Fannie Mae: What It Does And How It Operates

Chances are that you may have heard of Fannie Mae. But do you know what it does and how it operates?

The Federal National Mortgage Association (FNMA), typically known as Fannie Mae, is a government-sponsored enterprise (GSE) founded in 1938 by Congress during the Great Depression as part of the New Deal. It was established to stimulate the housing market by making more mortgages available to moderate- to low-income borrowers.

Fannie Mae does not originate or provide mortgages to borrowers. It purchases and guarantees them via the secondary mortgage market. In fact, it's one of two of the largest purchasers of mortgages on the secondary market. The other is its sibling, the Federal Home Loan Mortgage Corporation, or Freddie Mac, which is also a government-sponsored enterprise created by Congress. (For more, see: How Does Fannie Mae Make Money?)

Creating Liquidity

By investing in the mortgage market, Fannie Mae creates more liquidity for lenders, such as banks, thrifts and credit unions, which in turn allows them to underwrite or fund more mortgages. According to Fannie Mae, since 2009 it has provided $4.2 trillion in liquidity to the mortgage market.

The mortgages it purchases and guarantees must meet strict criteria. For example, the limit for a conventional loan for a single family home in 2014 is $417,000 for most areas, and $625,000 for high-cost areas including Hawaii and Alaska.

In order for a mortgage lender to be eligible to be backed by Fannie Mae it must agree to not practice unethical subprime lending practices. Subprime loans have higher rates than prime rate loans and are offered to borrowers with poor credit who are considered a higher risk by the lender. (For related reading, see: Subprime Lending: Helping Hand or Underhanded?)

Mortgage-Backed Securities

After purchasing mortgages on the secondary market Fannie Mae pools them to form mortgage-backed securities (MBS). MBS are asset-backed securities that are secured by a mortgage or pool of mortgages. Fannie Mae’s mortgage-backed securities are purchased by institutions, such as insurance companies, pension funds and investment banks. It guarantees payments of principal and interest on its MBS.

Fannie Mae also has its own portfolio, commonly referred to as a retained portfolio, which invests in its own and other institutions' mortgage-backed securities. Fannie Mae issues debt, called agency debt, to fund its retained portfolio. (For related reading, see: Fannie Mae, Freddie Mac and the Credit Crisis of 2008.)

Mortgage, Housing and Financial Crisis

Fannie Mae has been publicly traded since 1968. Until 2010, it traded on the New York Stock Exchange (NYSE). It was delisted following the mortgage, housing and financial crisis after its stock plummeted below the minimum capital requirements mandated by the New York Stock Exchange. It now trades over-the-counter. (For more, see: Who is to Blame for the Subprime Crisis?)

Unethical lending practices led to the crisis. During the housing boom of the mid-2000s, lenders lowered their standards and offered home loans to borrowers with poor credit. In 2007, the housing bubble burst and hundreds of thousands of these borrowers went into default, which led to what was known as the subprime meltdown. This had a knock-on effect on the credit markets, which sent the financial markets into a tailspin and created the most severe recession in decades in the United States. (For more, see: A Review of Past Recessions.)

Government Takeover and Bailout

In the latter half of 2008, Fannie Mae and Freddie Mac were taken over by the government via a conservatorship of the Federal Housing Finance Committee. Both were bailed out to the tune of $187.4 billion, which saved them from collapse. As of August 2014, Fannie Mae had repaid the government more than what it received in the bailout. (For related reading, see: Analyzing the Fannie Mae and Freddie Mac Fallout.)

Loan Modifications

Following the mortgage meltdown, Fannie Mae began to focus on loan modifications. Loan modifications change the conditions of an existing mortgage to help borrowers avoid defaulting on their mortgages, ending up in foreclosure and ultimately losing their home. Modifications can include a lower interest rate and extending the term of the loan, for example, which would lower monthly payments. Fannie Mae has completed more than 1.5 million loan modifications since 2009. (For related reading, see: Winners of the Fannie/Freddie Bailout.)

The Bottom Line

Fannie Mae has managed to turn itself around since being on the brink in 2008. Today it is the largest funder or backer of 30-year fixed rate mortgages and remains a key mechanism for facilitating home-ownership. (For more, see: Top 6 U.S. Government Bailouts.)