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What you need to know about Fannie, Freddie

Some questions and answers about Fannie Mae and Freddie Mac and their role in the mortgage market.
/ Source: The Associated Press

Some questions and answers about Fannie Mae and Freddie Mac and their role in the mortgage market:

Q: What are Fannie Mae and Freddie Mac?

A: Fannie Mae and Freddie Mac are the largest purchasers and insurers of mortgages in the country.

Q: What do they do?

A: They buy and guarantee mortgages from banks. Some of the mortgage debt bought by Fannie and Freddie is pooled and sold to investors. In this case, Fannie and Freddie essentially act as middlemen between banks and investors. Fannie and Freddie hold or back more than $5 trillion in mortgages, about half the outstanding mortgage debt in the United States.

Q: Why were they created?

A: To provide low- and middle-income Americans the opportunity to purchase houses with a reasonable interest rate by adding to the available cash banks can loan people. The money they provide is also supposed to help stabilize the mortgage market in times of stress. Fannie Mae was created in 1938 by the government, while Freddie Mac was established in 1970.

Q: So they are owned by the government?

A: No. Both Fannie and Freddie are now publicly owned and their stock traded on the open market.

Q: What problems do they currently face?

A: Over the past year, mortgages have defaulted at a faster rate, and companies have had to take billions of dollars in losses. Fannie and Freddie are required by their government regulator to have spare cash. With losses rising, that spare cash has been dwindling. That has forced them to raise new money during a time where it has been expensive and difficult to do so.

Most of the mortgages Fannie and Freddie insure or own are traditional, prime mortgages that are among the safest in the market. The pair backed very few of the exotic subprime mortgages that have caused the most problems over the past year.

Q: What happens in a government bailout?

A: In a bailout scenario, called a conservatorship, Fannie and Freddie's regulator — the Office of Federal Housing Enterprise Oversight — would take control of the companies and oversee their operations. Treasury Secretary Henry Paulson says the government wants to keep the companies operating in their current form without a government takeover.

Q: Can they fail?

A: If they did, says Brad Neigel, a senior analyst at Aite Group, a financial services research firm, "It would be the collapse of the entire mortgage industry as we know it." A government takeover would be the last option of choice, Neigel added.

Q: How do Fannie and Freddie's current problems affect borrowers?

A: If the government were to step in to help the pair, it would likely lead to lower interest rates on mortgages because investors would be assured of repayment, said Dan Green, a certified mortgage planning specialist and author of But those declines in rates would probably be offset by an increase in fees, Green added.