It allowed for banks charging low mortgage interest rates to encourage anyone interested in buying a home. It led to the creating a secondary market for mortgages. In this market, companies like Fannie Mae borrowed money from foreign markets at minimal interest rates since they were financially supported by the US Government. This enabled Fannie Mae to give fixed rate mortgage that have a very low deposit to any home buyer.
Fannie Mae monopolized the secondary market for the first thirty years after its inception. In 1968, the Vietnam War created great fiscal pressure. This led to Fannie Mae's privatization and its removal from the national budget by President Johnson. This is when it started to operate as a Government Supported Enterprise, GSE. It made profits for its shareholders and at the same time enjoyed being exempted from tax and oversight, despite being backed by the government. To prevent any further monopoly, another Government Supported Enterprise was formed in 1970. It was known as Freddie Mac. These two companies currently command a 90 per cent of the national secondary mortgage market.
GSEs have experienced great growth financially over the years. Their combined asset base is currently at 45 per cent more than those of the biggest bank in the country. However, their combined debt equals 46 per cent of the present national debts. This high growth as well as over-leveraging has caused concerns in the Congress, the SEC and the Justice Department regarding their financial practices.
Freddie Mac and Fannie Mae happen to be the only corporations in the Fortune 500 league that do dot abide by the requirement to furnish the public about any difficulties in finances they undergo. In case they collapse, the taxpayers will have to foot the multi-billion dollar outstanding debt. A recent probe into Freddie Mac by the SEC and the Justice Department discovered accounting errors to the tune of $4.7 billion, resulting in the dismissal of several top managers (Alford, 2003).
The GSEs' role in the crisis and reasons for their current financial difficulties
Various reasons have been attributed to the current situation of Freddie Mac and Fannie Mae. They include:
The home owners' inability to pay for their mortgages
Poor judgment by both the GSEs and borrowers
Speculating and overbuilding
Government regulation or lack thereof.
Federal Reserve policies
Complex financial innovations that distributed and concealed default risks
During high growth, increasing capital flow and great stability, market participants only concerned themselves with high yields forgetting about any risk involved. They did not properly exercise diligence. Other factors believed to have caused this situation include:
Weak underwriting standards
Unsound managing of risk
The complicated and opaque financial products
Excessive leverage that creates vulnerabilities in the system
Supervisors, regulators and policy makers did not adequately acknowledge and address risk accumulating in the financial market. They also failed to be at par with financial innovation and regulate the domestic financial market.
GSEs are limited by their charters to buy only buy family home mortgages that others originate. They are not entitled to diversifying their