Fannie Mae and Freddie Mac

Congress converted Fannie Mae from a government agency into a privately held, shareholder-owned corporation in 1968 through the Housing and Urban Development Act of 1968, removing its balance sheet obligations from the federal government while retaining its government-sponsored enterprise status and its implicit government backing.

Freddie Mac — formally the Federal Home Loan Mortgage Corporation — was created by Congress through the Emergency Home Finance Act of 1970, Public Law 91-351, to expand the secondary market for conventional mortgages and to provide competition for Fannie Mae. Its governing statute is the Federal Home Loan Mortgage Corporation Act, codified at 12 U.S.C. 1451 et seq. 

Freddie Mac originated as a government entity attached to the Federal Home Loan Bank System and was subsequently rechartered as a publicly traded shareholder-owned corporation through the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Public Law 101-73, which also eliminated the previously separate missions of the two enterprises and established their substantially identical modern roles.

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992, codified at 12 U.S.C. 4501 et seq. and enacted as Title XIII of the Housing and Community Development Act of 1992, Public Law 102-550, established the first comprehensive safety and soundness regulatory framework governing both enterprises and created the Office of Federal Housing Enterprise Oversight as their dedicated prudential regulator. The 1992 Act also established the affordable housing goals requiring both enterprises to direct specified percentages of their mortgage purchases toward low and moderate income borrowers and underserved geographic areas, with the Department of Housing and Urban Development administering the goal-setting authority under 24 CFR Part 81.

The GSE Business Model — Secondary Market Function

Neither Fannie Mae nor Freddie Mac originates mortgage loans directly to homeowners. Their function is entirely in the secondary market. Originating lenders — commercial banks, mortgage banks, savings institutions, and credit unions — make residential mortgage loans and then sell those loans that meet GSE purchase criteria to Fannie Mae or Freddie Mac. This sale replenishes the originating lender's capital, enabling it to make additional loans without being constrained by the size of its balance sheet.

Fannie Mae and Freddie Mac pool the purchased mortgages and issue mortgage-backed securities backed by those pools. Each MBS carries the guaranteeing enterprise's promise of timely payment of principal and interest to MBS investors — meaning the GSE, not the individual mortgage borrower, stands behind the cash flows to the MBS investor. If borrowers in the pool default, the GSE satisfies the scheduled payment to investors from its own resources. Investors receive the guaranteed cash flows without bearing individual borrower credit risk.

The GSE earns a guarantee fee on each securitised mortgage — a spread between the interest rate on the underlying loans and the rate passed through to MBS investors — as compensation for bearing the credit risk of the mortgage pool. 

This guarantee fee is the primary source of GSE revenue. The guarantee fee for both enterprises was increased following conservatorship and has remained elevated relative to pre-crisis levels, both to build capital reserves and to reduce the implicit subsidy the GSE guarantee provides to mortgage markets relative to private capital.

The Conforming Loan Limit

Both enterprises are prohibited by their statutory charters from purchasing single-family mortgages with origination balances above the conforming loan limit, which the FHFA adjusts annually pursuant to the requirement established in the Housing and Economic Recovery Act of 2008 that the baseline limit reflect changes in the average United States home price as measured by the FHFA House Price Index. The authority for the FHFA to set conforming loan limits derives from 12 U.S.C. 1717(b)(2) for Fannie Mae and the parallel provision of the Freddie Mac Act.

For 2025, the FHFA announced on November 26, 2024 that the baseline conforming loan limit for one-unit properties in most of the United States is eight hundred and six thousand five hundred dollars, an increase of thirty-nine thousand nine hundred and fifty dollars, or five point two percent, from the 2024 limit of seven hundred and sixty-six thousand five hundred and fifty dollars. The increase reflected the five point two percent rise in average United States home prices measured by the FHFA House Price Index for the third quarter of 2024 relative to the same period in 2023.

For 2026, the FHFA announced on November 25, 2025 that the baseline conforming loan limit increases to eight hundred and thirty-two thousand seven hundred and fifty dollars for most areas. High-cost areas — those in which one hundred and fifteen percent of the local median home value exceeds the baseline limit — receive higher limits set as a multiple of the area median home value, capped at one hundred and fifty percent of the baseline limit under HERA's formula. For 2025, the high-cost area ceiling was one million two hundred and nine thousand seven hundred and fifty dollars. Special statutory provisions apply to Alaska, Hawaii, Guam, and the United States Virgin Islands, where the baseline limit equals the high-cost area ceiling.

Mortgages above the conforming loan limit are called jumbo loans. They are ineligible for GSE purchase and must be retained on originating lender balance sheets or securitised through private-label channels without any GSE guarantee, creating a structurally different risk and pricing environment from the conforming market.

The 2008 Crisis and Conservatorship

The implicit government guarantee that Fannie Mae and Freddie Mac carried prior to 2008 — the market's assumption that the federal government would honour their obligations in a crisis despite no statutory commitment to do so — allowed both enterprises to borrow at spreads only marginally above Treasury yields and to accumulate enormous balance sheets with minimal capital relative to their risk exposures. By mid-2008, each enterprise had outstanding guaranteed MBS and debt obligations that together exceeded five trillion dollars while their combined capital cushion was approximately eighty billion dollars — an effective leverage ratio that left them extraordinarily vulnerable to the catastrophic decline in United States home prices underway.

The Housing and Economic Recovery Act of 2008, Public Law 110-289, signed by President George W. Bush on July 30, 2008, created the Federal Housing Finance Agency as the successor to both the Office of Federal Housing Enterprise Oversight and the Federal Housing Finance Board, consolidating regulatory authority under a single independent agency with expanded powers. Section 1101 of Division A of HERA, the Federal Housing Finance Regulatory Reform Act of 2008, established the FHFA as an independent agency under 12 U.S.C. 4511, with authority to act as conservator or receiver of the enterprises under 12 U.S.C. 4617.

HERA also granted the United States Treasury authority under 12 U.S.C. 1719 and 12 U.S.C. 1455 to purchase the obligations of Fannie Mae and Freddie Mac in unlimited amounts, removing any statutory ceiling on Treasury support. This provision was essential to making the subsequent conservatorship credible — investors needed certainty that the Treasury commitment was open-ended.

On September 6, 2008, FHFA Director James Lockhart placed both enterprises into conservatorship upon the consent of each board of directors, with public announcement on September 7, 2008. The conservatorship authority is grounded in 12 U.S.C. 4617(a)(2), which authorises the FHFA to appoint itself as conservator for the purpose of reorganising, rehabilitating, or winding up the affairs of a regulated entity. Under 12 U.S.C. 4617(b)(2)(A) and (B), the FHFA as conservator succeeded to all rights, titles, powers, and privileges of each enterprise, including the powers of the shareholders, directors, and officers.

The Senior Preferred Stock Purchase Agreements — executed on September 7, 2008 under Treasury authority established by HERA — provided each enterprise with an initial capital commitment of one hundred billion dollars in exchange for senior preferred stock and warrants to acquire approximately seventy-nine point nine percent of each enterprise's common stock. The Treasury ultimately provided one hundred and nineteen point eight billion dollars to Fannie Mae and seventy-one point seven billion dollars to Freddie Mac. Both enterprises subsequently generated sufficient profits to repay these amounts in full through dividend payments on the Treasury's senior preferred stock and have since been building capital reserves toward an eventual exit from conservatorship. As of 2025, both remain in conservatorship with no legislatively established exit timeline.

Implicit Versus Explicit Government Backing

The conversion of the implicit guarantee to an explicit commitment through the conservatorship structure represents the most significant change in the GSE framework since the 1992 Safety and Soundness Act. Prior to September 2008, the United States government had never formally committed to standing behind GSE obligations. The conservatorship and the Senior Preferred Stock Purchase Agreements made that commitment explicit, transforming agency MBS from instruments backed by an implied guarantee into instruments backed by demonstrated government financial support.

The market effect was immediate and significant. Agency MBS spreads over comparable Treasury yields tightened sharply following the conservatorship announcement as investors assigned a higher probability to full payment of GSE obligations. The Federal Reserve subsequently purchased over one trillion dollars of agency MBS through its quantitative easing programs, treating agency MBS as near-equivalent to Treasury securities for monetary policy implementation purposes.

Fannie Mae and Freddie Mac Versus Ginnie Mae — The Critical Distinction

Examination candidates must distinguish precisely among the three major government-related mortgage market entities.

Ginnie Mae — formally the Government National Mortgage Association — is a wholly government-owned corporation within the Department of Housing and Urban Development, created by the Housing and Urban Development Act of 1968. Ginnie Mae securities carry an explicit, direct guarantee of the full faith and credit of the United States under 12 U.S.C. 1721(g), making them the only mortgage-backed securities backed by the government's unconditional promise. Ginnie Mae securitises mortgages insured by the Federal Housing Administration under the National Housing Act, guaranteed by the Department of Veterans Affairs, and guaranteed by the Department of Agriculture's Rural Housing Service. Ginnie Mae does not purchase mortgages — it guarantees the securities issued by approved private issuers against those government-insured loans.

Fannie Mae and Freddie Mac are government-sponsored enterprises, not government agencies. Before 2008, their guarantees rested on an implied rather than explicit government commitment. After conservatorship, that commitment became explicit through demonstrated Treasury support rather than by statutory full faith and credit pledge. Agency MBS from Fannie Mae and Freddie Mac therefore carry the functional equivalent of government backing through the conservatorship and SPSPA framework rather than through a direct statutory guarantee. They trade at yields marginally above Ginnie Mae securities to reflect this technical distinction, though in practice the market treats all three as effectively government-backed.

Investment Characteristics of Agency MBS

Mortgage-backed securities issued by Fannie Mae and Freddie Mac are among the largest and most liquid fixed income instruments in the world. They are held by the Federal Reserve as part of its securities portfolio, by foreign central banks as dollar reserve assets, and by domestic pension funds, insurance companies, and bond mutual funds as core fixed income allocations. 

Under SEC Rule 15c3-1, the net capital rule for broker-dealers, agency MBS issued by Fannie Mae and Freddie Mac receive lower haircuts than non-agency securities, reflecting their government-backed credit quality.

Agency MBS carry three risk characteristics that distinguish them from plain Treasury bonds and require specific analytical treatment.

Prepayment risk arises because the underlying mortgage borrowers may pay off their loans before maturity — through refinancing when rates fall, home sale, or accelerated principal payments. When interest rates decline, prepayments accelerate as borrowers refinance at lower rates, returning principal to MBS investors at the moment when reinvestment yields are lowest and when the benefit of holding above-market coupon bonds would otherwise be greatest. 

This creates an asymmetric risk profile structurally similar to the negative convexity of callable bonds — price appreciation is capped by accelerating prepayments when rates fall, while price depreciation is fully felt when rates rise.

Extension risk is the mirror image. When rates rise, prepayments slow as refinancing becomes uneconomical, extending the effective maturity of the MBS beyond what investors anticipated when purchasing and exposing them to above-market duration precisely when long-duration instruments are losing value.

Credit risk on agency MBS guaranteed by Fannie Mae or Freddie Mac is minimal by design of the guarantee structure — the GSE bears credit losses on the underlying mortgages, not the MBS investor. This is the core economic function of the GSE guarantee and the reason agency MBS trade at much tighter spreads to Treasuries than comparable maturity non-agency mortgages pools without a guarantee.

The to-be-announced market — the TBA market — is the primary trading mechanism for agency MBS. In a TBA transaction, a buyer and seller agree on the key terms of an agency MBS trade — the issuing agency, coupon, face value, maturity, and settlement date — but the specific pools to be delivered are not identified until forty-eight hours before settlement under SIFMA's standard TBA settlement guidelines. 

The TBA market's standardisation creates exceptional liquidity, with daily trading volumes exceeding three hundred billion dollars making it one of the most actively traded fixed income markets in the world.

Accounting Treatment

Under Accounting Standards Codification Topic 948, Financial Services — Mortgage Banking, mortgage banking entities — including the GSEs themselves in their origination-related activities — account for mortgage loans held for sale at the lower of cost or fair value and recognise gains on sale of loans to the GSEs upon completion of the transfer. 

Investors in agency MBS account for their holdings under ASC 320 if classified as available-for-sale or trading, with unrealised gains and losses flowing through other comprehensive income or the income statement respectively. The Federal Reserve's agency MBS portfolio under its quantitative easing programs is accounted for at amortised cost under its specific accounting policies distinct from GAAP.

Examination Relevance and Key Takeaways

Fannie Mae and Freddie Mac appear on the SIE and Series 65 examinations in the context of the secondary mortgage market, government-sponsored enterprises, agency MBS, mortgage-backed security risk characteristics, and the 2008 financial crisis.

The key points to retain are these.

Fannie Mae is chartered under the Federal National Mortgage Association Charter Act, 12 U.S.C. 1716 et seq. Freddie Mac is chartered under the Federal Home Loan Mortgage Corporation Act, 12 U.S.C. 1451 et seq. Both are government-sponsored enterprises — not government agencies — and were subject to the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, 12 U.S.C. 4501 et seq., before being placed into conservatorship.

Neither enterprise originates mortgage loans. Their secondary market function is to purchase conforming mortgages from originating lenders, pool them into MBS carrying the GSE's credit guarantee, and sell those MBS to institutional investors, providing the liquidity that enables lenders to make additional loans. The 2025 baseline conforming loan limit is eight hundred and six thousand five hundred dollars for one-unit properties in most areas, adjusted annually by the FHFA under HERA's formula based on changes in average United States home prices. The 2026 limit is eight hundred and thirty-two thousand seven hundred and fifty dollars. Mortgages above the limit are jumbo loans ineligible for GSE purchase.

Both enterprises were placed into FHFA conservatorship on September 6, 2008 under 12 U.S.C. 4617 following catastrophic deterioration in their financial positions during the housing crisis. The Housing and Economic Recovery Act of 2008, Public Law 110-289, created the FHFA and granted the Treasury unlimited purchase authority for GSE obligations. The Senior Preferred Stock Purchase Agreements executed on September 7, 2008 provided one hundred billion dollars in initial support per enterprise. The Treasury ultimately provided one hundred and nineteen point eight billion dollars to Fannie Mae and seventy-one point seven billion dollars to Freddie Mac. Both remain in conservatorship as of 2025.

Ginnie Mae differs from both in being a wholly government-owned corporation whose MBS carry an explicit full faith and credit guarantee under 12 U.S.C. 1721(g), while Fannie Mae and Freddie Mac carry government support through the conservatorship structure rather than a direct statutory pledge. Agency MBS from all three are treated as effectively government-backed by the market.

Agency MBS carry prepayment risk — acceleration of principal return when rates fall — and extension risk — slowing of principal return when rates rise — as their primary analytical dimensions, with credit risk minimised by the GSE guarantee. The TBA market governs most agency MBS secondary trading under SIFMA's settlement conventions, with specific pool identification deferred until forty-eight hours before settlement.