Most borrowers never come into contact with mortgage finance giants Fannie Mae and Freddie Mac. That's because the companies work with lenders rather than consumers.
Nevertheless, Fannie and Freddie play an essential role in the mortgage industry and the economy in general. Here are answers to some basic questions about these companies and your stake in them:
What are Fannie Mae and Freddie Mac?
They are called government-sponsored enterprises because they initially were formed by the federal government. Fannie Mae is a common name for Federal National Mortgage Assn. in Washington, D.C. Freddie Mac is a common name for Federal Home Loan Mortgage Corp. in McLean, Va.
What do Fannie Mae and Freddie Mac do?
Fannie Mae and Freddie Mac buy mortgages from savings and loans, banks and other lenders to generate more cash for those lenders to make more home loans. Together they hold or guarantee $5.4 trillion of mortgages, about half of the nation's home loans outstanding.
What's the difference between the two?
There's no practical difference in their missions or criteria for buying and guaranteeing loans. Their origins differ: Fannie Mae was created under President Franklin D. Roosevelt in 1938 to make sure funds were available in the housing market during tough economic times. It was turned into a publicly traded company in 1968. Freddie Mac was created in 1970 so that Fannie Mae wouldn't have a monopoly on government-backed mortgages.
Why are they in trouble?
As home prices fell, so did the value of the mortgages the companies held, lowering their already small cushions of capital. As more of the loans they had backed went bad, they were no longer able to raise money from private sources.
Why should I care?
If the government hadn't stepped in, and Fannie Mae and Freddie Mac had failed, the damage to the mortgage and housing markets would have been huge. The overall financial system and the nation's economy also could have been hurt badly. In addition, the federal government is now explicitly guaranteeing debt issued by Fannie and Freddie. If defaults on mortgages held by Fannie and Freddie are greater than currently expected, the amount paid by taxpayers could be substantial.
Will this affect mortgage rates or the availability of home loans?
The government hopes its plan will bring down rates and make mortgages easier to get. Some experts caution, however, that the effect won't be dramatic.
Could this have been avoided?
The depressed housing market and high rate of foreclosures make it tough for anyone investing in home loans, but Fannie and Freddie took steps in 2006 and 2007 that came back to bite them. The companies lowered their standards for loans they would buy, and they backed riskier mortgages, including loans that didn't require borrowers to provide proof of their stated income. Such loans accounted for half the companies' credit losses in the second quarter this year.
What will happen to shareholders?
Shares of Fannie and Freddie, which have plunged more than 80% this year, are likely to slide further today in response to the actions announced Sunday. Depending on how much capital the government pumps into the firms to keep them solvent, the stocks could lose all their value.