The Federal National Mortgage Association (Fannie Mae) is the nation’s largest mortgage buyer and a financial juggernaut that affects the lives of tens of millions of home buyers. It was taken over by the federal government on Sept. 8, 2008, along with Freddie Mac, as the two mortgage giants struggled with deep losses and investors lost confidence in the pair.
The federal government created Fannie and Freddie to increase the availability of loans. Largely because of investors belief in an implicit government guarantee, these so-called government sponsored entities were able to lower the cost of millions of mortgages. But during the housing boom, they misused the governments support to enrich shareholders and executives by backing millions of shoddy loans. Fannie and Freddie lost more than $30 billion, in part as a result of the deals, losses that were borne mostly by taxpayers.
In May 2012, Fannie Mae announced that it made a profit in the first quarter and that it did not need additional bailout money a first since the federal government took it over in fall 2008. The company reported quarterly net income of $2.7 billion, up from a $6.5 billion loss in the first quarter of 2011.
A slowdown in the decline of home prices and in the number of homes entering serious delinquency allowed the company to eke out a profit after paying its dividend to the Treasury. Fannie Mae also said losses on its portfolio of home mortgages had probably peaked and that it expected better profits in the future, a sign that the worst might be over for the battered American housing market.
Fannie received about $116 billion from the Treasury over the previous three and a half years and paid back about $23 billion in dividends. Its brother institution, Freddie Mac, received about $72 billion and paid back about $18 billion.
Bank Settlement on Troubled Mortgages
In early January 2013, the Bank of America agreed to pay more than $10 billion to Fannie Mae to settle claims over troubled mortgages that soured during the housing crash, mostly loans issued by the bank Countrywide Financial subsidiary.
Under the terms of the deal, the bank will pay Fannie Mae $3.6 billion and will also spend $6.75 billion to buy back mortgages from the housing finance giant.
The settlement will resolve all of the lenders disputes with Fannie Mae, removing a major impediment to Bank of Americas rehabilitation. The bank had settled its fight with Freddie Mac in 2011.
Both Fannie and Freddie, which have posted billions of dollars in losses in recent years, have argued that Countrywide misrepresented the quality of home loans that it sold to the two entities at the height of the mortgage bubble. Bank of America assumed those troubles when it bought Countrywide in 2008.
Before the latest settlement announced, the Countrywide acquisition had cost Bank of America more than $40 billion in losses on real estate, legal costs and settlements, according to several people close to the bank.
Background: A Mortgage Giant Is Born
Fannie Mae was created during the Depression to make sure that sufficient funds were available to mortgage lenders, then rechartered by Congress in 1968 as a publicly traded company. Fannie Mae, Freddie Mac, which was created by Congress in 1970, buys mortgages from lending institutions and then either holds them in investment portfolios or resells them as mortgage-backed securities to investors.
Treasury Secretary Timothy F. Geithner has said that Fannie and Freddie did remarkably well in sustaining the secondary mortgage market for much of their history until the late 1990s, when they began to take on excessive risks and allow erosion in underwriting standards.
In the next decade, both companies admitted serious accounting errors. Freddie’s problems arose in 2003 when it disclosed that it had understated its income from 2000 to 2002; the company revised its results by an additional $5 billion. In 2004, Fannie was found to have overstated its results for the preceding six years; conceding that its accounting was improper, it reduced its past earnings by $6.3 billion.
Legal fees for defending the leaders of the companies at that time had grown to more than $160 million by the end of 2010, all covered by taxpayers.
In light of the accounting problems, the companies since 2004 were required to hold 30 percent more capital than the minimum previously required, in effect capping their ability to purchase mortgages.
As the housing market soured, both companies reported steep losses. But the mortgage meltdown also made the companies more important. When the credit markets seized up, Fannie and Freddie regained their central role in mortgage finance after losing significant market share to investment banks during the housing boom. They issued most of mortgage securities sold after investors lost confidence in deals put together by big investment banks.
In February 2008, federal regulators announced that they were easing some restrictions on lending by Fannie and Freddie. Then on March 19, the federal government announced that it was easing those restrictions in an effort to calm the turmoil afflicting the mortgage markets. Officials said the change could allow the two companies to invest $200 billion more in mortgages.
But on July 13, even as top officials continued to insist that the companies had adequate cash to weather the current financial storm, the Bush administration asked Congress to approve a sweeping rescue package that would empower officials to inject billions of federal dollars into the companies through investments and loans.
And the government did just that in early September, when the Treasury secretary, Henry M. Paulson Jr., announced the takeover of Fannie and Freddie, after advisers poring over the company’s books concluded that Freddies accounting methods had overstated its capital cushion. The move to place the companies into a conservatorship also grew out of concern among foreign investors that the companies’ debt might not be repaid.
Fannie and Freddie’s Role in the Crisis
The role of Fannie and Freddie in the housing bubble and bust has been hotly debated since the 2008 financial meltdown. The Financial Crisis Inquiry Commission, which was created by Congress in 2009, heard testimony from former Fannie Mae executives and former regulators that the fine balance between the company’s financial and mission goals led to conflicts between pursuing profitability and public policy, between paying competitive salaries and not wasting taxpayer money, and between choosing loosened financial constraints or tough regulation.
The six Democrats on the 10-member panel concluded that Fannie Mae and Freddie Mac contributed to the crisis but were not a primary cause? And in a finding likely to upset conservatives, it said that aggressive homeownership goals? set by the government as part of a philosophy of opportunity? were not major culprits.
One of the four Republican members, Peter J. Wallison, a former Treasury official and White House counsel to President Ronald Reagan, wrote a dissent, calling government policies to promote homeownership to low-income investors the primary cause of the crisis.
Reducing the Government’s Role
In February 2011 the Obama administration released a report that outlined three ways of reducing the government’s role in the housing market. The first would limit government insurance to creditworthy borrowers with low or moderate incomes; the second would provide insurance that would only kick in during times of crisis; and the third would offer government reinsurance for mortgages that met certain underwriting criteria.
Under the first two options, the cost of mortgages would almost certainly rise for most borrowers. Though many of the specifics needs to be hashed out, it seems that a system of housing-market support dating to the New Deal will be transformed.
House Republicans responded by announcing a package of eight bills that would dismantle the mortgage finance giants more quickly than the Obama administration proposed, while preventing them from serving their basic purpose as a source of cheap money for mortgage loans.
Life without Fannie and Freddie is the rare goal shared by the Obama administration and House Republicans, although it will not happen soon. Congress must agree on a plan, which could take years, and then the market must be weaned slowly from dependence on the companies and the financial backing they provide.
With hundreds of billions in government support necessary to keep the company running, questions are arising about the nature of the pay packages and how performance goals are determined. According to a report published in March 2011 by the inspector general of the Federal Housing Finance Agency, regulators approved generous executive compensation at Fannie and Freddie with little scrutiny or analysis. The pay was approved by the housing finance agency, which is charged with conserving the assets of Fannie and Freddie on behalf of taxpayers.
Another Federal Agency Filing Suit
On Sept. 1, 2011, it was reported that the Federal Housing Finance Agency was set to file suit against more than a dozen big banks, accusing them of misrepresenting the quality of mortgage securities they assembled and sold at the height of the housing bubble, and seeking billions of dollars in compensation. The suits are aimed at Bank of America, JPMorgan Chase, Goldman Sachs and Deutsche Bank, among others, according to individuals briefed on the matter.
In July, the agency filed suit against UBS, another major mortgage securitizer, seeking to recover at least $900 million. Those with knowledge of the case said the new litigation would be similar in scope.
The portfolio of Fannie Mae and Freddie Mac is worth roughly $1.5 trillion. The collapse of the market for mortgage-backed securities has made them even more crucial to the current functioning of the housing market. The pair and the Federal Housing Administration together now guarantee about 90 percent of all new mortgages, far above their historic level.
Civil Actions Brought by S.E.C.
In mid-December 2011, the Securities and Exchange Commission brought civil actions against six former top executives at Fannie Mae and Freddie Mac, saying that the executives did not adequately disclose their firms exposure to risky mortgages in the run-up to the financial crisis.
The cases represent the first major action by the S.E.C. in its more than three-year investigation of the government-controlled mortgage giants that were at the center of the housing crisis.
The S.E.C.s cases will rely heavily on whether the two mortgage companies under-reported or misled investors about their ownership of subprime loans and mortgages that required few documents from borrowers in the years leading up to and including the housing bust.
The complaint alleges, for instance, that Fannie Mae executives described subprime loans as those made to individuals with weaker credit histories? while only reporting one-tenth of the loans that meet that criteria in 2007. The S.E.C. complaint contends that Freddie Mac executives falsely proclaimed that certain businesses had virtually no exposure to ultra-risky loans.
As part of its announcement, the S.E.C. said that Fannie Mae and Freddie Mac agreed to settle with regulators and cooperate with its investigation of the executives. The Justice Department has also investigated the two mortgage giants, but no charges have been brought to date.
Legal Fees Mount at Fannie and Freddie
In February 2012, a regulatory analysis found that taxpayers had advanced almost $50 million in legal payments to defend former executives of Fannie Mae and Freddie Mac in the three years since the government rescued the giant mortgage companies.
During that time, $37 million went to three former Fannie Mae executives accused of securities fraud, according to the analysis by the inspector general of the Federal Housing Finance Agency, which oversees both companies. Acting as their conservator, the agency is charged with protecting taxpayers from further losses at Fannie Mae and Freddie Mac.
Although the legal costs for the former executives are a small fraction of the companies mortgage losses, many at the housing agency believe that it is imperative to take steps to limit these fees.
The legal costs are the responsibility of taxpayers because of contracts struck by the companies before they collapsed. Those agreements, which are typical in corporate America, state that legal fees incurred by executives defending against lawsuits will be advanced by the companies. If a court or jury rules that officials breached their duties or acted in bad faith, the officials will have to repay the advances.
But with legal outlays since 2004 reaching $99.4 million for Franklin D. Raines, Fannie Maes former chief executive; J. Timothy Howard, former chief financial officer; and Leanne G. Spencer, former controller, it seems unlikely that the taxpayers will ever recover the money even if some or all of them are found liable. The three former executives were accused of a comprehensive accounting fraud that the company’s former regulator said was aimed at maximizing their bonuses.
The inspector general’s report noted that the legal contracts could have been repudiated when the companies were taken over in September 2008. They were not, though, and taxpayers have covered the costs since then.
Regulator Rebuffs Obama on Plan to Ease Housing Debt
A major obstacle to reducing homeowners mortgage debt has been Fannie and Freddies policy against debt forgiveness, or principal reduction, which many believe is an indispensable tool for fixing the housing problem.
Edward J. DeMarco, acting director of the Federal Housing Finance Agency the independent government regulator that administers Fannie Mae and Freddie Machas held his ground on debt relief. Fannie and Freddie say reducing the principal is bad for business, and as a result bad for taxpayers.
Critics counter that banks and investors have benefited from the government response to the housing collapse while borrowers have largely been left to sink. Proponents of debt forgiveness argue that the failure to reduce debt is hurting the economy, postponing inevitable losses and costing more in the long run. While 28 percent of all loans that are modified go into default again within a year, loan modifications involving principal reduction are more successful.
But Fannie and Freddie maintain that deciding who merits principal reduction raises concerns about fairness. They argue that if future lenders believe there is a chance that borrowers will not have to repay the entire amount, they will price that risk into their loans, raising costs for everyone.
For more than a year, Mr. DeMarco has come under increasing pressure, particularly from the Obama administration to reconsider his long standing opposition to debt forgiveness, since the announcement of a multibillion-dollar foreclosure abuse settlement that requires banks to write down mortgage debt for some eligible homeowners. Loans backed by Fannie and Freddie more than half of all outstanding mortgage loans are not eligible for relief under the settlement.
But in late July 2012, Mr. DeMarco said once again that his agency would not let Fannie or Freddie offer debt forgiveness to homeowners, rejecting the entreaties of Congressional Democrats and the Obama administration. The agency said it had concluded after months of study that debt forgiveness might benefit up to half a million homeowners, but that the costs including the cost to taxpayers outweighed the potential benefits.The decision was a direct rebuff to the Obama administration’s efforts to increase help for homeowners.
Treasury Changes Fannie and Freddie Bailout Deal
In August 2012, the Treasury Department announced it was changing the terms of its bailout agreement with Fannie Mae and Freddie Mac in a way that will shrink the holdings of the two mortgage giants more quickly and will require payment to the government of all quarterly profits the companies earn.
The department announced the changes in an effort to deal with concerns that the companies could at some point exhaust the federal support they were guaranteed when they were taken over by the government in September 2008 during the financial crisis.
The two firms would have to turn over all profits they earn every quarter. They would also be required to accelerate the reduction of their mortgage holdings to hit a cap of $250 billion by 2018, four years earlier than planned.
Under the new arrangement, the firms’ portfolios can be no larger than $650 billion each at the end of 2012.The Obama administration unveiled a plan last year to slowly dissolve Fannie and Freddie, with the goal of shrinking the government’s role in the mortgage system. The proposal would remake decades of federal policy aimed at supporting Americans ability to buy homes and could make home loans more expensive. However, Congress hasn’t yet decided how far the government’s role in mortgages should be reduced.
Federal National Mortgage Association (Fannie Mae) is a government-sponsored enterprise (GSE) chartered by the United States Congress to support liquidity and stability in the secondary mortgage market, where mortgage-related assets are purchased and sold. The Company’s activities include providing market liquidity by securitizing mortgage loans originated by lenders in the primary mortgage market into Fannie Mae mortgage-backed securities (Fannie Mae MBS), and purchasing mortgage loans and mortgage-related securities in the secondary market for its mortgage portfolio. Fannie Mae operates in three business segments: Single-Family business, Multifamily Business (formerly Housing and Community Development (HCD)) and Capital Markets group. Its Single-Family Credit Guaranty and Multifamily businesses work with its lender customers to purchase and securitize mortgage loans customers deliver to the Company into Fannie Mae MBS.