Definition
A Government-Sponsored Enterprise (GSE) is a type of financial services corporation created by the United States Congress with the intent to improve credit flow to specific economic sectors. GSEs are privately held but receive support from the federal government to fulfill their purposes. These enterprises do not lend money directly to the public. Instead, they ensure lenders have greater availability of funds and better interest rates by purchasing mortgages for their portfolios and issuing mortgage-backed securities (MBS). Two major examples of GSEs are the Federal National Mortgage Association (FNMA or Fannie Mae) and the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac).
Examples
Federal National Mortgage Association (FNMA - Fannie Mae)
Fannie Mae was established in 1938 to stimulate the housing mortgage market by creating a secondary market for the trading of mortgages. Fannie Mae buys mortgages from lenders, which they then hold in their portfolios or are bundled into mortgage-backed securities that can be sold. This process helps lenders raise funds to make new loans.
Federal Home Loan Mortgage Corporation (FHLMC - Freddie Mac)
Freddie Mac was created in 1970 to expand the secondary market for mortgages and to complement the work of Fannie Mae. Like Fannie Mae, Freddie Mac buys mortgages, pools them, and sells them as securities to investors. This helps to stabilize and expand the residential mortgage market by increasing the supply of money available for mortgage lending.
Frequently Asked Questions
What is the primary purpose of a GSE?
The primary purpose of a GSE is to increase the availability and reduce the cost of credit to certain sectors of the economy, such as housing and agriculture, in support of public policy goals. They achieve this by creating a secondary market for loans, which provides liquidity and stability.
Are GSEs part of the government?
GSEs are not government agencies; they are privately held corporations. However, because they were created by Congress and align closely with government objectives, they receive certain benefits and government oversight.
How do Fannie Mae and Freddie Mac differ?
Both Fannie Mae and Freddie Mac serve similar functions by buying mortgages and issuing mortgage-backed securities. The main difference lies in their histories and sources of mortgage loans:
- Fannie Mae mainly buys mortgages from large retail banks.
- Freddie Mac tends to purchase loans from smaller banks, credit unions, and mortgage lenders.
What are mortgage-backed securities (MBS)?
Mortgage-backed securities (MBS) are bonds secured by mortgages or collections of mortgages. A GSE like Fannie Mae or Freddie Mac pools multiple mortgages and sells these collections as securities to investors. The investors receive returns based on the mortgage payments from the borrowers.
Are investments in GSEs risk-free?
While GSEs have the implicit backing of the federal government, they are not risk-free investments. Their guarantees do not have the full faith and credit of the U.S. government, which means they can be impacted by broader financial market disruptions.
Related Terms
Mortgage
A mortgage is a loan used to purchase real estate, where the property itself serves as collateral for the loan.
Secondary Mortgage Market
The secondary mortgage market is where existing mortgages are bought and sold. GSEs like Fannie Mae and Freddie Mac are major players in this market, providing liquidity by purchasing these mortgages.
Mortgage-Backed Security (MBS)
A mortgage-backed security is an investment similar to a bond, made up of a bundle of home loans purchased from the issuing banks.
Liquidity
Liquidity refers to how quickly and easily an asset can be converted to cash without significantly affecting its price.
Online References to Additional Resources
- Federal National Mortgage Association (Fannie Mae) - Official Website
- Federal Home Loan Mortgage Corporation (Freddie Mac) - Official Website
- U.S. Securities and Exchange Commission (SEC) - Mortgage-Backed Securities
Suggested Books for Further Studies
- The Mortgage Wars: Inside Fannie Mae, Big-Money Politics, and the Collapse of the American Dream by Timothy Howard
- Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques by Frank J. Fabozzi
- Inside the Fed: Monetary Policy and its Management, Martin through Greenspan to Bernanke by Stephen H. Axilrod
Fundamentals of Government-Sponsored Enterprises: Finance Basics Quiz
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