Wikipedia : Fannie Mae

Both articles taken from www.wikipedia.org . Fannie Mae´s original article

Fannie Mae

The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, was founded in 1938 during the Great Depression as part of the New Deal. It is a government-sponsored enterprise (GSE), though it has been a publicly traded company since 1968.^[2] The corporation's purpose is to expand the secondary mortgage market by securitizing mortgages in the form of mortgage-backed securities (MBS),^[3] allowing lenders to reinvest their assets into more lending and in effect increasing the number of lenders in the mortgage market by reducing the reliance on locally-based savings and loan associations (aka "thrifts").^[4] For a comprehensive list of articles discussing Fannie Mae, see Fannie Mae and Freddie Mac: A Bibliography.

Business

Fannie Mae makes money partly by borrowing at low rates, and lending at higher rates. It borrows in the debt markets by selling bonds, and provides liquidity to mortgage originators by purchasing whole loans in order to create mortgage backed securities in which it retains or sells to investors worldwide. Since its implied government guarantee meant it could borrow at very low rates, it earned a higher profit than did the non-government companies doing the same work. This was called "The big, fat gap" by Alan Greenspan.^[54] By August, 2008, Fannie Mae's mortgage portfolio was in excess of $700 billion.
Fannie Mae also earned a significant portion of its income from guaranty fees it received as compensation for assuming the credit risk on the mortgage loans underlying its single-family Fannie Mae MBS and on the single-family mortgage loans held in its retained portfolio. Investors, or purchasers of Fannie Mae MBSs, are willing to let Fannie Mae keep this fee in exchange for assuming the credit risk; that is, Fannie Mae's guarantee that the scheduled principal and interest on the underlying loan will be paid even if the borrower defaults.
Fannie Mae's charter has historically prevented it from guaranteeing mortgages with a loan-to-values over 80% without mortgage insurance or a repurchase agreement with the lender;^[5] however, in 2006 and 2007 Fannie Mae did purchase subprime and Alt-A loans as investments.^[55]

Business mechanism

Fannie Mae headquarters at 3900 Wisconsin Avenue, NW in Washington, D.C.

Fannie Mae is one of the purchasers of conforming mortgages, which it packages into MBS. Fannie Mae buys loans from approved mortgage sellers, either for cash or in exchange for a mortgage-backed security that comprises those loans and that, for a fee, carries Fannie Mae's guarantee of timely payment of interest and principal. The mortgage seller may hold that MBS or sell it. Fannie Mae may also securitize mortgages from its own loan portfolio and sell the resultant mortgage-backed security to investors in the secondary mortgage market, again with a guarantee that the stated principal and interest payments will be timely passed through to the investor.^{[citation needed]} Because these MBS are backed by Fannie Mae—a so-called Agency MBS—they are particularly attractive to investors. In addition, Fannie MBS, like those of Fannie Mae MBS and Ginnie Mae MBS, are eligible to be traded in the "to-be-announced," or "TBA" market.^[56] By purchasing the mortgages, Fannie Mae and Freddie Mac provide banks and other financial institutions with fresh money to make new loans. This gives the United States housing and credit markets flexibility and liquidity.^[57]
In order for Fannie Mae to provide its guarantee to mortgage-backed securities it issues, it sets the guidelines for the loans that it will accept for purchase, called "conforming" loans. Mortgages that don't meet the guidelines are called "nonconforming". Fannie Mae produced an automated underwriting system (AUS) tool called Desktop Underwriter (DU) which lenders can use to automatically determine if a loan is conforming; Fannie Mae followed this program up in 2004 with Custom DU, which allows lenders to set custom underwriting rules to handle nonconforming loans as well.^[58] The secondary market for nonconforming loans includes jumbo loans, which are mortgages larger than the maximum mortgage that Fannie Mae and Freddie Mac will purchase. In early 2008, the decision was made to allow TBA (To-be-announced)-eligible mortgage-backed securities to include up to 10% "jumbo" mortgages.^{[citation needed]}

Conforming loans

Fannie Mae and Freddie Mac have a limit on the maximum sized loan they will guarantee. This is known as the "conforming loan limit." The conforming loan limit for Fannie Mae, along with Freddie Mac, is set by Office of Federal Housing Enterprise Oversight (OFHEO), the regulator of both GSEs. OFHEO annually sets the limit of the size of a conforming loan based on the October to October changes in mean home price, above which a mortgage is considered a non-conforming jumbo loan. The conforming loan limit is 50 percent higher in Alaska and Hawaii. The GSEs only buy loans that are conforming to repackage into the secondary market, lowering the demand for non-conforming loans. By virtue of the law of supply and demand, then, it is harder for lenders to sell these loans in the secondary market; thus these types of loans tend to cost more to borrowers (typically 1/4 to 1/2 of a percent). Indeed, in 2008, since the demand for bonds not guaranteed by GSEs was almost non-existent, non-conforming loans were priced nearly 1% to 1.5% higher than conforming loans.

Implicit guarantee and government support

Originally, Fannie had an 'explicit guarantee' from the government; if it got in trouble, the government promised to bail it out. This changed in 1968. Ginnie Mae was split off from Fannie. Ginnie retained the explicit guarantee. Fannie, however, became a private corporation, chartered by Congress and with a direct line of credit to the US Treasury. It was its nature as a Government Sponsored Enterprise (GSE) that provided the 'implied guarantee' for their borrowing. The charter also limited their business activity to the mortgage market. In this regard, although they were a private company, they could not operate like a regular private company.
Fannie Mae received no direct government funding or backing; Fannie Mae securities carried no actual explicit government guarantee of being repaid. This was clearly stated in the law that authorizes GSEs, on the securities themselves, and in many public communications issued by Fannie Mae.^{[citation needed]} Neither the certificates nor payments of principal and interest on the certificates were explicitly guaranteed by the United States government. The certificates did not legally constitute a debt or obligation of the United States or any of its agencies or instrumentalities other than Fannie Mae. During the sub-prime era, every Fannie Mae prospectus read in bold, all-caps letters: "The certificates and payments of principal and interest on the certificates are not guaranteed by the United States, and do not constitute a debt or obligation of the United States or any of its agencies or instrumentalities other than Fannie Mae." (Verbiage changed from all-caps to standard case for readability).^{[citation needed]}
However, the implied guarantee, as well as various special treatments given to Fannie by the government, greatly enhanced its success.
For example, the implied guarantee allowed Fannie Mae and Freddie Mac to save billions in borrowing costs, as their credit rating was very good. Estimates by the Congressional Budget Office and the Treasury Department put the figure at about $2 billion per year.^[59] Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA "implicitly taxpayer-backed agencies".^[60] The Economist has referred to "the implicit government guarantee"^[61] of FHLMC and FNMA. In testimony before the House and Senate Banking Committee in 2004, Alan Greenspan expressed the belief that Fannie Mae's (weak) financial position was the result of markets believing that the U.S. Government would never allow Fannie Mae (or Freddie Mac) to fail.^[62]
Fannie Mae and Freddie Mac were allowed to hold less capital than normal financial institutions: e.g., they were allowed to sell mortgage-backed securities with only half as much capital backing them up as would be required of other financial institutions. Regulations exist through the FDIC Bank Holding Company Act that govern the solvency of financial institutions. The regulations require normal financial institutions to maintain a capital/asset ratio greater than or equal to 3%.^[63] The GSEs, Fannie Mae and Freddie Mac, are exempt from this capital/asset ratio requirement and can, and often do, maintain a capital/asset ratio less than 3%. The additional leverage allows for greater returns in good times, but put the companies at greater risk in bad times, such as during the current subprime mortgage crisis. FNMA is not exempt from state and local taxes. In addition, FNMA and FHLMC are exempt from SEC filing requirements; they file SEC 10-K and 10-Q reports, but many other reports, such as certain reports regarding their REMIC mortgage securities, are not filed.
Lastly, money market funds have diversification requirements, so that not more than 5% of assets may be from the same issuer. That is, a worst-case default would drop a fund not more than five cents. However, these rules do not apply to Fannie and Freddie. It would not be unusual to find a fund that had the vast majority of its assets in Fannie and Freddie debt.^{[citation needed]}
In 1996, the Congressional Budget Office wrote "there have been no federal appropriations for cash payments or guarantee subsidies. But in the place of federal funds the government provides considerable unpriced benefits to the enterprises... Government-sponsored enterprises are costly to the government and taxpayers... the benefit is currently worth $6.5 billion annually.".^[64]

Accounting

FNMA is a financial corporation which uses derivatives to "hedge" its cash flow. Derivative products it uses include interest rate swaps and options to enter interest rate swaps ("pay-fixed swaps", "receive-fixed swaps", "basis swaps", "interest rate caps and swaptions", "forward starting swaps").

• FNMA's accounting is discussed in Barron's: Fannie Mae faces more income issues – Banks – Financial – Real Estate – Financial Services – General^{[dead link]}

Duration gap is a financial and accounting term for the difference between the duration of assets and liabilities, and is typically used by banks, pension funds, or other financial institutions to measure their risk due to changes in the interest rate

• UPDATE – Fannie Mae average duration gap widens in April^{[dead link]}

"The company said that in April its average duration gap widened to plus 3 months in April from zero in March." "The Washington-based company aims to keep its duration gap between minus 6 months to plus 6 months. From September 2003 to March, the gap has run between plus to minus one month."