Fannie Mae - Subprime Mortgage Crisis

Topics: Subprime mortgage crisis, Fannie Mae, Mortgage Pages: 11 (2998 words) Published: January 31, 2011
FANNIE MAE - SUBPRIME MORTGAGE CRISIS

BACKGROUND OF FANNIE MAE
History

Federal National Mortgage Association (Fannie Mae) is a government-chartered corporation created by President Franklin D. Roosevelt and the U.S. National Congress in 1938. It was established due to the Great Depression, when lots of households were homeless. The intention of government to establish Fannie Mae is to extend mortgage funds in the community, at all times, under different economic conditions, and to lower the costs of buying a house. This function facilitates the affordability of low-income group. In 1968, Fannie Mae was privatized due to the government financial policy and became an individual company. Ginnie Mae, a newly established government mortgage association, then took its responsibility of ensuring government mortgages. In 1970, Freddie Mac was created and entered into competition in order to improve the efficiency of the mortgage industry. Together with Fannie Mae and Ginnie Mae, they are generally known as government-sponsored enterprises (GSEs) since they are government authorized organizations.

In 2004, SEC discovered that Fannie Mae was not reporting its accounts according to Generally Accepted Accounting Principles (GAAP). It deliberately lowered its expenses in the income statement and overstated its net income between 2001 and 2004. The internal senior managers did this in order to maximize their bonuses. The operation of

Fannie Mae – Subprime Mortgage Crisis

Fannie Mae has been governed by additional legislations passed by the congress after the accounting scandal.

In September 2008, after the subprime mortgage crisis, the Federal Housing Finance Agency was appointed to be conservator of it.

Functions and Business Mechanism of Fannie Mae

Figure 1 shows the functions of Fannie Mae. Fannie Mae makes profit by buying loans from institutional mortgage sellers (such as banks and other financial institutions) in exchange for cash or other mortgage-backed securities. By purchasing securitized mortgages from other institutions, it guarantees, against a fee, that businesses have sufficient and consistent funds to pay back the stated principles and interests of the loans. With the guarantee, Fannie Mae pools its loans together and sells these newly packed securities (mortgage-backed securities) in the secondary mortgage market. These mortgage-backed securities are of diversified risk and sold with the company’s guarantee of payment. In addition to the buying and selling of mortgage loans, Fannie Mae also tries to borrow funds for the debt market and uses the proceeds the purchase mortgages for the banks as its own investment. These financial services provide by Fannie Mae and other GSEs aim at ensuring liquidity and stability in the housing market in United States.

Fannie Mae – Subprime Mortgage Crisis

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Figure 1: Functions of Fannie Mae

FAILURE OF FANNIE MAE

Subprime Mortgages

The objective of the U.S. government to allow low and moderate income groups having home ownership through as-is condition laid the foundation of the subprime crisis in 2007. Throughout the past 30 years, subprime mortgages have become an important instrument in helping the low and middle income groups to purchase and own houses in the United States. GSEs like Fannie Mae and Freddie Mac and other big investment banks in U.S. performed an important role in the expansion of this kind of loans.

The government has been continuously initiating incentives and regulations to help distressed U.S. citizens in achieving home mortgages since 1968, such as tax incentives for government-sponsored enterprises (GSEs) to purchase mortgage-backed securities and setting goals and regulations to reach the objective. In 1977, the United Congress and the Carter Administration enforced the Community Reinvestment Act which forces banks Fannie Mae – Subprime Mortgage Crisis

to set up new branches in slum areas and grant loans to...

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