FANNIE MAE.

The Federal National Mortgage Association (FNMA) (NYSE: FNM), commonly known as Fannie Mae, is a government sponsored enterprise (GSE) of the United States. It is a stockholder-owned corporation authorized to make loans and loan guarantees. It is the leading market-maker in the U.S. secondary mortgage market, which helps to replenish the supply money for mortgages and enables money to be available for housing purchases. As of 2008, Fannie Mae and the Federal Home Loan Mortgage Corporation (Freddie Mac) own or guarantee about half of the U.S.'s $12 trillion mortgage market. As a result, the corporations were particularly affected by the economic downturn in late 2007 and early 2008. Although they guarantee or own only half of the mortgage market, because the subprime mortgage crisis has caused almost all other lending sources to pull out of the market, they are responsible for more than 80% of new mortgages being made in 2008. The name "Fannie Mae" is a creative pronunciation of the company's acronym, FNMA, that has been adopted officially for ease of identification. It is more than an informal nickname; FNMA refers to itself by this name. On September 7, 2008, Federal Housing Finance Agency (FHFA) director Lockhart announced he had put Fannie Mae and Freddie Mac under the conservatorship of the FHFA. The action is "one of the most sweeping government interventions in private financial markets in decades". HISTORY: Fannie Mae was founded as a government agency in 1938 as part of Franklin Delano Roosevelt's New Deal to provide liquidity to the mortgage market. For the next 30 years, Fannie Mae held a virtual monopoly on the secondary mortgage market in the United States. In 1968, to remove the activity of Fannie Mae from the annual balance sheet of the federal budget, it was converted into a private corporation. Fannie Mae ceased to be the guarantor of government-issued mortgages, and that responsibility was transferred to the new Government National Mortgage Association (Ginnie Mae). HOW FANNIE MAE WORKS: By buying mortgages and repackaging the loans for resale via mortgage-backed securities, or by owning mortgages outright, Fannie Mae and Freddie Mac, provide banks and other financial institutions with fresh money to make new loans. This gives the United States housing and credit markets flexibility and liquidity.[6] In a traditional loan, a bank or another lender might lend money to an individual to buy a home out of the funds deposited with that bank or lender. The bank or lender would charge interest and accept monthly payments on the loan until the loan was repaid after 30 years. There are two problems with this model. The first is that the customer may want a fixed rate of interest, but the bank has to pay a variable rate of interest to its depositors as the interest rates in the economy rise and fall. This exposes the bank to the risk that it might need to pay more to its depositors than it receives from the loan. The second problem is that the bank may run out of funds to lend to its customers (ie. there is more customer demand for loans than customer deposits in the bank). A solution to these problems is for the bank to sell bonds to outside investors based on the mortgages it has made. For a simplified example, a bank can sell one hundred $1000.00 bonds that pay 7% interest based on a mortgage loan for $100,000.00 that it made where it charged its customer 7%. The bond purchaser's money would therefore be recouped to the bank and the bond owners would effectively be lending the funds to the homeowner. The homeowner wouldn't know this because they would still be receiving the bill from the bank who would pass the payments on to the bond owners (this is known as servicing the loan). Doing this solves both problems simultaneously, as the investor would be seeking a sure fixed interest rate to invest their money and the bank would recoup its funds to lend more money. Under this model however, the investor is at risk if the borrower doesn't pay their monthly payment and if the loan is not repaid either from the borrowers payment or from the sale of the house. Even though many investors might purchase the bonds that are based on multiple mortgages, betting that only very few of them would have any problems, the US government sought to increase demand for these bonds (and therefore supply of mortgages, and therefore, lower mortgage interest rates) by creating Fannie Mae to guarantee the bonds. What Fannie Mae does is essentially makes any missed payments to the bondholder that the borrower misses, and also makes up for any loss for the loan not being fully repaid either by the borrower or from the sale of the house, and skims a certain percentage of the payment each month and holds the funds in reserve as insurance against these scenarios. Therefore investors believe they have no risk unless Fannie Mae itself becomes bankrupt. This process is essentially similar to what is known as bond insurance and is also used very often in State and City municipal bonds. Later, Fannie Mae expanded to also buy mortgage bonds or loans outright using borrowed money, and make money based on the difference between interest it receives from the bonds and what it has to pay on its borrowings. In order for Fannie Mae to provide its guarantee or insurance, it sets the guidelines for the loans that are made. Since a bank will either make more money holding a Fannie Mae guaranteed loan (being protected from loss), or make more money selling a Fannie Mae guaranteed loan as bonds, any loans that it would make without the guarantee would be because the loan falls outside of the guidelines. Mostly this would be because the loan has more relaxed guidelines. However, up until 2007 many loans were made that didn't conform to the guidelines and were sold as bonds without the Fannie Mae guarantee. THE MORTAGE CRISIS FROM LATE 2007: 2007, the subprime mortgage crisis began. An increasing number of borrowers, often with poor credit, that were defaulting on their mortgages caused a precipitous decrease in demand for any mortgage-backed securities (MBS) that weren't guaranteed by Fannie Mae or Freddie Mac. Home prices declined as increasing foreclosures added to the already large inventory of homes and stricter lending standards made it more and more difficult for borrowers to get mortgages. This depreciation in home prices led to growing losses for the GSEs. In July of 2008, the government attempted to ease market fears by reiterating their view that "Fannie Mae and Freddie Mac play a central role in the US housing finance system". The Treasury Department and the Federal Reserve took steps to bolster confidence in the corporations, including granting both corporations access to Federal Reserve low-interest loans (at similar rates as commercial banks) and removing the prohibition on the Treasury Department to purchase the GSEs' stock. Despite these efforts, as of August 2008, shares of both Fannie Mae and Freddie Mac have tumbled more than 90% from their one-year prior levels. On August 27, 2008, Fannie Mae announced that the company's chief financial officer, Stephen Swad, was being replaced by David C. Hisey and former Executive Vice President of Capital markets, Peter Niculescu, would take on an expanded role as the new Chief Business Officer to replace Robert J. Levin, who would be retiring as Executive Vice President and Chief Business Officer. The company also announced that Michael Shaw would be appointed as the new chief risk officer and Daniel Mudd, the company's president and chief executive officer, would remain in place. BUSSINESS: One part of Fannie Mae's income is generated through the positive interest rate spread between the rate paid to fund the purchase of mortgage investments and the return it earns on those retained mortgage investments. Fannie Mae's mortgage portfolio was in excess of $700 billion as of August 2008. Fannie Mae also earns a significant portion of its income from guaranty fees it receives as compensation for assuming the credit risk on the mortgage loans underlying its single-family Fannie Mae MBS and on the single-family mortgage loans held in its retained portfolio. Investors, or purchasers of Fannie Mae MBSs, are willing to let Fannie Mae keep this fee in exchange for assuming the credit risk; that is, Fannie Mae's guarantee that the scheduled principal and interest on the underlying loan will be paid even if the borrower defaults. Alan Greenspan and Ben Bernanke have spoken publicly in favor of greater regulation of the GSEs, due to the size of their holdings and the public belief in a government guarantee that does not exist. Conforming loans: Fannie Mae and Freddie Mac have a limit on the maximum sized loan they will guarantee. This is known as the "conforming loan limit". The conforming loan limit for Fannie Mae (along with Freddie Mac) is set by Office of Federal Housing Enterprise Oversight (OFHEO), the regulator of both GSEs. OFHEO annually sets the limit of the size of a conforming loan based on the October to October changes in mean home price, above which a mortgage is considered a non-conforming jumbo loan. The GSEs only buy loans that are conforming, to repackage into the secondary market, lowering the demand for non-conforming loans. By virtue of the law of supply and demand, then, it is harder for lenders to sell the loans, thus it would cost more to the consumers (typically 1/4 to 1/2 of a percent.) The conforming loan limit is 50 percent higher in Alaska, Hawaii, . However, in 2008, since the demand for bonds not guaranteed by the corporations is almost non existent, non-conforming loans are almost 1% to 1.5% higher than the conforming loans. Guarantees and subsidies: Speculation that the U.S. government would bail out an insolvent Fannie Mae is a hypothesis that had never been tested until recently, when the subprime mortgage crisis hit the U.S. On July 11, 2008, the New York Times reported that U.S. government officials were considering a plan for the U.S. government to take over Fannie Mae and/or Freddie Mac should their financial situations worsen due to the U.S. housing crisis. The government officials also stated that the government had also considered calling for explicit government guarantee through legislation of $5 trillion on debt owned or guaranteed by the two companies. Shares in U.S. mortgage finance firms Fannie Mae and Freddie Mac plunged on Friday, July 11, 2008, and market speculation mounted that the government was set to take them over to resolve their funding problems. Shares continued to plummet as investors became unsure about the adequacy of the capital held by FNMA. U.S. Treasury Secretary Henry M. Paulson as well as the White House went on the air to defend the financial soundness of Fannie Mae. Fannie Mae and smaller Freddie Mac own or guarantee almost half of all home loans in the United States. They face billions of dollars in potential losses, and may need to raise additional, potentially substantial, amounts of new capital as the current downturn in the U.S. housing market continues. Markets assume that the taxpayer will if necessary take on the burden of all their mortgages because they underpin the whole U.S. mortgage market. If they were to collapse, mortgages would be harder to obtain and much more expensive. U.S. Treasury Secretary Henry Paulson has said the government's primary focus is in supporting Fannie Mae and Freddie Mac in their current form. No actual guarantees: Fannie Mae receives no direct government funding or backing; Fannie Mae securities carry no government guarantee of being repaid. This is explicitly stated in the law that authorizes GSEs, on the securities themselves, and in many public communications issued by Fannie Mae. Neither the certificates nor payments of principal and interest on the certificates are guaranteed by the United States government. The certificates do not constitute a debt or obligation of the United States or any of its agencies or instrumentalities other than Fannie Mae. Assumed guarantees: There is a wide belief that FNMA securities are backed by some sort of implied federal guarantee, and a majority of investors believe that the government would prevent a disastrous default. Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA "implicitly taxpayer-backed agencies."[11] The Economist has referred to "[t]he implicit government guarantee"[12] of FHLMC and FNMA. In testimony before the House and Senate Banking Committee in 2004, Alan Greenspan expressed the belief that Fannie Mae's (weak) financial position was the result of markets believing that the U.S. Government would never allow Fannie Mae (or Freddie Mac) to fail. Federal subsidies: The FNMA receives no direct federal government aid. However, the corporation and the securities it issues are widely believed to be implicitly backed by the U.S. government. In 1996, the Congressional Budget Office wrote "there have been no federal appropriations for cash payments or guarantee subsidies. But in the place of federal funds the government provides considerable unpriced benefits to the enterprises... Government-sponsored enterprises are costly to the government and taxpayers... the benefit is currently worth $6.5 billion annually."[13]. Fannie Mae and Freddie Mac are required to hold less capital than normal financial institutions: e.g., it is allowed to sell mortgage-backed securities with only half as much capital backing them up as would be required of other financial institutions. Specifically, regulations exist through the FDIC Bank Holding Company Act that govern the solvency of financial institutions. The regulations require normal financial institutions to maintain a capital/asset ratio greater than or equal to 3%. The GSEs, Fannie Mae and Freddie Mac, are exempt from this capital/asset ratio requirement and can, and often do, maintain a capital/asset ratio less than 3%. The additional leverage allows for greater returns in good times, but put the companies at greater risk in bad times, such as during the current subprime mortgage crisis. FNMA is also exempt from state and local taxes. In addition, FNMA and FHLMC are exempt from SEC filing requirements; however, both GSEs voluntarily file their SEC 10-K and 10-Q. Conservatorship: On September 7, 2008, Federal Housing Finance Agency (FHFA) Director James B. Lockhart III announced pursuant to the financial analysis, assessments and statutory authority of the FHFA, he had placed Fannie Mae and Freddie Mac under the conservatorship of the FHFA. FHFA has stated that there are no plans to liquidate the company. The announcement followed reports two days earlier that the Federal government was planning to take over Fannie Mae and Freddie Mac and had met with their CEOs on short notice. Under the reported plan, the federal government, via the Federal Housing Finance Agency, would place the two firms into conservatorship, and for each entity, dismiss the chief executive officer, and dismiss the present board of directors and elect a new board of directors, and cause to be issued new common stock to the federal government. The value of the common stock to pre-conservatorship holders would be greatly diminished, in the effort to maintain the value of company debt and of mortgage-backed securities. The authority of the U.S. Treasury to advance funds for the purpose of stabilizing Fannie Mae, or Freddie Mac is limited only by the amount of debt that the entire federal government is permitted by law to commit to. The July 30, 2008 law enabling expanded regulatory authority over Fannie Mae and Freddie Mac increased the national debt ceiling US$800 billion, to a total of US$ 10.7 Trillion in anticipation of the potential need for the Treasury to have the flexibility to support the federal home loan banks. FINANCIALS: FNMA is a financial corporation which uses derivatives to "hedge" its cash flow. Derivative products it uses include interest rate swaps and options to enter interest rate swaps ("pay-fixed swaps", "receive-fixed swaps", "basis swaps", "interest rate caps and swaptions", "forward starting swaps"). FNMA's accounting is discussed in Barron's: Fannie Mae faces more income issues - Banks - Financial - Real Estate - Financial Services - General Duration gap is a financial and accounting term for the difference between the duration of assets and liabilities, and is typically used by banks, pension funds, or other financial institutions to measure their risk due to changes in the interest rate UPDATE - Fannie Mae average duration gap widens in April "The company said that in April its average duration gap widened to plus 3 months in April from zero in March." "The Washington-based company aims to keep its duration gap between minus 6 months to plus 6 months. From September 2003 to March, the gap has run between plus to minus one month." In late 2004, Fannie Mae was under investigation for its accounting practices. The Office of Federal Housing Enterprise Oversight released a report [2] on September 20, 2004, alleging widespread accounting errors, including shifting of losses so senior executives could earn bonuses. Fannie Mae was expected to spend more than $1 billion in 2006 alone to complete its internal audit and bring it closer to compliance. The necessary restatement was expected to cost $10.8 billion, but was completed at a total cost of $6.3 billion in restated earnings as listed in Fannie Mae's Annual Report on Form 10-K. Concerns with business and accounting practices at Fannie Mae predate the scandal itself. On June 15, 2000, the House Banking Subcommittee On Capital Markets, Securities And Government Sponsored Enterprises held hearings on Fannie Mae. On December 18, 2006, U.S. regulators filed 101 civil charges against chief executive Franklin Raines; chief financial officer J. Timothy Howard; and the former controller Leanne G. Spencer. The three are accused of manipulating Fannie Mae earnings to maximize their bonuses. The lawsuit sought to recoup more than $115 million in bonus payments, collectively accrued by the trio from 1998–2004, and about $100 million in penalties for their involvement in the accounting scandal. ARGUMENTS FOR AND AGAISNT THE EXISTENCEOF FANNIE MAE: Fannie Mae was originally created to facilitate the selling of mortgages as bonds (known as the "secondary mortgage market"). Some believe that the secondary mortgage market system is important because it keeps borrowers interest rates down by matching investors who want a long term fixed rate of interest with borrowers who want a long term fixed loan rate, avoiding the interest rate risk protection costs that might be occurred by a regular bank lender who has a variable rate cost of funds. The secondary market also helps with supply and demand imbalances in lending funds. Although many bonds were created in the secondary market that weren't guaranteed by Fannie Mae, in 2008 the demand for bonds without the guarantee has dried up. This causes proponents of Fannie Mae to declare that without the company there would be little or no new mortgages made in the United States, causing a more serious crisis. Most opponents to the existence of Fannie Mae generally agree[citation needed] that the sudden elimination of the companies in the current market would cause dramatic problems in new mortgage lending. However, many opponents argue that the companies should be nationalized and be structured only to be a lender of last resort during times such as these. The main argument against the companies is that they were vehicles of private profit but public loss, meaning that during the good times private stockholders made a lot of money and then the taxpayer will be responsible for the losses of the company. Some opponents don't believe that there should be a secondary mortgage market at all, as they believe that the disconnect between the loan decision maker (the bank), and the ultimate lender of the funds and the ones who would take any losses (the bond holders) was a fundamental cause of the lax lending standards which caused the subprime mortgage crisis. FURTHER READING: Muolo, Paul; Padilla, Matthew (2008). Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis. Hoboken, NJ: John Wiley and Sons. ISBN 978-0-470-29277-8. Guberman, Ross. "Fannie Mae Before the Meltdown: The View from August 2002", Washingtonian, August 1, 2002. Retrieved on 2008-07-15.