Congress created Fanny Mae and Freddie Mac. Their purpose was to buy bank loans made for purchasing a house. A bank or lender only has so much capital. Once its reaches a limit of assets -deposits, it cannot loan any more.
At this point the loan is sold to Fannie Mae and the bank gets their capital back and can reloan the money. They get to keep a management fee say 1% for watching over the loan (I could be wrong on this), but as I understand it, if they can turn over say 1,000,000 10 times in one year they can make 10% on management alone.
Fannie Mae packages these loans in packages of say $10 million and sells them on the open market. Now from what I understand, if the package doesn’t perform as expected, it can be returned or the bad stuff is exchanged for good stuff.
Mind you there is an expected number of loans that will be payed off early and and expected number of defaults.
Now the clincher is, that since it was created by the Congress, there is an implyed guarantee that it cannot go broke. That is why people are so eager to buy the packages. Your 401k is not guaranteed and neither is your IRA.
Now say they get 1% off of each transaction also, every piece of crap that is rubber stamped in a rising economy isn’t going to smell bad in a rising real estate market. It will be sold at a profit and put back into the pool.
With the real estate market going up, their ability to accept all and every loan doesn’t really come into question. Lets make money and lots of it.
Its when the market starts to go down. From what I have read between the lines, is that Fannie Mae’s packages to investors lately have a higher rate of default.
The question that is arising; are they taking their bad loans and throwing them into a new package for investors, giving them a few months of lag time before they are returned as bad? They are being accused of this presently although indirectly. Congress has told them to divest some of their holdings.
There is also another thing they can do since they are so big. They can take an options position on the market, put or call and then sell their package at a loss and make a bundle on the position. (This is not what they are really doing, their method is very convoluted, this is just a way of simplifying it. The Wall Street Journal had an article on how they could lower interest rates that was more definitive).
