Of 1970 when fannie mae had been recently privatized

Info icon This preview shows pages 13–15. Sign up to view the full content.

View Full Document Right Arrow Icon
of 1970, when Fannie Mae had been recently privatized and Freddie Mac was newly created, they represented 4.4% of the mortgage market; by 1991, they captured 28.4%; by the time of the financial crisis, 41.3% with a combined $1.43 trillion mortgage portfolio and $3.50 trillion in mortgage-backed security (MBS) guarantees; and, as of August 2010, they had left the US taxpayers with a dent of close to $150 billion, with some projections anticipating that this figure will more than double in years to come, with substantial downside risk.
Image of page 13

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
12 We start by describing what the GSEs do: what roles they play in the mortgage markets. We then trace the origins of Fannie Mae and Freddie Mac, what special features of these enterprises caused the financial markets to treat them specially, and what allowed them to register their staggering growth. 1.1 The Essence of the GSEs What exactly do Fannie and Freddie do? The GSEs are engaged in two somewhat related businesses: residential mortgage securitization (currently about $3.5 trillion) and residential mortgage investment (currently about $1.7 trillion). The GSEs’ securitization business operates as follows: They buy mortgages from originators (mostly fixed-rate, single-family home mortgages, although they do also buy some adjustable-rate mortgages and some multi-family mortgages); they form pools of these mortgages (so that the “law of large numbers” reduces the variability in outcomes that might arise from a single mortgage); and they issue (sell) “pass-through” mortgage-backed securities (MBS) that are formed from these pools to investors. These MBS represent claims on the interest and principal repayments that are “passed through” from the pool of mortgage borrowers to the securities investors (minus various fees). 1 Because the investors have no direct knowledge of the creditworthiness of the mortgage borrower, they need to be reassured that they will receive the promised interest and principal repayments. Both Fannie Mae and Freddie Mac provide guarantees to investors in their MBS against the risk of default by borrowers of the underlying mortgages. In return, both charge a “guarantee fee”. Although the GSE guarantee (so long as it can be honored) removes the credit risk from the securities, the MBS investor is still subject to interest-rate risk. Any long-lived fixed-rate debt instrument carries interest-rate risk: When interest rates for new securities are higher than the interest rate on an existing (but otherwise comparable) security, the value of the latter decreases; when interest rates for new securities are lower, the value of the existing security increases. However, for fixed-rate mortgages (and the MBS that are formed from them), the interest-rate risk for the investor is heightened, because mortgage borrowers are usually able to prepay their mortgage (and, in the United States, do so without paying any fee or penalty.
Image of page 14
Image of page 15
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern