What Is a Government-Sponsored Enterprise?
A government-sponsored enterprise is a quasi-governmental entity established to enhance the flow of credit to specific sectors of the American economy. Created by acts of Congress, these agencies, though privately held, provide public financial services. GSEs help to facilitate borrowing for all sorts of individuals, from students to farmers to homeowners.
For example, Federal Home Loan Mortgage Corporation (Freddie Mac) was originally created as a GSE in the housing sector to encourage homeownership among the middle class and working class. Other mortgage GSEs, as they are called, include Federal National Mortgage Association (Fannie Mae) and Government National Mortgage Association (Ginnie Mae), which were introduced to improve the flow of credit in the housing market, while also reducing the cost of that credit.
The History of Government-Sponsored Enterprises
The first GSE created was in the farming sector with the inception of Farm Credit System (FCS) in 1916. The Farm Credit System is a network of federally chartered borrower-owned lending institutions tasked with providing an accessible source of credit to farmers, ranchers, and others involved in agriculture.
The FCS gets its huge funding capital from the Federal Farm Credit Banks Funding Corporation, which sells bonds on securities markets. Another farming GSE, Federal Agricultural Mortgage Association (Farmer Mac), was created in 1988 and guarantees the timely repayment of principal and interest to agricultural bond investors.
To stimulate the housing segment, in 1932, the government established the Federal Home Loan Banks (FHLB) which is owned by over 8,000 community financial institutions. Fannie Mae, Ginnie Mae, and Freddie Mac were later chartered in 1938, 1968, and 1970, respectively. 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.
SLM Corporation (Sallie Mae) was set up in 1972 to target the education sector. The establishment originally serviced and collected federal student loans on behalf of the Department of Education. It ended its ties to the government in 2004 and now offers student loans privately, along with advice on financing higher education and federal loan programs.
How a Government-Sponsored Enterprise Works
Government-sponsored enterprises 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. The degree to which an agency bond issuer is considered independent of the federal government impacts the level of its default risk. Bond investors holding most but not all types of agency bonds have their interest payments exempt from state and local taxes.
Although GSE bonds carry the implicit backing of the U.S. government, they are not direct obligations of it, unlike Treasury bonds. For this reason, these securities will offer a slightly higher yield than Treasuries, since they have somewhat if slightly, higher credit risk and default risk.
Economic Importance of the Government-Sponsored Enterprise
Their aggregate loans in the secondary market make GSEs the largest 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.
In fact, following the 2008 subprime mortgage crisis, Fannie Mae and Freddie Mac received $187 billion worth of federal assistance almost immediately to mitigate the negative impact that the wave of defaults was wrecking 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 by the Federal Housing Finance Agency.
- A government-sponsored enterprise (GSE) is a quasi-governmental entity established to enhance the flow of credit to specific sectors of the American economy.
- Government-sponsored enterprises do not lend money to the public directly; instead, they guarantee third-party loans and purchase loans in the secondary market, ensuring liquidity.
- GSEs also issue short- and long-term bonds (agency bonds) that carry the implicit backing of the U.S. government.