Fannie, Freddie: How they got here

Fannie, Freddie: How they got here
Here's how the two mortgage giants became wards of the federal government.

NEW YORK (CNN) -- Call it a bailout, or a rescue, Fannie Mae and Freddie Mac are now firmly under the control of the U.S. government.

The widely anticipated move was the logical next step as the housing crisis continued to erode the two mortgage giants.


"We have determined that it is necessary to take action," Treasury Secretary Henry Paulson said Sunday. "Our markets will not recover until the end of this housing crisis. Fannie Mae and Freddie Mac are critical to turning the corner on housing." (Paulson's statement)

And with that, the U.S. government took control of sister companies Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500), two massive public companies at the heart of the nation's mortgage system. Together, Fannie and Freddie own, or guarantee more than half of the U.S. mortgage market - that's more than $5 trillion in loans.

Here's how they work: Banks loan money to home buyers. The banks then sell those mortgages - assuming they meet certain credit standards - to Fannie Mae or Freddie Mac.

Banks then use the money from they get from the sale of those mortgages to make new loans. It's a system that provides a continuous supply of relatively low-interest cash so that banks can keep making affordable loans to home buyers.

So where do Fannie and Freddie get the money to keep buying mortgages from banks? They bundle the mortgages they buy from banks and resell them to major investors. They get a good rate of return because, historically, Fannie and Freddie bonds have been considered to be almost as safe as U.S. government bonds.

But as home prices started to drop, and homeowners started to default, Fannie and Freddie got caught holding the bag - using their own cash to cover bad loans.

Fannie and Freddie's credit rating fell, and the possibility of running out of money became very real. That would have ground the U.S. mortgage industry to a halt, driving home prices even lower.

Mortgage rates - even for those with good credit - started to increase. Some analysts believe that a 30-year mortgage - now at about 6-1/3% - is 1 to 1-1/2 percentage points higher than it would be Fannie and Freddie were in better financial health.

In an emergency move in July, Paulson pledged direct financial support for the two private but government-sponsored entities. But he said he hoped the promise of support would be enough to shore up investor confidence, and get money flowing back to through the mortgage system.

"If you have a bazooka in your pocket and people know it, you probably won't have to use it,'' Paulson told the Senate Banking Committee on July 15.

But without real government intervention and an "explicit" guarantee from the U.S. government, the stock of the two companies continued to drop, and major investors - including the central banks of Russia and China - started selling Fannie and Freddie bonds.

That made it harder, and more expensive, for Fannie and Freddie to raise money - and forced Paulson to use his "bazooka" Sunday.

First Published: September 7, 2008: 1:08 PM EDT

U.S. seizes Fannie and Freddie

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