Freddie Mac

Federal Home Loan Mortgage Corporation, or Freddie Mac, is a U.S. government-sponsored but privately owned corporation created for the purpose of increasing the supply of funds for home mortgages. The origin of Freddie Mac goes back to the Depression era when the U.S. government wanted to make it easier for potential homeowners to build and own their houses. In order to ease availability of funds to these individuals, the government created an organization that came to be known as Fannie Mae. In 1970 the U.S. Congress continued with the privatization of the mortgage market and legislated the creation of Freddie Mac.

Freddie Mac, along with other government-sponsored organizations like Fannie Mae and Ginnie Mae, [Page 715]increases the volume of funds available for mortgages while simultaneously lowering their cost by providing a secondary market for mortgages. In what is called the primary market, a financial institution approves a home-builder's request for a mortgage, funds the mortgage through deposits it attracts and its equity. Without a secondary market, the total volume of mortgages would be limited to the share of their total deposits that the financial institutions would be willing to commit to mortgages.

A secondary market for mortgages is created when the financial institution sells the mortgage to an institution like Freddie Mac. Freddie Mac bundles a number of these mortgages together and creates one collective asset whose cash flows are derived from the collection of mortgage payments—interest as well as the principle repayments. This collection of mortgages is called a mortgage backed security or MBS. Freddie Mac sells all or parts of this MBS to investors. Since Freddie Mac can bundle mortgages from different types of borrowers and from different regions, the MBS portfolio becomes diversified across various risk categories and has higher return and lower risk than a portfolio of mortgages held by a particular financial institution. The improved risk-return profile makes these securities attractive for individual investors. Creation of this secondary market increases the volume of funds available for mortgages and competition between various providers of funds to this market lowers the cost at which home-builders can obtain mortgages.

Freddie Mac and Fannie Mae provide similar services but compete with each other. Ginnie Mae, on the other hand, provides guarantees on loans issued by government agencies and deals with smaller sized mortgages. In contrast to Ginnie Mae, Freddie Mac deals with mortgages that are not federally insured and can be of different sizes and different interest rates. Freddie Mac mortgages tend to be of larger sizes. Together these institutions are knows as Government Sponsored Enterprises, or GSEs, because government places looser restrictions on them relative to fully private companies. Although these enterprises are not fully backed by the government, they can raise funds in the market at advantageous rates because of the common perception that the government will not allow these institutions to default. The government sponsorship became very important in the summer of 2008 when problems with the housing market exploded into a full-blown financial crisis.

Freddie Mac became a central part of the mortgage credit crisis of 2008 after a $300 billion government bailout package.

At the end of 2007, Freddie Mac held $710 billion worth of mortgage backed securities in its portfolio. The mortgage backed securities market has grown from about $200 billion in 1989 to more than $2 trillion in 2006. Till about 2001, Freddie Mac and other GSEs dominated this market, together maintaining a market share of about 80 percent. Private issuers held the remainder of the market. Since 2002, however, private issuers began offering what became known as subprime mortgages. The share of these subprime mortgages increased from about 20 percent in 2002 to about 55 percent in 2006. Private issuers resort to securitization—they hand over the administration of the mortgage contracts to suppliers of funds instead of holding the mortgages to maturity.

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