Definition, What It Does, Impact

Definition, What It Does, Impact

Freddie Mac is a government-owned corporation that buys mortgages and packages them into mortgage-backed securities. Its official title is the Federal Home Loan Mortgage Corporation or FHLMC.

Banks use the funds received from Freddie to make new loans to homebuyers. That boosts the housing market and allows more Americans to become homeowners.

The FHLMC gives banks the ability to create 30-year mortgages. Without Freddie, the banks would have to keep the loans on their books for 30 years. That would tie up too much money. It would also be too risky. Can you imagine how many people would default over 30 years?

Freddie resells the MBS to investors on the secondary market. That allows more investors to profit from the real estate sector. Freddie uses the proceeds to buy more bank mortgages. That starts the whole process all over again.

How It Works

The FHLMC buys mortgages from banks and other lenders. It combines similar types of mortgages into bundles. It then sells shares of the bundles to pension funds, mutual funds, and insurance companies. 

Freddie guarantees that the investors will receive an agreed-upon payment each month. The U.S. Treasury Department backs the guarantee. 

When you make your monthly mortgage payment, the bank sends it to the FHLMC. Freddie bundles your payment with others and sends it to the investors.

It doesn’t sell all the mortgages it buys. FHLMC keeps some as investments.

How It Affects the Economy

Freddie Mac affects the U.S. economy by lowering interest rates. That makes more loans available to more new homeowners. For example, reducing the rate from 8.5% to 8% allowed an additional 791,000 moderate-income families to buy homes.

Read about:   611 Credit Score (+ The #1 Way To Fix It)

Freddie also makes interest rates more consistent. In 1970, mortgage rates varied by as much as 1.7% between the nation’s cities. Today, that difference is only 0.1%.

Since being nationalized, Freddie has initiated programs to help homeowners avoid foreclosures. Freddie Mac stimulates the housing market. In healthier times, residential construction comprised 5% of the economy. By doing so, it creates wealth for homeowners who receive greater equity from higher-priced homes.

How It Affects You

Freddie Mac lowers the interest rates on the mortgages you get from the bank. In fact, it estimates it lowers the rate 0.5 percent, which translates to a $12,000 over the life of a $100,000 loan.

Freddie Mac also provides monthly housing market analyses. If you are thinking of buying or selling a home, take a look at the FHLMC reports. They give you a good idea of what is happening in the real estate market. 

Who Owns Freddie Mac

The U.S. government has warrants for 79.9% of Freddie Mac’s common stock. The U.S. Treasury also owns senior preferred stock. Since July 8, 2010, some of Freddie’s common stock has become available over the counter, but its price has been very low.

On September 6, 2008, the federal government bailed out Fannie and Freddie. The Federal Housing Finance Agency became the conservator of Freddie Mac. The Treasury Department bought up to $100 billion in Fannie and Freddie preferred stock and mortgage-backed securities.

Before that, Fannie and Freddie were government-sponsored enterprises. They were corporations whose goals were to maximize shareholder value. Both were even listed on the New York Stock Exchange. As a result, their managers tried to function as profitably as private banking competitors.

Read about:   Prepayment Penalty Definition

They were different from other corporations in a big way. The federal government virtually guaranteed their loans. That made them less risk-averse. They were pressured to take on risk to improve their return while knowing that they would never go bankrupt.

Fannie and Freddie found that holding many of these products was more profitable. This defect in their set up was brought to light when the subprime mortgage crisis exploded. As housing prices fell in 2006, the value of the GSEs’ loans plummeted.

Rather than allow them to go bankrupt, Paulson bought out their shares. Stockholders lost all value, although they would have if the companies had gone bankrupt. If they hadn’t been nationalized, there would essentially have been no housing market whatsoever. Banks just stopped lending without government guarantees. After nationalization, Fannie and Freddie owned 90% of the U.S. housing market. 

Freddie and Fannie

Freddie Mac is the “little brother” to Fannie Mae, the Federal National Mortgage Association. The Emergency Home Finance Act of 1970 created the FHLMC to compete with Fannie Mae.

Until the Act, Fannie Mae only bought Federal Housing Association approved loans. It was more likely to hold them on its books, rather than securitize them. Freddie changed that. It could buy any loan and securitize most of them. The prime differences between Freddie Mac and Fannie Mae are in their products and target markets. 

President Lyndon Johnson had turned Fannie into a publicly traded corporation two years earlier. He wanted to use its budget to finance the Vietnam War.

Freddie Mac went public in 1989. The Financial Institutions Reform, Recovery, and Enforcement Act made the change in response to the Savings and Loan Crisis. 

Read about:   Definition, Characteristics, Different Types of Mortgage

Leave a Reply

Your email address will not be published.