How the Once-Respected Fannie Mae and Freddie Mac Helped Fuel the U.S. Real Estate Bubble

Shah Gilani

Fannie Mae (NYSE: FNM), originally designated as a "government-sponsored enterprise" (GSE), was born in 1938 as a child of U.S. President Franklin Delano Roosevelt's Great-Depression-fighting "New Deal," and was designed to stimulate mortgage lending.

Fast-forward 30 years. In 1968, Fannie Mae shares were sold to the public to help finance the Vietnam War.

Freddie Mac (NYSE: FRE), also a GSE, was created by Congress in 1970 to compete with the growing – but monopolistic – Fannie Mae.

Both firms were successful, profitable and made steady money by charging a fee to guarantee mortgage-originators against homeowner defaults. Their combined guarantees totaled almost $3.7 trillion at the end of 2008.

They also developed high standards for loans that they themselves would buy and then package into mortgage-backed securities (MBS). They sold these pools of "conforming" loans to institutional investors and made even bigger profits as the MBS business exploded.

It all changed in the 1990s for Fannie and Freddie. Intensely competitive banks and investment banks aggressively rounded up their own pools of mortgage loans to package and sell to eager investors. Non-bank originators – the largest and most aggressive of which was Countrywide Financial Corp. (NYSE: BAC) – were eager to supply the growing demand for mortgages to be pooled and sold to investors

The resulting "velocity" of mortgage money meant that competition for good borrowers became tremendous as easy and cheap money flooded the economy. To keep mortgage origination pipelines full, standards began to fall. New products were created to entice new borrowers. Subprime, Alt-A, Pick-A-Pay, adjustable rate mortgages (ARMS), and a host of other offerings brought in lower quality borrowers who eagerly bet the farm their homes and their futures on the rising real estate bubble's ascent to investment and speculative heaven.

 In the end, however, real estate was merely the latest financial bubble, which burst like all of its predecessors.

[Editor's Note: For additional insights on how Fannie Mae and Freddie Mac will short-circuit Fed Chairman Ben S. Bernanke's so-called "exit strategy," please click here to check out an additional story, which appears elsewhere in today's issue of Money Morning.

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News and Related Story Links:

• Money Morning Investigation of the Banking Bailouts:
  Foreign Bondholders – and not the U.S. Mortgage Market – Drove the Fannie/Freddie Bailout.
• Wikipedia:
  Government-Sponsored Enterprise (GSE).
• Wikipedia:
  New Deal.
• WhiteHouse.gov:
  Franklin Delano Roosevelt.
• Wikinvest:
  Mortgage-backed Securities.

Shah Gilani

About the Author

Browse Shah's articles | View Shah's research services

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

He helped develop what has become known as the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of 10X Trader, Shah presents his legion of subscribers with the chance to earn ten times their money on trade after trade.

Shah is also the proud founding editor of The Money Zone, where after eight years of development and 11 years of backtesting he has found the edge over stocks, giving his members the opportunity to rake in potential double, triple, or even quadruple-digit profits weekly with just a few quick steps.

Shah is a frequent guest on CNBC, Forbes, and Marketwatch, and you can catch him every week on Fox Business's "Varney & Co."

He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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