- The notion of private profit (with fat bonuses for executives, along with a nice growth rate and dividends for stockholders) and public risk, in the form of an implied guarantee on securities issued and guaranteed by Fannie and Freddie. The implied guarantee lowered GSE funding costs, which was great for shareholders. Federal regulators failed to require the mortgage giants to hold sufficient capital, which we now see was terrible for taxpayers.
- While Fannie's and Freddie's prime business is guaranteeing the payment of mortgage interest to investors, their balance sheets are mainly comprised of investments in mortgage-backed securities. So in a weak real estate market, the GSEs not only suffer from making the guarantee payments to investors, they take massive losses in their investment portfolios.
Fannie Mae ( FNM) and Freddie Mac ( FRE) have begun to address mortgage underwriting practices that helped lead to the credit crisis, even as Congress wrestles with bigger questions about the future shape of the mortgage giants. Freddie Mac, the smaller of the two government-sponsored enterprises placed in conservatorship by federal authorities last month, recently informed banks and thrifts that it will stop buying stated-income, or so-called Alt-A, mortgages early next year. These loans carry more risk because borrowers have not documented their ability to repay them. But Fannie and Freddie continue to purchase other loans with special risks, such as mortgages with down payments financed by second mortgages, also known as "piggyback" loans. The government is mulling how to structure the GSEs going forward, with options ranging from allowing them to continue as government agencies or privatize them and splitting them up. Federal Reserve Chairman Ben Bernanke on Friday said some form of federal backing of the two companies would probably be necessary. Either way, Congress must address two key problems: