Understanding Government-Sponsored Enterprises: GSE Definition & Examples

What Is a Government-Sponsored Enterprise (GSE)?

A government-sponsored enterprise (GSE) is a quasi-governmental entity established to enhance the flow of credit to specific sectors of the U.S. economy. Created by acts of Congress, these agencies—although they are privately held—provide public financial services. The primary purpose of GSEs is to enhance credit flow across various sectors like housing and agriculture.

For example, the Federal Home Loan Mortgage Corp. (Freddie Mac) was created as a GSE in the housing sector. It was intended to encourage homeownership among the middle and working classes. Freddie Mac is considered a mortgage GSE.

Another example of a mortgage GSE is the Federal National Mortgage Association (Fannie Mae). This entity was introduced to improve the flow of credit in the housing market (while also reducing the cost of that credit).

In a broader economic context, GSEs play an integral role in the financial market's stability. For example, Freddie Mac increases mortgage credit availability to low to moderate-income families and underserved areas.

Understanding the Functioning of Government-Sponsored Enterprises

GSEs do not lend money to the public directly. Instead, they guarantee third-party loans and purchase loans in the secondary market, thereby providing money to lenders and financial institutions.

GSEs also issue short- and long-term bonds, referred to as agency bonds. How independent an agency bond issuer is from the federal government affects its default risk. Most agency bond investors do not have to pay state and local taxes on their interest payments. Fannie Mae and Freddie Mac bonds are not exempt from these taxes.

GSE bonds have U.S. government support but are not fully guaranteed by it. Unlike Treasury bonds, they are not direct obligations of the government. For this reason, these securities offer a slightly higher yield than Treasury bonds, since they have a somewhat higher degree of credit risk and default risk.

Key Examples of Government-Sponsored Enterprises

The Farm Credit System (FCS), the first GSE, was created in 1916 for farmers. It still exists as a network of federally approved, borrower-owned institutions that provide easy credit to farmers, ranchers, and agriculture-related companies.

The FCS receives its funding capital from the Federal Farm Credit Banks Funding Corporation, which sells bonds on securities markets. Another farming GSE, the Federal Agricultural Mortgage Corporation (Farmer Mac), was created in 1988. It guarantees the timely repayment of principal and interest to agricultural bond investors, purchases loans from lenders, provides financing for lenders and farmland investors, and issues long-term standby purchase commitments.

To stimulate the housing sector, in 1932, the government established the Federal Home Loan Bank (FHLB) system, which is owned by more than 6,500 community financial institutions. Fannie Mae, Ginnie Mae, and Freddie Mac were chartered later, in 1938, 1968, and 1970, respectively. While similar in some ways, Ginnie Mae is not technically a GSE. The housing GSEs purchase mortgages from lenders on the secondary mortgage markets. The proceeds from the sale are used by lenders to provide more credit to borrowers or mortgagors.

Sallie Mae was created in 1972 to target the education sector. While the establishment originally serviced and collected federal student loans on behalf of the U.S. Department of Education, it ended its ties to the government in 2004. Sallie Mae now offers student loans privately, along with advice on financing higher education and federal loan programs.

Important Considerations for Government-Sponsored Enterprises

GSE loans in the secondary market are so large that GSEs are among the biggest financial institutions in the U.S. A collapse of even one GSE could lead to a downward spiral in the markets, which could lead to an economic disaster. Since they have an implicit guarantee from the government that they will not be allowed to fail, GSEs are considered by critics to be stealth recipients of corporate welfare.

After the 2008 subprime mortgage crisis, Fannie Mae and Freddie Mac received $187 billion in federal help. This large sum was intended to mitigate the negative impact that the wave of defaults was wreaking on the housing market and the national economy. They were also placed into government conservatorship. Both agencies have repaid their respective bailouts since then, though they remain under the control of the Federal Housing Finance Agency.

The Bottom Line

Entities established by Congress, the purpose of GSEs is to enhance credit flows and provide stability and liquidity in key sectors like housing, agriculture, and education. Examples of GSEs include Fannie Mae, Freddie Mac, and the Federal Home Loan Bank system, all of which play a significant role in the housing finance market. While most GSEs are privately held, Ginnie Mae is a GSE that is government-owned and part of HUD.

GSEs do not directly lend funds to the public but instead support liquidity by purchasing loans and issuing bonds. While GSEs are not directly guaranteed, they carry a perception of safety due to the implicit government backing. The GSEs play a critical role during financial challenges, such as the 2008 subprime mortgage crisis, and their ongoing conservatorship by the Federal Housing Finance Agency.

As critical components in financial markets with significant influence, there are potential risks associated with GSEs. For example, the combination of their large size and implicit government guarantee can impact the broader financial market if they face distress.

Correction—May 29, 2023: The latest version of this article has removed Ginnie Mae as an example of GSE.