Arguments over the Fate of Fannie Mae and Freddie Mac - Research Paper Example

Number] Fannie Mae and Freddie Mac Mortgage lending in the twentieth century took place usually through banks, loans and thrifts. The Great Depression in 1938 was a time when banks became short of cash and most mortgage borrowers went default. In such times, the Federal National Mortgage Association was founded as an enterprise sponsored by the government with just a budget of $1 billion (Peter12). It was commonly called ‘Fannie Mae’ and its aim was to facilitate the expansion of the mortgage market (Kate, Business). Its establishment provided local banks with the capital they could use to finance the home mortgages. This in turn, made ownership of affordable housing easily and widely available. The company allows its clients to reinvest their property and assets in order to earn more profit and thus, increase the number of money lenders in the market. Fannie Mae also assisted banks in issuing a greater number of housing loans. Since 1968, Fannie Mae has become a publicly traded organization and has held the monopoly of the mortgage market for as long as thirty years since its inception. In 1970, Fannie Mae acquired a higher status in the market and now got the authority to buy private mortgages. Also, the federal government created the another similar firm, the Federal Home Loan Mortgage Corporation, more commonly known as Freddie Mac in 1970 with the aim to compete with and thus help improve the standards of Fannie Mae in the market (Kate). The company started its work by buying mortgages in the market, pooling them up and selling them to the investors with a ‘backing security’. This allowed the lending money available in the market to increase and hence, more home purchases to be available for the customers. Together, the two companies brought great and rapid changes to the US economy. They formed a type of liquid market for the mortgages which defined a very important new rule in the market according to which, the financial institutions did not have to hold on to the mortgages and could easily sell them in the market (Peter 18). In this way, the funds of the companies were freed and they could use it to make further additional mortgages. Thus, the Fannie Mae and Freddie Mac together had a very positive impact on the business market (Duhigg, Friday). Rates of home ownership were also increased in the country and the companies earned large profits in the mere space of two decades. They raised enough money that allowed them to buy mortgages from a number of varied sources which included both pension and mutual funds and also, the governments of foreign countries (Duhigg). The main aim of the two mortgage firms was to make the procedure of home ownership better and easier for families with a limited income (Duhigg). They did this by offering specially designed affordable methods and making the mortgage credit available under a very large variety of economic conditions. They easily beat their rivals in the market with the help of the funding advantage they had over them and there was much debate in the market regarding their successes. Many critics stated that the government’s support was the main reason behind the outstanding achievements of the Fannie Mae and Freddie Mac. This was true to quite an extent because the US government was sponsoring the monopoly both the companies held in the market (Duhigg, Friday). Ironically, this monopoly, coupled with too much trust in the guarantees given by the government that led to the mortgage crisis eventually. The mortgage crisis started in 2003 – 2004. It was basically caused by the irregular system of the government firms who had given away more loans than their budget could afford. Moreover, the government sponsored enterprises like the Fannie Mae and the Freddie Mac also lost control of the originators in the mortgage market. The competition between the two organizations further deteriorated the power of the GSEs which led to a sharp decline in the standards of the mortgage firms and a massive crisis in the market. The mortgage companies started giving riskier loans to the insurance companies and their clients and the financial standards became difficult to maintain (Peter 11). Massive sums of moneys were withdrawn from banks to be given off as loans but only few of them were returned and so the debts increased in the US mortgage market. Many GSEs lost their market shares as well and then had to lower their rates in an attempt to reclaim them. Surely, the standards of the mortgage market deteriorated significantly. In such times, the private companies got the upper hand and received more customers as their policies were favorable and they had more capital and incentives to offer. So, in retaliation, the GSEs like Fannie and Fannie reduced their profits so as to attract more borrowers and lenders. The need to get clients was so great that at numerous occasions, their status was overlooked. A large sum of money was loaned to people who could not even afford to pay it back. Debts of the GSEs increased and they moved towards bankruptcy (DiVenti 242). Some of the GSEs even collapsed under the burden of the massive debts they got on their shoulders. Fannie and Freddie would had certainly went default had they did not have government autonomy and capital at their backs. But undoubtedly, the US economy fell into a serious mortgage crisis. The mortgage crisis had devastating results. In late 2007, the world’s economy suffered from a massive financial crisis also called the 2008 Global Financial Meltdown (DiVenti 231 - 242). As a result of this crisis, many financial institutions collapsed, banks went default and stock markets fell all over the world. Housing markets also underwent a lot of suffering which eventually resulted in unemployment and evictions. It also had an important role in bringing down business empires and a decline in consumer wealth (DiVenti 231). The meltdown of 2007 – 2008 was a period of great global recession and brought many countries under debt. At such a time, Fannie Mae and Freddie Mac along with other companies continued to suffer from further great losses when home prices started depreciating and it became more troublesome for the borrowers to acquire mortgages. Interests on loans were lowered as well; the shares of the two companies fell about 90 percent their original value in these times. The losses experienced by the Fannie Mae and the Freddie Mac were so great that the finance institutions of the US concluded that the two firms would certainly become ‘insolvent’ in the near future. The US government was blamed for the collapse of both the mortgage companies (Paige). Many accused the government officials of unnecessarily supporting them and allowing them to increase up to a size which became risky for the market. Fannie Mae and Freddie Mac along with other GSEs were encouraged by the government to buy a great number of loans of lower credit quality, which also caused many problems later on as the debts of both the firms grew very large and the global financial system became at risk (DiVenti 242). Fannie Mae lost millions of dollars in accounting scandals in the few years before the mortgage crisis; however, the government covered up these loses in order to save the company’s reputation (Kate). When these scandals were exposed during the financial meltdown of 2008, many conservative economists also criticized the government of giving the GSEs an unfair advantage in the market. Most economists also accused Fannie and Freddie of having an extremely flawed functioning system. They said that the companies provide their clients with short – term systematic benefits only but fail to take into account, the consequences of their actions on the market in the long run (Duhigg‎). Many of them demanded that the companies should be eliminated as there now remained no genuine or logical reason to defend their survival especially, after such a massive crisis. Therefore, in September 2008, the officials of the federal finance agency decided to take over the autonomy of both the Fannie Mae and the Freddie Mac (Kate). The federal takeover of the two companies by the US Treasury was a move that helped them placed under conservatorship. According to the Treasury Secretary, this was done in order to safeguard the money and capital which had previously been lost in the mortgage crisis and also to make genuine improvements to the flawed structure of Fannie and Freddie (DiVenti 231). This was faced with a lot of criticism as the members of both the firms were not happy with the intervention of the government in the matters of the private markets. However, the conservatorship had some positive effects now that the federal authorities had learned their lesson well from the mortgage crisis. The debt ceiling in the US treasury was raised significantly so that the government had more flexibility in helping and supporting Fannie and Freddie. But as it turned out, the conservatorship resulted in two very major problems. Firstly, private shareholders still had all the rights which they had prior to the crisis of 2008 and their interests still remained intact (Date). Secondly, the futures of the staff of Fannie and Freddie became very uncertain and they demanded that the government should at least give them a reasonable amount of time in case they decide to shut down the company or something like that. As it turned out, the government itself was unsure of what was to be done with Fannie and Freddie and the question still remains unsolved. The status of the two mortgage firms remains unclear to date particularly, because of the guarantee that the government continued to provide to the finances of both the companies. While there are some in their favor, most economists hold the opinion that Fannie Mae and Freddie Max are now flawed beyond repair and thus, they should be eliminated from the industry. Even after two years since the financial crisis, the arguments over the fate of the Fannie Mae and the Freddie Mac remained unresolved. It was in August 2010 that the US government and treasury proposed another set of measures to curtail the powers of Fannie and Freddie. It was aimed that such measures would help reform the status of the finance market and ensures a continuous flow of revenue in the mortgage business. Liquidation was promoted in the market with the hope that it would help make the housing market function effectively. However, these proposals did not much help in achieving what was desired and the Fannie Mae and Freddie Mac have started phasing out of the financial picture. Ironically, the US government has not come up with anything that can substitute their place and there are great chances of finding a vacuum in the mortgage industry in the near future (Date). Works Cited DiVenti, Theresa R. "Fannie Mae and Freddie Mac: Past, Present, and Future." Cityscape: A Journal of Policy Development and Research. 11.3 (2009): 231 - 242. Duhigg, Charles. "Loan-Agency Woes Swell From a Trickle to a Torrent", The New York Times, July 11, 2008. Web. 10 October 2012. Kate, Pickert. "A Brief History of Fannie Mae and Freddie Mac." Time Business14 Jul 2008, Web. 10 October 2012. Date, Raj. "The Giants Fall: Eliminating Fannie Mae and Freddie Mac.” Make Markets Be Markets. “Research Note, Cambridge Winter Center for Financial Institutions Policy, Cambridge, MA. (2010): n. page. Print. http://www.rooseveltinstitute.org/sites/all/files/Fannie and Freddie.pdf. Paige, Leslie K. “Corporate Welfare for the Politically Connected: The Story of Fannie Mae and Freddie Mac”. Through the Looking Glass A CAGW Special Report, Web. 10 October 2012 Peter, Wallison. "Are Fannie and Freddie Safe and Sound?" International Economy 2003, 17. 3 (2004), pp11 - 18. Print. Read More