Fannie Mae Effect

Created by Congress, Fannie and Freddie -- called G.S.E.'s, for government-sponsored entities -- bought trillions of dollars' worth of mortgages to hold or sell to investors as guaranteed securities. The companies were also Washington powerhouses, stuffing lawmakers' campaign coffers and hiring bare-knuckled lobbyists.

The Federal Reserve System is the most powerful institution in the United States economy. Functioning as the central bank of the United States, acting as a regulator, the lender of last resort, and setting the nation’s monetary policy via the Federal Open Market Committee, there is no segment of the American economy unaffected by the Federal Reserve [endnoteRef:1]. This power becomes even more substantial in times of “unusual and exigent circumstances,” as Section 13(3) of the Federal Reserve Act gives authority to the Board of Governors to act unilaterally in lending and market making operations during financial crisis[endnoteRef:2]. As illustrated by their decision making in the aftermath of the 2007-2008 Great Recession,

In September 2008, the federal government assumed control of the Federal Na- tional Mortgage Association and the Federal Home Loan Mortgage Company, two “government-sponsored” but publicly owned companies better known as Fannie Mae and Freddie Mac, respectively. At the time, the two organizations owned or guaranteed nearly one-half of the approximately $12 trillion of home mortgages in the United States. For decades, the federal government had used Fannie Mae and Freddie Mac to create an orderly and liquid market for homeowner mortgages, but the enormous losses each suffered in 2007 and 2008 undercut that role and forced the U.S. Department of the Treasury to take over their operations.

Many factors that led to the crash of the financial markets in 2008. Liberals and conservatives have differing views on the reasons for this crisis. From 1980 to 2007, deregulation, HUD, the Community Reinvestment Act (CRA), and bank management pushing banks to make high risk loans caused the market to shatter. Hedge funds contributed a humongous portion of the market crash. A commission of conservatives and liberals was established to try get to the bottom of how the stock market crashed. The name of the commission to conduct this study is Financial Inquiry Commission.

The Federal Reserve went into action in response to the 2008 recession by rapidly reducing interest rates with the hopes of encouraging economic growth. The federal funds target rate was decreased to between zero and .25 percent. The results of the rate changes caused what is called “zero bound”, this reduced the effectiveness of monetary policy with the near non-existence of interest rates.

The first and more important factor that lead to the subprime mortgage crisis was governments creation of Freddie and Fannie. This move by the government to intercede the private financial industry sector eventually lead to the US government being the largest lender of mortgages in the US. In addition to the flawed notion that government should determine who and how a borrow qualifies for mortgage loan is disconcerting in and of itself, but this also marked a fundamental change in banks models of originate and hold

In 1970 the Federal Home Loan Mortgage Corporation was created to expand the secondary market for mortgages. Now known as Freddie Mac, this company is a public government-sponsored enterprise. A government-sponsored enterprise is a financial services corporation created by the United States Congress. Freddie Mac was chartered “with a public mission to stabilize the nation's residential mortgage markets and expand opportunities for homeownership and affordable rental housing.”

The financial crisis of 2007-2008 was one of the worst economic downturns the United States has faced since the Great Depression of the 1930s. It affected the banking industry by causing banks to squander money on mortgage defaults, bringing interbank lending to halt, as well as affecting credit being provided to consumers. Another effect was that it caused certain businesses to essentially run out or come to an end. Many companies had to take advantage of bailouts, but the economic was still in disarray. The financial crisis also affected the country in the long-term by bringing about new regulatory programs such as Dodd-Frank Wall Street Reform and Consumer Protection Act (Singh, 2015).

Our economy is a machine that is ran by humans. A machine can only be as good as the person who makes it. This makes our economy susceptible to human error. A couple years ago the United States faced one of the greatest financial crisis since the Great Depression, which was the Great Recession. The Great Recession was a severe economic downturn that occurred in 2008 following the burst of the housing market. The government tried passing bills to see if anything would help it from becoming another Great Depression. Trying to aid the government was the Federal Reserve. The Federal Reserve went through a couple strategies in order to help the economy recover. The Federal Reserve provided three major strategies to start moving the economy in a better direction. The first strategy was primarily focused on the central bank’s role of the lender of last resort. The second strategy was meant to provide provision of liquidity directly to borrowers and investors in key credit markets. The last strategy was for the Federal Reserve to expand its open market operations to support the credit markets still working, as well as trying to push long term interest rates down. Since time has passed on since the Great Recession it has been a long road. In this essay we will take a time to reflect on these strategies to see how they helped.

Congress is continuously attempting to decide if Fannie Mae should be privatized or owned by the government. One thing the government should focus on is reducing the monopoly characteristics in Fannie Mae. With government intervention, Fannie Mae should be broken up into many smaller companies. This would spread the risk among the financial market and Fannie Mae would have to compete against other companies to stay in business. If unfortunate events lead to another economic crisis, the financial pressure would be placed on more than one company and investors would not have to rely on Fannie Mae to stay afloat (Reiss, David, 951-952). This idea was recently discussed among two senators, Bob Corker and Mark Warner who consider splitting Fannie’s single-family business from their multifamily business. They think the single-family businesses could then be split again into smaller companies (www.money.cnn.com).

The financial crisis was triggered by a complex interplay of policies that encouraged home ownership, providing easier access to loans for subprime borrowers, overvaluation of bundled subprime mortgages based on the theory that housing prices would continue to escalate, questionable trading practices on behalf of both buyers and sellers, compensation structures that prioritize short-term deal flow over long-term value creation, and a lack of adequate capital holdings from banks and insurance companies to back the financial commitments they were making. Questions regarding bank solvency, declines in credit availability and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during 2008 and early 2009. Economies worldwide slowed during this period, as credit tightened and international trade declined. Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion and institutional bailouts.

Shortly after the financial crisis in 2008, many economists had to rethink their approach to the market. Everyone knew we had a panic because the stock market and the housing market collapsed. American economy was reaching to the bottom. Many people considered it as a second worst recession after the great the Great Depression. But what was the cause? Who were responsible for the crisis? What can we learn from this turmoil? In the recent New York Times Sunday magazine article, Nobel Prize winner Paul Krugman offered his explanation for the causes and insight toward fixing the economy.

There are competing measures of financial stress, including three versions calculated by regional Federal Reserve Banks (Chicago, Cleveland and St. Louis). Two regional Federal Reserve Bank measures (Chicago and St. Louis) are pointing to similar conclusions, namely that financial conditions in the absolute sense are still loose, but have become less accommodative in recent weeks. They do not, in any way, point to a tight environment, at least when viewed from a historical perspective. Those who support the case for the Fed remaining on the side-lines assert that, despite a negative real federal funds rate, easy financial conditions now provide less help to the real economy. The lower degree of accommodative conditions in the financial system seen in recent weeks is, in some commentators’ opinion, already equivalent to a 25 basis points increase in the federal funds target. Markets have, therefore, already done the FOMC’s job. Meanwhile, the Federal Reserve Bank of Cleveland’s measure of financial stress has entered territory signifying a moderate level of tautness. Credit market instruments are important components for these measures of stress.

The importance of central banks is derived from their main objectives - the pursuit of price stability, stable economic growth, interest rate and exchange rate stability. If disturbances occur in markets, central banks can use the tools of monetary policy and stabilize the mentioned variables (Richter, Wahl, 2011). The immediate task for central banks during the 2007-2008 crisis was to avoid a market collapse due to low liquidity and to mitigate the panic which emerged with deteriorating trust in financial institutions. As data presented by Ivashina and Scharfstein demonstrate, the level of lending in the United States plummeted by staggering 47% between the third and fourth quarter in 2008 to almost one seventh of the 2007 financial peak (from $701.5billion to $150.2billion) (Ivashina, Scharfstein,

There are many factors that led to the collapse, but ultimately the large decline in home prices following the collapse was large to blame. The borrowers were not the only ones feeling the heat of their poor financial decisions. The securities that were backed by the subprime mortgages lost their value causing financial firms and investors everywhere to feel the pressures. In early 2007, reportedly over 25 subprime lenders filed for bankruptcy, and there was more than $1 trillion invested in securities owned by financial firms and hedge funds (Singh, 2008). It was not long before governments worldwide became involved in what would ultimately lead to the U.S. recession.