What happens if fannie mae fail

While Fannie Mae and Freddie Mac will undoubtedly earn a lot of money going forward, those earnings are for the benefit of the government and not stockholders. It is possible that current stockholders could participate if Fannie and Freddie are eventually released, the chance of that happening is impossible to evaluate, which makes the companies an unsuitable long-term investment.

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Stock Market. Industries to Invest In. Getting Started. Planning for Retirement. Retired: What Now? Fannie Mae and Freddie Mac exist to support the U. Instead, they buy mortgage loans from the banks and financial institutions that originate them. This keeps money flowing back into lending institutions so they have plenty of funding on hand to write more mortgages and help more people buy homes.

Fannie Mae was chartered by Congress in during the Great Depression. The crisis had wreaked havoc on the housing market, and leaders wanted to increase funding for home buying and make homeownership more affordable and accessible.

Fannie Mae changed the way mortgage lending worked, making it possible for lenders to extend long-term mortgage loans with smaller down payments, and it greatly expanded the mortgage credit market. Fannie Mae remained a government owned entity for the first three decades of its existence, with a near monopoly over the secondary mortgage market. Fannie Mae was privatized in , and Freddie Mac was created in as a competitor to dilute its monopolization of the market.

Fannie and Freddie are private corporations that were chartered by Congress—the formal term for this kind of company is a Government Sponsored Enterprise GSE.

Because of the large role they play in the economy and their governmental affiliation, some investors assume they are implicitly guaranteed by the federal government. Even though Freddie Mac and Fannie Mae are technically shareholder-owned, they have been under government conservatorship since the Great Recession. Many investors who hold stock in the two companies are eagerly waiting for them to emerge from government control so their stock can trade on public exchanges again.

In the company was converted to a mixed-ownership corporation—making it both publicly and privately owned. However, by , Congress decided to allow FNMA to become entirely private, and in it allowed the company to begin buying conventional mortgages. Later, during the s, Fannie Mae began issuing mortgage-backed securities. These investments bundle mortgages into a security format that makes it easier for investors to buy. With investors involved, FNMA gained more liquidity and was able to buy more government-backed and conventional mortgages.

One of the biggest ways Freddie Mac makes a difference in the mortgage market is by buying loans from smaller banks. The idea is that by getting home loans off the balance sheets of community banks, these types of institutions are able to offer affordable mortgages to a wider variety of consumers. Because they are government sponsored enterprises, and because they were created by Congressional charter, Fannie Mae and Freddie Mac have a high level of special oversight from the government.

Some things to keep in mind about these two companies include:. However, all parties involved, including the FHFA, have retained advisers to help them get back on track for non-governmental ownership.

But they were also public companies, whose bonds and shares were widely held by investors. Given their importance, most investors in Fannie and Freddie assumed that they were too big to fail. If the companies ever ran into trouble, they assumed the government would bail Freddie and Fannie out. This especially gave Freddie and Fannie favorable treatment in the bond market.

The implicit guarantee made their bonds less risky bets than bonds from other financial companies, helping them borrow money more cheaply.

Fannie and Freddie borrowed trillions of dollars, meaning that their bonds were very widely held—further ensuring they became too big to fail. Research by Michael LaCour-Little, Eric Rosenblatt, and Vincent Yao into foreclosures in Southern California between and found that in virtually every case of foreclosure, the borrower had used large amounts of the property's equity to take out additional loans through refinancing or home-equity lines.

Even after the resulting foreclosure, borrowers came out ahead in the end. Many who already owned a primary residence also took advantage of the upward trajectory of home prices in the mids. And many of those purchases were financed through non-traditional mortgage options. Between one-fifth and one-third of Alt-A and negative amortizing loans another high-risk loan product that actually allows the principle to increase were used to buy second residences or investment properties — a rate between two and three times greater than the average for all mortgages.

Of course, all these data assume that borrowers accurately identified the intended purpose of their loans, which is unlikely to be the case. Evidence suggests widespread fraud, with many people taking out these mortgages to buy investment properties or second homes while classifying their purchases as primary residences to secure lower interest rates.

Alternative mortgage structures with negative amortization schedules or low teaser rates thus provided "house flippers" with a way to make leveraged bets on continued house-price inflation at a lower cost than traditional year loans.

This increased demand in the housing market, helping to drive the astronomical increase in home prices. While Fannie Mae and Freddie Mac are often blamed for the mortgage crisis, the causes of their failure have been widely misunderstood.

Many observers who focus on the types and terms of mortgages as sources of the GSEs' collapse have suggested that affordable-housing requirements contributed to the problem. Congress and the Department of Housing and Urban Development in recent decades have imposed and have repeatedly intensified rules requiring the GSEs to provide affordable-housing loans to lower-income borrowers, and these observers say this contributed to the excessive risk the two companies took on.

But this assumption, too, turns out to be largely unfounded. The Alt-A and interest-only loans that helped topple the GSEs were not especially useful in reaching those income-based affordable-housing goals. The percentage of Fannie Mae's Alt-A loans that counted toward affordable-housing goals fell short of HUD's overall requirements every year between and , according to data from the Financial Crisis Inquiry Commission. Because too many of the Alt-A loans could not be applied toward the overall HUD requirements, increases in Alt-A lending had to be offset by a larger number of traditional mortgages that did count toward the income-based housing goals.

In fact, it was the same factor that caused borrowers to choose Alt-A loans — the lack of income documentation — that also made these loans ineligible to be counted toward the income-based affordable-housing requirements. Bush, pointed out in , if the marginal purchase of an Alt-A mortgage made the attainment of income-based housing goals less likely, one can safely conclude that the increase in the GSEs' Alt-A mortgage purchases after were motivated by business considerations and shareholder profits rather than by affordable-housing mandates.

Another common complaint — that the role played by the GSEs as a peculiar sort of public-private hedge fund contributed to their collapse — also appears to be poorly founded. Fannie and Freddie have a complicated, two-sided business model. One side is the well-known securitization business through which the enterprises fund home loans by issuing mortgage-backed securities to investors. The other is a capital-market business in which GSEs issue debt to buy securities — often funding the purchase of the same mortgage-backed securities they issued.

Before the housing crisis, the latter aspect — the hedge-fund aspect of the business — was the focus of concern for many would-be reformers, including former Federal Reserve chairman Alan Greenspan. They worried that the GSEs' large, debt-funded portfolios of mortgage securities created systemic risk.

Greenspan argued that the portfolios made the GSEs vulnerable to large shifts in interest rates that could cause the market value of their liabilities to greatly exceed the market value of their assets; this would cause the enterprises to flounder, precipitating a taxpayer bailout. To reduce this risk, Greenspan advocated a hard cap on GSE portfolios, which would focus their operations away from their hedge-fund investment activities and toward their traditional guarantee business. The Bush Administration embraced this reform, as did the Senate Banking Committee which passed legislation to this effect in , though the bill never became law.

As it turned out, however, the traditional guarantee business, not the hedge-fund operation, was the undoing of the GSEs. Thus, while GSEs were indeed vulnerable, reformers had been focused on the wrong side of the business, and their proposed reforms would not have averted the eventual taxpayer bailout. Those who advocated reform before the crisis were right to worry, however, about implied federal support for ostensibly private, shareholder-owned corporations.

Such an assumption creates conditions ripe for exploitation, as risk is transferred from creditors to taxpayers and any reward is kept by shareholders and management. The assumption of a federal backstop was the most damaging flaw in the financial regulatory system in the years leading up to the financial crisis. Fannie and Freddie were not regulated by financial-market participants, who believed their obligations to be backed by the Treasury, nor were they regulated by government officials, who were hamstrung by their limited authority over the enterprises.

Yet the GSEs were not the only financial institutions to collapse in , and it would seem the most salient lesson of the crisis was just how far and wide the implied government safety net extended.

While the government had no legal obligation to bail out the GSEs, market participants bet on Fannie and Freddie, assuming that the Treasury would have no choice but to rescue them in a crisis because the costs of failing to do so would have been far greater. The same cost-benefit arithmetic is what motivated the TARP bailout, as well as the rescue of the auto industry. Today, policymakers favor two approaches to preventing another mortgage crisis.

But both ignore the evidence that has come to light in the last five years about the causes of the crisis, and both neglect the real problems that linger in the American mortgage system. First, now that the crisis is over, it is easy for policymakers to pledge that this most recent bailout was the last.

But promises to end to all public guarantees of mortgage credit mean little when the housing market is relatively stable; during a crisis, adhering to such a pledge requires a tolerance for chaos and for public panic that most elected officials do not have.

As a result, mortgage credit will not be guaranteed by the government — except in a crisis, when such guarantees will inevitably be deemed essential for the good of the economy.

The promise that we have seen the last bailout, therefore, does little to effect change in housing-finance markets. Apart from no-bailout pledges, policymakers' other favored solution has been to pass rules that restrict the types of mortgages that GSEs or other public guarantors are allowed to purchase. This approach, however, ignores the evidence discussed above about the true origins of the most recent crisis. Instead, the new regulations take for granted the original, mistaken interpretation of the crisis — that the problem was poor mortgage-contract design and not unsustainable increases in home prices.

The Consumer Financial Protection Bureau created in by the Dodd-Frank financial-regulation reform law recently adopted an "Ability-to-Repay Rule," which will require that, starting in January , in order to receive liability protection, lenders must take steps to verify that borrowers have the ability to repay their loans.

To do this, lenders must ensure that mortgages meet "qualified mortgage" loan parameters, which explicitly exclude negative amortization schedules and interest-only loans, as well as loans with terms longer than 30 years. These regulations could make it more costly to speculate on housing, but they will also disadvantage households with adequate but inconsistent incomes that made prudent use of non-traditional amortization schedules to finance home purchases. Unfortunately, recent regulatory efforts to standardize mortgages have ignored the mortgage-contract feature that seems to have played a much larger role in the crisis: the feature that allows households to take on additional debt through cash-out refinancing or home-equity loans as the value of their homes increase.

The new qualified-mortgage rules require a household to pay off a portion of its principal each month, but the rules do not restrict a household's ability to later extract this equity through incremental borrowing. This incremental borrowing eliminated the buffer that would have otherwise protected lenders from loss. More importantly, as described above, the rise in home prices was driven in large part by the ease with which a household could use additional home equity to borrow cash.

Households cannot sell off part of a home when it increases in price. Without refinancing and home-equity loan options, households could only liquefy house-price increases by selling the home, moving out, and downsizing to a less expensive residence.

The transaction costs involved — realtor fees, closing costs, the disruption and costs associated with moving — would dramatically reduce the allure of housing as an investment. Under these circumstances, the house-price boom would have been far less dramatic and the subsequent crisis significantly less severe.

The CFPB's efforts to standardize mortgages appear to be aimed at encouraging the issuance of private mortgage-backed securities, which has remained moribund since the crisis. The problem is that the type of investor who bought the AAA tranches of private mortgage-backed securities does not want to worry about the mortgages that collateralize their investments.

These investors buy AAA debt precisely because it relieves them of the obligation to study the likely credit performance of the pool of loans. But since it was the crash of the housing market — and not the type of mortgages made available in the last decade — that brought about the credit losses, standardizing mortgage types would not relieve these investors of their worries. Policymakers should therefore not assume pools of capital willing to hold government-backed AAA securities would be equally inclined to hold private mortgage obligations.

When policymakers attempted a major regulatory reform of the GSEs in , Fannie and Freddie argued that, as long as they were not subject to a long list of new regulations, they would have the flexibility to rescue the American mortgage market in the event of a crisis.

Alan Greenspan mocked this suggestion, pointing out that holding mortgage-backed securities does not provide purchasing power to buy mortgage-backed securities. As Greenspan trenchantly recognized at the time, in the event of a genuine mortgage crisis, the GSEs would be the first to fail. Unfortunately, that is exactly what happened in Had these institutions simply been required to hold equity capital in roughly the same proportion that banks are, shareholders would have absorbed all of the losses, and the taxpayer bailout would have been unnecessary.

This is perhaps the simplest and most straightforward of all the lessons of the crisis — and it could be the least complicated and most effective reform to implement — but it seems to be the least appreciated. As legislators and regulators continue to pursue the right mix of rules for the home-loan industry, it is vital that they correctly identify the problems to be solved.