Fannie Mae and Freddie Mac: A Legal and Policy Overview

Fannie Mae and Freddie Mac:
A Legal and Policy Overview
Updated February 28, 2008
N. Eric Weiss
Analyst in Financial Institutions
Government and Finance Division
Michael V. Seitzinger
Legislative Attorney
American Law Division

Fannie Mae and Freddie Mac:
A Legal and Policy Overview
In the wake of accounting and management scandals involving Freddie Mac and
Fannie Mae, Congress has expressed a heightened interest in the regulation of these
two government-sponsored enterprises. Fannie Mae and Freddie Mac, whose stocks
are traded on the New York Stock Exchange, are chartered by Congress to support
the secondary home mortgage market. In return for fulfilling this public mission,
they are given special privileges.
The Office of Federal Housing Enterprise Oversight (OFHEO), which regulates
Fannie Mae and Freddie Mac for safety and soundness, imposed extra capital
requirements and reached agreements with Fannie and Freddie to limit the growth of
their holdings of mortgages. After Fannie Mae and Freddie Mac published timely
financial statements in February 2008, OFHEO removed the growth caps effective
March 1, 2008. The extra capital requirements remain in place, but could be
removed in the future.
The Economic Stimulus Act of 2008 increased the maximum size of a mortgage
that Fannie Mae and Freddie Mac can purchase during 2008 to $729,750 in high-cost
areas. Supporters hope that this will reduce the cost of mortgages for more than the
previous limit of $417,000.
The purpose of this report is to give a general legal and policy background on
why the enterprises came into existence, what their missions are, and how they carry
out those missions.
This report will be updated as events warrant.

In troduction ......................................................1
Operations .......................................................2
Historical Development.............................................3
GSE Privileges....................................................5
Regulation .......................................................5
Other Current Issues and Recent Developments..........................6
Affordable Housing Mission.....................................6
GSE Regulatory Reform Legislation...............................7

Fannie Mae and Freddie Mac:
A Legal and Policy Overview
Fannie Mae (Federal National Mortgage Association)1 and Freddie Mac (Federal
Home Loan Mortgage Corporation),2 referred to in this report as “the enterprises,”
are privately owned, congressionally chartered financial institutions created to
establish and maintain a secondary mortgage market.3 They are two of three
government-sponsored enterprises (GSEs) that provide capital to primary market
mortgage originators in support of an overall federal policy to assure ready4
availability of financing for housing. Fannie Mae and Freddie Mac support the
residential mortgage market by purchasing mortgages from lenders that use the
proceeds to make more loans available to home buyers. In exchange for carrying out
their public policy missions, Congress has granted the enterprises statutory benefits
not available to other private financial institutions, discussed below.
Even though Fannie Mae and Freddie Mac are congressionally chartered, both
are private, shareholder-owned entities, and their shares are traded on the New York
Stock Exchange. The enterprises are headed by 18-member Boards of Directors, 13
of whom are elected by their shareholders, and five of whom are appointed annually
by the President. Of the five appointed by the President, at least one must come from
the homebuilding industry, at least one from the mortgage lending industry, at least
one from the real estate industry, and, in the case of Freddie Mac, at least one from
an organization that has represented consumer or community interests for not less
than two years or one person who has demonstrated a career commitment to
providing housing for low-income households.5 Although the board members owe
a fiduciary responsibility to the shareholders of their respective enterprises, they are
also obligated to assure that their enterprises are fulfilling their statutory missions.
Two of the largest financial institutions in the world, Fannie Mae and Freddie
Mac have grown significantly over the past 15 years. Between 1990 and 2005, assets

1 12 U.S.C. §§ 1716 et seq.
2 12 U.S.C. §§ 1451 et seq.
3 See, e.g., 12 U.S.C. § 1716.
4 The other GSE is the Federal Home Loan Bank System, 12 U.S.C. §§ 1421 et seq., which
is comprised of 12 regional Federal Home Loan Banks (FHLBs) that lend funds to their
member mortgage lenders based upon the security of those lenders’ mortgages. 12 U.S.C.
§ 1431.
5 12 U.S.C. § 1723(b), 12 U.S.C. § 1452(a)(2)(A).

at the enterprises grew more than 944% to $1.64 trillion, while outstanding liabilities
increased by 980% to $1.51 trillion. By comparison, the amount of publicly held
federal debt at the end of 2005 was $4.6 trillion. In fact, the enterprises have become
two of the largest private debt issuers in the world. In addition to enterprise debt,
investors hold more than $2.5 trillion in mortgage-backed securities issued by the
enterprises.6 The enterprises are exempt under law from registering their stock with
the Securities and Exchange Commission (SEC), but have agreed to voluntarily
register. Registration makes the enterprises subject to the SEC’s financial filing
In 2003, Freddie Mac announced that it would have to restate financial reports
for the previous three years due to improper accounting methods.7 In November
2003, Freddie Mac revised its earnings for 2002 and earlier years upward by $5.0
billion. Freddie Mac dismissed its three top executives as a result of these
accounting discrepancies, Freddie Mac has not filed any earnings statements with the
SEC and has been behind other publicly owned firms in announcing financial results;
Freddie Mac released preliminary six-month 2006 results in October 2006 while
other firms were getting ready to release third quarter results.
After initially denying that it had a similar problem, Fannie Mae was found to
have manipulated reported earnings.8 In December 2006, Fannie Mae issued a
restatement, which reduced reported earnings for 2001-2004 by $6.3 billion. Fannie
Mae’s chief executive officer and its chief financial officer resigned as a result of the
misstatement. Fannie Mae filed its 2004 financial report with the SEC on December
6, 2006. On December 12, 2006, Fannie Mae sued its former auditor, KPMG, for $2
billion in damages related to the accounting problems.
The purpose of this report is to give a general legal and policy background on
why the enterprises came into existence, what their missions are, and how they carry
out those missions.
Fannie Mae and Freddie Mac support the U.S. housing finance system by
purchasing mortgages from primary lenders that use the proceeds to make new home
loans, thereby stabilizing the availability of mortgage credit over the business cycle.
The enterprises are permitted to buy mortgage loans on single-family or multi-unit

6 For more information on these figures, see Office of Management and Budget, Budget of
the United States Government, Fiscal Year 2007, Analytical Perspectives, p. 223 at
[]. Also, see Office of Federal
Housing Enterprise Oversight, Mortgage Markets and the Enterprises in 2006, June 2007
at [].
7 See CRS Report RS21567, Accounting and Management Problems at Freddie Mac, by
Mark Jickling, for more details.
8 See CRS Report RS21949, Accounting Problems at Fannie Mae, by Mark Jickling, for
more details.

property; they may be fixed or adjustable rate (or a hybrid), a first or second lien, and
may be conventional, insured by the Federal Housing Administration (FHA), or
guaranteed by the Department of Veterans Affairs (VA). Single-family mortgage
purchases are subject to the “conforming loan limit,” which is $417,000 in most
states for 2007 for single-unit houses and is adjusted annually.9 The enterprises have
limited authority to undertake other activities.
The Economic Stimulus Act of 2008 temporarily increased the conforming loan
limit in high cost areas to a maximum of $729,750.10 The limit for any area would
be the greater of (1) the 2008 conforming loan limit ($417,000); or (2) 125% of the
area median house price, but no more than 175% of the 2008 conforming loan limit
($729,750, which is 175% of $417,000). The act gave the Department of Housing
and Urban Development (HUD) 30 days to calculate the new limits. The increase
expires December 31, 2008.
The enterprises finance the purchase of mortgages in two ways. First, they may
be held “in portfolio” and financed by the sale of ordinary bonds and other debt. This
strategy generally earns high profits because of the spread between the rates earned
on long-term mortgages and the relatively low cost of shorter-term borrowing.
Financing in this manner creates risk, however, because if market interest rates rise
significantly, borrowing costs can rise enough to reduce yields from the mortgages
whose rates generally do not rise (or are adjusted more slowly).
The second way the enterprises finance the purchase of mortgages is
securitization. This is done by pooling similar mortgages together with and reselling
them as securities backed by the entire pool to investors. Mortgage-backed
securitization earns a smaller but more constant profit from the differential between
the yield on mortgages in the pool and the payout to investors in the securities.
Historical Development
Prior to the development of the secondary mortgage market, mortgage markets
were local, and there were significant differences across the nation in mortgage rates
and serious fluctuations in lending activity. Primary lenders had to balance their
lending practices with their deposits received, which led to severe credit shortages
during economic downturns, when savings accounts were depleted by withdrawals.11
This shortage was exacerbated due to the concentration of major money centers in

9 Office of Federal Housing Enterprise Oversight, “2007 Conforming Loan Limit to Remain
at $417,000,” November 28, 2006, at [
pdf]. It remained at $417,000 in 2008. For a discussion of the conforming loan limit see
CRS Report RL34236, Fannie Mae and Freddie Mac: Proposals to Regulate Their
Mortgage Portfolio Size in the 110th Congress, by N. Eric Weiss and CRS Report RS22172,
The Conforming Loan Limit, by N. Eric Weiss and Mark Jickling.
10 P.L. 110-185 was signed into law on February 13, 2008. See CRS Report RS22799, The
Recovery Rebates and Economic Stimulus for the American People Act of 2008 and Jumbo
Mortgages, by N. Eric Weiss for more information.
11 Michael P. Malloy, The Regulation of Banking 381 (1992).

areas like Chicago and New York, far from many who needed home loans. There
was no way to move funds from these areas where mortgage money was available to
other areas such as California where it was in relatively short supply. In effect, this
amounted to a geographic barrier that prevented the law of supply and demand from
operating on a national level in the home loan market.12 The secondary mortgage
market combined these many regional mortgage markets into a single national market
that draws financing from around the world.
To encourage improvement in housing standards and conditions and to provide
a system of mutual mortgage insurance, Congress enacted the National Housing Act
in 1934.13 Title III of the National Housing Act established national mortgage
associations, giving rise to the creation of Fannie Mae. In its original form, Fannie
Mae was a federal government agency that was chartered to support government-
backed mortgages and carry out some government subsidy functions. In 1954,
Congress re-chartered Fannie Mae as a mixed government and private sector entity,
with a clearly delineated separation between its market-oriented (i.e., secondary
mortgage trading) and governmental (i.e., special assistance and managing and
liquidating government-held mortgages) functions.14 In 1968, Congress split the firm
into two distinct organizations, with the secondary market arm retaining the Fannie
Mae name and the government functions arm taking the name Ginnie Mae, short for
the Government National Mortgage Association.15 The partitioning legislation re-
chartered Fannie Mae as a GSE to become completely privately owned with no
federal funding. Fannie Mae completed this transition in 1970.
In 1970, Congress enacted the Emergency Home Finance Act,16 which
authorized Fannie Mae to buy conventional mortgages. Fannie Mae bought most of
the mortgages from mortgage bankers. Savings and loans, the other major source of
mortgage money, were restricted to holding mortgages and were generally unable to
work with Fannie Mae. To facilitate secondary market trading of conventional
mortgages for savings and loan associations, the act created Freddie Mac as a wholly-
owned subsidiary of the Federal Home Loan Bank System (FHLBS). In 1989,
Congress re-chartered Freddie Mac so that its shares could trade on the New York
Stock Exchange, in the same manner as Fannie Mae’s.17 The 1989 act also did away
with the separate missions of Fannie Mae and Freddie Mac, with the result that today
the two enterprises have similar characteristics.

12 See Carrie Stradley Lavargna, Government Sponsored Enterprises are “Too Big to Fail:”
Balancing Public and Private Interests, 44 Hastings L.J. 991, 998 (1993).
13 48 Stat. 1246.
14 P.L. 83-560, Title II.
15 Housing and Urban Development Act of 1968 (P.L. 90-448).
16 P.L. 91-351.
17 P.L. 101-73.

GSE Privileges
To help Fannie Mae and Freddie Mac accomplish their public policy missions,
Congress granted each of the enterprises certain benefits not available to other private
financial institutions. For example, the limitations and restrictions concerning
dealing in, underwriting, and purchasing investment securities for its own account
by a national banking association do not apply to the enterprises.18 Perhaps the
biggest advantage that Fannie Mae and Freddie Mac enjoy over other private
companies is the presumption on the part of investors that, were the enterprises to fall19
into dire financial straits, the government would bail them out. This presumption
of an implied federal guarantee allows many market advantages, including the ability
to obtain capital for their operations at near governmental interest rates. Critics argue
that this implied guarantee lends to the enterprises such an advantage that it20
effectively squeezes out serious competition in the housing market.
Given the ambiguous relationship that exists between the enterprises and the
federal government, Congress has long been concerned about the adequacy of GSE
regulation so that Fannie Mae and Freddie Mac can meet their public policy missions
and not pose risks to taxpayers. In this regard, Congress enacted the Federal Housing
Enterprises Financial Safety and Soundness Act of 1992.21 The act splits the
oversight functions of mission from safety and soundness between two primary
regulators: (1) the Department of Housing and Urban Development (HUD) and (2)
the Office of Federal Housing Enterprise Oversight (OFHEO), an independent entity
within HUD.22
HUD is responsible for mission regulation and general policy oversight of
Fannie Mae and Freddie Mac. In particular, the regulator’s authority includes the
establishment and enforcement of the affordable housing goals, ensuring compliance
with fair lending practices, and having prior approval authority over new programs.
In terms of the affordable housing goals, the HUD Secretary is required to set three
specific targets: (1) the low-and-moderate income goal, which is the percentage of
annual business that must be for families with incomes below the area median

18 12 U.S.C. § 24. For other examples of specific benefits afforded GSEs, see Note, Bradley
K. Krehely, Government Sponsored Enterprises: A Discussion of the Federal Subsidy of
Fannie Mae and Freddie Mac, 6 N.C. Banking Inst. 519 (2002).
19 This is despite the fact that the enterprises include in circulars for their debt and mortgage-
backed securities the statement that those securities are not guaranteed by the federal
20 See Note, Bradley K. Krehely, Government Sponsored Enterprises: A Discussion of the
Federal Subsidy of Fannie Mae and Freddie Mac, 6 N.C. Banking Inst. 519, 533 (2002).
21 P.L. 102-550, Title XIII; 106 Stat. 3941; 12 U.S.C. §§ 4501 et seq.
22 For why Congress separated these two functions, see CRS Report RS21724, GSE
Regulatory Reform: Frequently Asked Questions, by N. Eric Weiss.

income; (2) the special affordable housing goal, which is the percentage of housing
units financed that must be for families with low or very low incomes; and (3) the
geographically targeted goal, which is the percentage of business targeted to
disadvantaged localities. HUD must evaluate their success in achieving these
affordable housing goals.23
HUD also must approve new programs that the enterprises wish to undertake to
ensure that the new programs support the enterprises’ missions.24
OFHEO’s mission is to oversee the financial safety and soundness of the
enterprises. To fulfill its mission, OFHEO is authorized to establish and ensure
compliance with capital standards for the enterprises, conduct annual risk-based
examinations to assess the management practices and financial condition of the
enterprises, and take enforcement actions as specified by statute. OFHEO must
classify the enterprises into one of four capital categories: adequately capitalized,
undercapitalized, significantly undercapitalized, or critically undercapitalized. The
Director of OFHEO determines the classification category of each enterprise based
on the minimum, critical, and risk-based capital requirements. If an enterprise should
fall into any of the three classifications other than adequately capitalized, the Director
is authorized to impose a variety of sanctions.25
Other Current Issues and Recent Developments
Two key legislative issues before Congress concerning the GSEs that have not
been discussed are (1) the affordable housing mission and (2) the adequacy of the
GSE regulatory system.
Affordable Housing Mission
HUD has consistently held that the enterprises “lag the market” in the sense that
neither dedicates as high a proportion of its business to low- and moderate-income
populations as the rest of the market, particularly for first-time home buyers.26 Thus,
in 2004 HUD significantly raised the affordable housing goals over the next four
years. For example, low- and moderate-income borrowers must account for 56% of

23 12 U.S.C. §§ 4541-4567.
24 12 U.S.C. § 4542.
25 12 U.S.C. §§ 4511-4526. For more information on the capital standards and range of
enforcement actions available to OFHEO, see CRS Report RL33940, H.R. 1427 and S.

1100: Reforming the Regulation of Government-Sponsored Enterprises, by Mark Jickling,

Edward Vincent Murphy, and N. Eric Weiss.
26 See prepared testimony of Alphonso Jackson, Secretary, U.S. Department of Housing and
Urban Development, in U.S. Congress, House Committee on Financial Services, Hearing
on oversight of the Department of Housing and Urban Development, including thethnd
Department’s budget request for fiscal year 2005, hearings, 108 Cong., 2 sess., May 20,

2004, at [].

the mortgages purchased by the enterprises by 2008.27 Previously, the lending
requirement for this segment of the population was only 50%. In addition, HUD
established home purchase subgoals for each of the three goal categories. By raising
the goal targets and introducing home purchase subgoals, HUD intended to
encourage the GSEs to increase their purchases of affordable housing loans and move
them into a leadership position in the single-family conventional conforming loan
GSE Regulatory Reform Legislation
The House Committee on Financial Services on May 9, 2007, reported H.R.
1427, as amended. The full House passed the bill on May 22, 2007, by a vote of 313
to 104. It would make changes in GSE regulation and create an affordable housing
fund tied to the value of mortgages securitized and held in portfolio by the
enterprises. S. 1100 has been introduced in the Senate; this bill does not have an
affordable housing fund.28 S. 2391, the Government-Sponsored Enterprise Mission
Improvement Act, would create an affordable housing fund. Both S. 1100 and S.

2391 were referred to the Senate Committee on Banking, Housing and Urban Affairs.

Another bill, H.R. 2895, the National Affordable Housing Trust Fund Act of
2007, would create a national affordable housing trust fund that would combine the
GSE affordable housing fund with one created by the Federal Housing
Administration. The House passed H.R. 2895 by a vote of 264-148 on October 10,
2007. The Senate referred it to the Committee on Banking, Housing, and Urban
In the absence of legislative reform, financial regulators and the Administration
have taken steps to reduce the importance of some of the government ties with the
GSEs that, in the past, have helped propagate the notion of an implied government
guarantee. The most recent developments on this front include the following:
!Beginning July 2006, the Federal Reserve required the GSEs to pay
up front for cash payments that the Fed makes on their behalf, rather
than allowing them to take advantage of intraday overdrafts.29

27 For more details, links to the five parts of the final rule are available on the HUD website
at [].
28 See CRS Report RL33940, H.R. 1427 and S. 1100: Reforming the Regulation of
Government-Sponsored Enterprises, by Mark Jickling, Edward Vincent Murphy, and N.
Eric Weiss for more information on these bills.
29 Federal Reserve, “Changes to Policy Statement on Payments System Risk,” press release,
February 5, 2004, at [

!The President has declined, since 2004, to exercise his authority to
appoint five directors to the boards of Freddie Mac and Fannie
Mae. 30
!Since 2004, the Department of the Treasury has been considering a
plan to limit the debt issuances of Fannie Mae and Freddie Mac.31

30 See the proxy statements of Fannie Mae and Freddie Mac, available at
[] and
[ ht t p: / / www.f r e ddi i nve st or s/ pdf f i l e s/ 2003pr oxy.pdf ] .
31 Rob Blackwell, “A Treasury View on GSE Debt, And Unintended Consequences,”
American Banker, May 14, 2004.