Issue 44 -Who are those Americans with the strange names? Freddie Mac and Fanny Mae -Sep 2008

Who are those Americans with the strange names? Freddie Mac and Fanny Mae

Over recent months, we have heard a lot about the ‘credit crunch’ and how badly some Northern hemisphere institutions such as Northern Rock in Britain and Bears Stern in U.S.A. have been affected.

And then suddenly, it seemed, we came to hear of two Americans who were also in trouble, namely ‘Freddie Mac’ and ‘Fannie Mae’. Despite their improbable names, they too are financial institutions, along with their ‘siblings’ the lesser known ‘Ginnie Mae’, Sallie Mae’ and ‘Farmer Mac’. All five, however, have official names that are somewhat longer than their more commonly used nicknames.

‘Freddie Mac’ derived from Federal Home Loan Mortgage Corporation with its ‘FRE’ code on the New York Stock Exchange
‘ Fannie Mae’ is from Federal National Mortgage Association (NYSE ‘FNM’)
‘ Ginnie Mae’ is Government National Mortgage Association (NYSE ‘GNM’)
‘ Sallie Mae’ is SLM Corporation (NYSE ‘SLM’) dealing in student loans and ‘Farmer Mac’ is the Federal Agricultural Mortgage Corporation. (NYSE ‘AGM’)

Their set-up and operations are reasonably similar, in that all were set-up originally to help people finance property, or in one case ‘Sallie May’, to finance student loans that were backed by mortgages over property. ‘Ginnie Mae’ was set up in 1968 to be the guarantor of mortgages. Originally bodies of the Federal Government, they are all now owned by stockholders.

Some of these agencies guarantee loans and the others simply ‘buy’ loans from banks and repackage them into mortgage securities, which are simply bundles of loans that are then ‘sliced and diced’ and sold to private investors. Borrowers pay principal and interest to the mortgage originators, who pass them through to Freddie, Fannie and co, who clip the ticket by imposing fees on the way through and they in turn pass payments through to investors.

Without delving too deeply into the intricacies of what happened in each case, in general it can be stated that most of their present woes (along with the woes of many banks) came initially from making housing loans to people who really couldn’t afford to buy a home, because their incomes were insufficient to cover the cost of regular repayments.

In many cases, as banks fell over themselves to lend all the money that they had at their disposal, they undertook to make loans to many would-be home-owners who really shouldn’t have been given loans. So-called ‘lo-doc’ and ‘no-doc’ loans were made, as there names imply, on the basis of minimum or no documents. Those who applied for loans simply wrote whatever income figures were necessary to achieve the required loan. Most often, there was no further documentary evidence required to achieve a loan and no checking of the data on the application form.

The immediate effect of all this credit was to make housing seem more affordable to more people. This had the result of increasing demand which in turn led to higher prices, following the laws of supply and demand.

After a while, with larger numbers than usual of people starting to get behind on their repayments, banks started to repossess the secured homes in ever-increasing numbers. With large numbers of properties being put on the market for sale, supply outstripped demand and prices began to fall. As prices fell, the value of the house properties securing the loans became less than the outstanding loan amounts, resulting in negative equity for the homeowners.

Many borrowers, knowing that their debt exceeded the value of their homes and was getting worse; and that their regular repayments were far greater than they could have been paying to rent a home, decided that enough was enough, walked out of their homes and rented somewhere else. So great was this exodus (usually over week-ends) that the Monday morning mail at the banks began to be called ‘jingle mail’, the result of all those house-keys being mailed back to the bank.

In New Zealand, we don’t have the equivalent of these institutions and I believe that the incidence of ‘lo-doc’ and ‘no-doc loans has been relatively small, so that direct exposure to these losses and their after-effects should be minimal. For the sake of our economy, let us hope so.