Government-sponsored enterprises history

GSEs are privately owned companies chartered by the federal government to serve public purposes in the financial markets. GSEs include some of the largest financial institutions in the United States, such as Fannie Mae (the FEDERAL NATIONAL MORTGAGE ASSOCIATION) and Freddie Mac (the Federal Home Loan Mortgage Corporation). Those two GSEs each fund more than a trillion dollars of home mortgages and dominate the U.S. housing finance system.

Government subsidizes the organizations by giving them exemptions from taxes and regulations that apply to other companies. The most important subsidy that government gives to GSEs is the ability to borrow money inexpensively, at rates close to those of the U.S. Treasury. The government does this by creating the perception that it will not permit GSEs to default on their financial obligations.

This so-called implied government guarantee means that taxpayers could be called upon to provide resources if a GSE ever fails. When one GSE, the FARM CREDIT SYSTEM, announced in 1985 that it could not meet its obligations, the government arranged for funding to allow the system to continue in business. The Wilson administration created the Farm Credit System (FCS) as the first GSE in 1916. The FCS was a borrower cooperative that helped farmers to obtain credit at a time when most financial institutions concentrated their lending in urban areas. In economic terms, the FCS helped to overcome a significant market imperfection.

Government established the second GSE, the Federal Home Loan Bank System, in 1932 to help the savings and loan (S&L) industry to deal with the financial devastation caused by the Great Depression. Savings and loan associations owned the Federal Home Loan Banks and used them to provide credit to help the S&Ls to fund home mortgages. As a result, some liquidity was preserved in the industry, and the market for residential mortgages was preserved in the face of bank failures, common during the depression.

The Reconstruction Finance Corporation, the giant New Deal federal agency, chartered the Federal National Mortgage Association in 1938 to help cope with the impact of the Great Depression on the home mortgage market. In 1968, the government divided the agency into two parts, the Government National Mortgage Association (Ginnie Mae), which remained within government, and a privately owned company called the Federal National Mortgage Association (Fannie Mae). Fannie Mae is an investor-owned company with shares that trade on the NEW YORK STOCK EXCHANGE.

In 1970, the savings and loan industry persuaded Congress to create the Federal Home Loan Mortgage Corporation (Freddie Mac), as a GSE with powers similar to those of Fannie Mae, but that would be owned by savings and loan associations. In 1989, after the collapse of much of the S&L industry, Congress changed the ownership structure so that it, too, was owned by private investors.

In their early years, Fannie Mae and Freddie Mac helped to standardize mortgage forms and to make the home mortgage market more efficient. Thanks to their implied government backing, the two GSEs are able to issue hundreds of billions of dollars of debt obligations and mortgage- backed securities that help to reduce the cost of homeownership by perhaps one-quarter of a percentage point, in terms of the interest rate that consumers pay on their mortgages. The two mortgage assistance agencies have purchased approximately 60 percent of residential, conforming mortgages from originators as a result.

The government has also created two other GSEs, Sallie Mae (the Student Loan Marketing Association) and a small struggling GSE known as Farmer Mac (the Federal Agricultural Mortgage Corporation). Sallie Mae supported legislation that in 1996 provided for a transition period for removing government sponsorship from the company. As a completely private company, Sallie Mae will be able to enter new lines of business that today are precluded by the terms of its federal charter.

Recently GSEs have become controversial as a tool of government. As the financial markets, and especially the home mortgage market, have become more efficient, the GSEs have lost much of their original ability to overcome the market imperfections that previously existed. Thus, when Fannie Mae and Freddie Mac deployed new automated mortgage underwriting systems in the 1990s, some large commercial banks and other competitors charged that the two GSEs were using their huge size and market power to dampen rather than promote innovation.

The two GSEs have evolved from providers of supplementary assistance to the home mortgage market to become predominant funders. Their government subsidies have permitted the two companies to double in size every five years since 1970. Because of the immense political influence that accompanies the market power of the GSEs, it is not clear whether government can devise an exit strategy so that they can give up their government sponsorship to become completely private competitors in today’s efficient financial markets.

Further reading

• Congressional Budget Office. Controlling the Risks of Government-Sponsored Enterprises. Washington, D.C.: April 1991. 
• ———. The Public Costs and Public Benefits of Fannie Mae and Freddie Mac. Washington, D.C.: Congressional Budget Office, July 1996. 
• Stanton, Thomas H. A State of Risk. New York: Basic Books, 1991. 
• ———. Government Sponsored Enterprises: Mercantilist Companies in the Modern World. Washington, D.C.: American Enterprise Institute, 2002. 

Thomas H. Stanton