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 American economy. Created by acts of Congress, these agencies–although they are privately-held–provide public financial services. GSEs help to facilitate borrowing for a variety of individuals, including students, farmers, and homeowners.

Key Takeaways

  • 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 (GSEs) do not lend money to the public directly; instead, they guarantee third-party loans and purchase loans in the secondary market, ensuring liquidity.
  • Government-sponsored enterprises (GSEs) also issue short- and long-term bonds (agency bonds) that carry the implicit backing of the U.S. government.
  • Mortgage issuers Fannie Mae and Freddie Mac are examples of government-sponsored enterprises (GSEs).

For example, the agency Federal Home Loan Mortgage Corporation (Freddie Mac) was originally 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. Other mortgage GSEs include the Federal National Mortgage Association (Fannie Mae) and the Government National Mortgage Association (Ginnie Mae). Both of these entities were introduced to improve the flow of credit in the housing market (while also reducing the cost of that credit).

How a Government-Sponsored Enterprise (GSE) Works

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. 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, unlike Treasury bonds, they are not direct obligations of the U.S. government. For this reason, these securities will offer a slightly higher yield than Treasury bonds, since they have a somewhat higher degree of credit risk and default risk.

The first GSE, the Farm Credit System (FCS), was created in 1916 to serve the farming sector. The FCS still exists as a network of federally chartered, borrower-owned lending institutions. They are tasked with providing an accessible source of credit to farmers, ranchers, and other entities involved in agriculture.

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 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 chartered later: 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 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.

Special Considerations

The aggregate loans of GSEs in the secondary market make them some of 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 a combined $187 billion worth of federal assistance. This large sum was intended 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.