New York Times.

So is there any rescue which lies in sight for Fanny or Freddie?

The government has granted the Federal Reserve Bank of New York the authority to lend to the both companies if necessary. They would pay 2.25 percent for any borrowed funds. The Treasury Secretary Henry Paulson says that the Treasury is seeking expedited authority from Congress to expand its current line of credit to the two companies and buy shares of the companies if necessary. Congress will also be called on to raise the national debt limit.

This plan seems to bring grim news to the economy.

Says Martin Crutsinger and Alan Zibel of InsideBayArea, “Now that the federal government has thrown a lifeline to mortgage giants Fannie Mae and Freddie Mac, taxpayers could be on the hook for billions more if the crisis of confidence spreads.”