Federal National Mortgage Association

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For the Chicago-based chocolate confectionery, see Fannie May.
Fannie Mae (Federal National Mortgage Association)
Type Public
Founded 1938
Headquarters Washington, DC
Key people Daniel Mudd, President & CEO
Industry Credit Services
Products Financial Services
Revenue $53.8 billion (2003)
Employees 5,400
Website www.fanniemae.com

The Federal National Mortgage Association (FNMA) (NYSE: FNM), commonly known as Fannie Mae, is a government sponsored enterprise (GSE) of the United States government. As a GSE, it is a shareholder-owned corporation authorized to make loans and loan guarantees. It is not backed or funded by the U.S. government, nor do the securities it issues benefit from any explicit government guarantee or protection.

This secondary mortgage market helps to replenish the supply of lendable money for mortgages and ensures that money continues to be available for new home purchases. The name "Fannie Mae" is a creative acronym of the company's full name that has been adopted officially for ease of identification.

Contents

[edit] History

Fannie Mae was founded as a government agency in 1938 as part of Franklin Delano Roosevelt's New Deal to provide liquidity to the mortgage market. For the next 30 years, Fannie Mae held a virtual monopoly on the secondary mortgage market in the United States.

In 1968, to help balance the federal budget, Fannie Mae was converted into a private corporation.[1] Fannie Mae ceased to be the guarantor of government-issued mortgages, and that responsibility was transferred to the new Government National Mortgage Association (Ginnie Mae).

[edit] Business

FNMA's primary method for making money is by charging a guarantee fee on loans that it has securitized into mortgage-backed security bonds. 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 principal and interest on the underlying loan will be paid regardless of whether the borrower actually repays.

Alan Greenspan and Ben Bernanke have spoken publicly in favor of greater regulation of the GSEs, due to the size of their holdings and the public belief in a government guarantee that does not exist.[1] [2].

[edit] Conforming loans

Fannie Mae (along with Freddie Mac) 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 GSEs only buy loans that are conforming, to repackage into the secondary market, making the demand for non-conforming loans lower. By virtue of the laws of supply and demand, then, it is harder for lenders to sell the loans, thus it would cost more to the consumers (typically 1/4 to 1/2 of a percent.) The conforming loan limit is 50 percent higher in Alaska, Hawaii, Guam and the US Virgin Islands.

[edit] Guarantees and subsidies

Speculation that the US government would bail out an insolvent Fannie Mae is a hypothesis that has never been tested, until recently when the subprime mortgage crisis hit the US.

[edit] Explicit guarantees

Fannie Mae receives no direct government funding or backing. Fannie Mae securities carry no government guarantee of being repaid. This is explicitly stated in the law that authorizes GSEs, on the securities themselves, and in many public communications issued by Fannie Mae. Despite this, there is a wide perception that these notes carry an implied government guarantee, and the vast majority of investors believe that the government would prevent them from defaulting on their debt. Whether the federal government would bail out Fannie Mae in the event of insolvency is a hypothesis that has never been tested.

Neither the certificates nor payments of principal and interest on the certificates are guaranteed by the United States government. The certificates do not constitute a debt or obligation of the United States or any of its agencies or instrumentalities other than Fannie Mae.

[edit] Implicit guarantees

There is a wide perception that FNMA securities are backed by some sort of implied federal guarantee, and a majority of investors believe that the government would prevent a disastrous default. Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA "implicitly taxpayer-backed agencies." [2] The Economist has referred to "[t]he implicit government guarantee"[3] of FHLMC and FNMA.

[edit] Federal subsidies

The FNMA receives no direct federal government aid. However, the corporation and the securities it issues are thought to benefit from government subsidies. The Congressional Budget Office writes, "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." [4]. Fannie Mae has looser restrictions placed on its activities than normal financial institutions: e.g., it is allowed to sell mortgage-backed securities with half as much capital backing them up as would be required of other financial institutions.

[edit] Subprime adjustable rate loans

Freddie Mac announced on February 27, 2007 that they will buy subprime adjustable rate mortgages only if the borrowers qualify for the maximum rate of the loan, not just the initial low introductory (known as teaser) rate.

[edit] Financials

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"). Here's a guide through some of its financials and accounting:

"transfer negative numbers to its balance sheet under "accumulated other comprehensive income," or AOCI." (Page 123 - "Balance Sheets" - "Stockholders? Equity" - "Accumulated other comprehensive loss") ([http://phx.corporate-ir.net/phoenix.zhtml?c=108360&p=irol-SECText&TEXT=aHR0cDovL2NjYm4uMTBrd2l6YXJkLmNvbS94bWwvZmlsaW5nLnhtbD9yZXBvPXRlbmsmaXBhZ2U9MjY3MDAzNiZkb2M9MSZudW09MTI2dtaylor "2002 earnings of $6.4 billion would have been overwhelmed by $8.9 billion in cash-flow hedging losses." (Page 124 - "Accumulated Other Comprehensive Income (Loss)" - "Net cash flow hedging losses on derivatives hedging debt").

"$3 billion in losses that were recognized in 2002-2003" (Page 122 - "Statements of Income" - "Other expenses" - "Debt extinguishments, net").

"$19 billion paid to settle underwater interest-rate swaps in those years." (Page 125 - "Cash-Flows" - "Cash flows from (used in) financing activities" - "Net payments to purchase or settle hedge instruments").

"interest rate swaps on its books rose from $23 billion in 2002 to $149 billion in 2003." (Page 79 - Table 30 "Cash flow hedges" - "Receive-fixed swaps").

"exclude its AOCI numbers from the calculations of capital" (Page 158 - "Core capital" is "Stockholders' Equity" excluding AOCI).

[edit] Duration gap

Main article: Duration gap

Also see Bond Duration

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

"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."

"last summer's 5-month ?duration mismatch? cost Fannie nearly a year of earnings."

[edit] Accounting scandal

In late 2004, Fannie Mae was under investigation for its accounting practices. The Office of Federal Housing Enterprise Oversight released a report [3] on September 20, 2004, alleging widespread accounting errors, including shifting of losses so senior executives could earn bonuses.

Fannie Mae was expected to spend more than $1 billion in 2006 alone to complete its internal audit and bring it closer to compliance. The anticipated restatement was estimated at $10.8 billion, however, after review resulted in $6.3 billion in restated earnings as listed in Fannie Mae's Annual Report on Form 10-K.

Concerns with business and accounting practices at Fannie Mae predate the scandal itself. On June 15, 2000, the House Banking Subcommittee On Capital Markets, Securities And Government Sponsored Enterprises held hearings on Fannie Mae[4].

On December 18, 2006, U.S. regulators filed 101 civil charges against chief executive Franklin Raines; chief financial officer J. Timothy Howard; and the former controller Leanne G. Spencer. The three are accused of manipulating Fannie Mae earnings to maximize their bonuses. The lawsuit seeks to recoup more than $115 million in bonus payments, collectively accrued by the trio from 1998–2004, and about $100 million in penalties for their involvement in the accounting scandal.

[edit] References

  1. ^ Krishna Guha, Saskia Scholtes, James Politi: Saviours of the suburbs, Financial Times, June 4 2008, page 13
  2. ^ Vernon L. Smith, "The Clinton Housing Bubble", Wall Street Journal, December 18, 2007, pA20
  3. ^ The Economist, "Fannie and Freddie ride again", July 5, 2007
  4. ^ Congressional Budget Office, Assessing the Public Costs and Benefits of Fannie Mae and Freddie Mac, May 1996

[edit] See also