Fannie, Freddie, Ginnie and all about that government crap...

So, market crash in 2008, who is to blame? We've been though this one many times, some blame the shadow banking system, some blame deregulations, securitizations, other point their fingers at Greenspan while many are holding a knife at the doors of the credit rating agencies. Well, in my view, they all play a huge role but today, I want to write about the three government giants, Fannie, Freddie and Ginnie because many people don't seem to have a clue what they do and where they come from other than the fact that they deal with mortgages.

Fannie Mae was chartered by the reconstruction finance corporation during the great depression in 1938 to buy mortgages insured by the FHA. Back in the day, Fannie either held the mortgages they bought in its portfolio or they simply resold them to thrifts, banks, insurance companies or investors at a later time. The model worked fine but there was one major issue with this system. Fannie Mae, in order to buy these mortgages, they did it by borrowing the money. In 1968, the mortgage portfolio of Fannie had grown to 7.2$ billion USD and the government started to notice this issue. So in order  to get the debt off the government’s balance sheet, president Johnson’s administration reorganized Fannie as a publicly traded corporation and created Ginnie Mae to take over Fannie’s subsidized mortgage program and loan portfolio and this was how Ginnie Mae was created.

Two years later, the thrifts and banks persuaded congress to charter a second GSE and Freddie Mac was created to help the thrifts sell their mortgages once again. Like we mentioned in the beginning, before 1968, Fannie Mae held the mortgages it purchased, profiting from the spread between its cost of funding and the interest paid on the mortgages. The new laws in 1970 gave Ginnie, Fannie and Freddie the option of securitization. So yes, in my point of view, the most early build up of the 2008 crisis can even start from as early as here. Therefore in 1971, Freddie got into the business of buying mortgages, pooling them and then selling MBS to investors. They did not originate mortgages, they bought them from banks and mortgage companies; either held them in the portfolio or securitized them and guaranteed them. The entire business model was changed.

The new laws in 1970 not only gave Freddie the option of securitization, but it also set the government sponsored enterprises’ minimum capital requirement at 2.5% of asset plus 0.45% of the MBS they guaranteed. Do you even know what kind of leverage this is?  They could borrow more than 200$ for each dollar of capital that was used to guarantee the MBS. If they owned the securities, they could borrow 40$ for each dollar of capital. Combined, they owned or guaranteed 5.3$ Trillion USD of mortgage related assets at the end of 2007 with only 70$ Billion USD in capital! This is a leverage ratio of 75:1! Talk about risk! The Basel accord is also to blame for this! The leverage ratio of the five major investment banks in 2007 were as high as 40 to 1, and you have the government leveraging at 75 to1. Ridiculous! So now you get why these guys didn't work out! A private business with a goal to maximize shareholder equity with the backing of the government, I don't think Johnson thought this one out too well back in the 60's!