I was just reading an article on Fannie Mae and Freddie Mac and it occurred to me that there could be a lot of our readers who do not understand what these two quazi government agencies do. Don't feel bad as the whole thing is really a difficult concept to explain and for some of us, including me, to comprehend. That's why I rely on our valuable lending partners like Teresa O'Dette of O'Dette Mortgage to make sure I got it straight. I am going to take a shot at providing you a very broad and general simplification.

Both these agencies were originally chartered by the U.S. government to help promote home ownership. Fannie Mae in 1938 and Freddie came along in the 70's as a result of the S&L crisis and to give borrowers more options. Both of these agencies essentially act as money providers. Originally the money came from the U.S. Treasury but since the agencies have become privatized, their stock is sold on the N..Y exchange and their investors fill the coffers via stock and bonds.

The agencies both purchase mortgages from banks. This is what is known as the "secondary market." Let's just use the Bank of America for an example. When a borrower applies to the B of A for a loan, the B of A makes sure that all of the qualifications of the borrower and the property they are borrowing on conform to the exact standards that Fannie and/or Freddie require. If these standards are strictly conformed with when a loan is originated, Fannie/Freddie guarantee the bank that they will buy the loan from them, thus freeing up more money in the B of A so that the B of A can make more loans. What, you say, is the purpose of all of this? Well the B of A retains the servicing of the loan that they sold to Fannie or Freddie, thus continuing to employ people and make money. When lenders like the B of A loan out money on conforming loans they are really just counting on selling the loan and turning those proceeds around and loaning them again.

When a loan is made to a consumer by a bank or other mortgage seller, it is important to make sure that the qualifications for the home being purchased and the borrower conform to the standards set forth by these two agencies, thus insuring that it will be purchased on the secondary market.   In the "olden days" these qualifications were pretty stringent. More recently and just pre-crash, the agencies, bowing to pressure from their stockholders to make more and more profit (by selling more and more money), allowed the standards to relax to the point where they would accept just about anyone as a qualified borrower.

While the real estate values continued to go up, people continued to buy homes and need mortgages. The wheels kept spinning and Fannie/Freddie stock holders were happy with the profits. All of a sudden, the market went south and people stopped buying, mortgages dried up and there was a glut of homes on the market. Supply and demand kicked in and the massive inventory made all of our homes worth less. The building industry collapsed and people lost their jobs. One by one, the balls started falling out of the sky and the value of Fannie and Freddie stock (which I am told is in just about everyone's portfolio) went down, down.  The self renewing coffers of Fannie and Freddie dried up also.  

The Housing and Economic Recovery Act, signed in 2008 by George Bush established the Federal Housing Finance Agency and gave the U.S. Treasury the authority to loan Fannie and Freddie the money that they needed to continue. If the Treasury had not "bailed out" these two agencies, Fannie and Freddie would have gone bankrupt and there would be no more mortgage market as we know it.

Besides advancing the agencies the money to allow them to continue, the Federal Housing Finance Agency took conservatorship over Fannie and Freddie in 2008 firing both the CEOs and their boards of directors. This move was necessary so that the agencies could begin the process of re-building and revising their practices. This revision of practices is ongoing and one of the reasons why we are seeing such a tightening in the lending qualifications for consumers. Gone are the days of the "loans for anyone who can fog a mirror.". It's getting back to basics. One needs to be able to actually make the payments and show that ability in order to get a loan.