Definition
Freddie Mac, short for Federal Home Loan Mortgage Corporation (FHLMC), is a U.S. government-sponsored enterprise (GSE) that buys mortgages from financial institutions, bundles them into mortgage-backed securities, and sells them to investors. By doing this, it provides liquidity to the mortgage market, which allows lenders to offer more mortgages to home buyers. Freddie Mac is considered one of the biggest secondary mortgage market players, alongside Fannie Mae.
Key Takeaways
- Freddie Mac, officially known as the Federal Home Loan Mortgage Corporation, is a public government-sponsored enterprise (GSE) that operates in the secondary mortgage market. This organization purchases existing mortgages from financial institutions, combines them into mortgage-backed securities, and sells them to investors, thus providing liquidity to lenders.
- By providing a steady stream of funding for mortgage loans, Freddie Mac plays a vital role in the United States housing market. This enables lenders to offer long-term, fixed-rate mortgages to homebuyers, making homeownership more accessible for Americans.
- Despite its public mission, Freddie Mac is a shareholder-owned company. However, following the 2008 financial crisis, it was placed under the conservatorship of the Federal Housing Finance Agency (FHFA), demonstrating the risks associated with its operations and the importance of regulation in the housing finance sector.
Importance
Freddie Mac, officially known as the Federal Home Loan Mortgage Corporation, is a crucial entity in the United States mortgage market.
Its primary importance lies in its role to buy mortgages on the secondary market, pool them, and sell them as mortgage-backed securities to investors on the open market.
This activity provides liquidity, stability and affordability to the U.S housing market by freeing up lenders’ funds so they can issue more home loans.
Consequently, it helps stimulate home ownership and rental housing.
However, Freddie Mac also carries systemic risk, as seen during the 2008 financial crisis when inadequate regulation and oversight led to its heavy participation in buying risky mortgage, contributing to the housing bubble and its eventual burst.
Explanation
Freddie Mac, which is a nickname for the Federal Home Loan Mortgage Corporation (FHLMC), is a government-sponsored enterprise that was established to promote stability and affordability in the housing market. Its primary purpose is to offer a secondary marketplace for banks and other official mortgage originators.
In simple terms, Freddie Mac buys mortgages on the secondary market, pools them, and then sells them as a mortgage-backed security to investors on the open market. This provides a continuous flow of affordable funding for banks that can be used for home loans, essentially making more money available for people to purchase homes.
One of the major ways Freddie Mac contributes to the housing market is by supplying banks with the ability to lend borrowers the capital needed to buy homes. After a loan has been given to a borrower for a home purchase, the loan is sold to Freddie Mac.
This enables the bank to eliminate the risk of default — which happens when the borrower fails to make payments — and to free up capital to issue more loans. By doing so, Freddie Mac essentially stimulates the real estate market by making home purchases more attainable for individuals.
Examples of Freddie Mac
Acquisition of Residential Mortgages: A real-world example of Freddie Mac could be when a local bank in Dallas, Texas, approves a mortgage for a resident who bought a new home. Rather than keep that mortgage in its portfolio, the bank could sell it to Freddie Mac, thus freeing up capital to be able to lend to other homeowners. The selling and buying of the mortgage would ensure the fluid movement and availability of capital within the housing market.
Securitization of Mortgages: Once Freddie Mac has purchased the mortgage from the bank, they would then package it together with other similar residential mortgages. This amalgamation is turned into a Mortgage-Backed Security (MBS) which is then sold to investors, which include pension funds, insurance companies, or foreign governments. For instance, an investment firm in New York might buy these securities as a part of their diversified investment portfolio for steady and reliable returns.
Guarantor of Mortgages: Lastly, Freddie Mac plays the role of a guarantor. Suppose a family in Miami has defaulted on their mortgage which was bought and then securitized by Freddie Mac. As the guarantor, Freddie Mac would cover the loss for the investors who bought the Mortgage-Backed Securities. This helps to instill confidence in investors and keep the housing finance system stable and trustworthy.
Frequently Asked Questions About Freddie Mac
What is Freddie Mac?
Freddie Mac, also known as the Federal Home Loan Mortgage Corporation, is a government-sponsored enterprise created by Congress in 1970 to support the mortgage market. It purchases, guarantees, and securitizes mortgages in order to provide a reliable supply of mortgage lending.
What does Freddie Mac do?
Freddie Mac’s primary function is to provide liquidity to the nation’s mortgage finance system. It does this by buying up mortgages provided by lenders, packaging them into mortgage-backed securities, and selling them to investors on the open market.
How does Freddie Mac affect the economy?
By providing liquidity to the mortgage market, Freddie Mac facilitates a stable and affordable mortgage market. This can contribute to lower interest rates for borrowers and provide opportunities for home ownership and rental housing.
What is the relationship between Freddie Mac and Fannie Mae?
Like Freddie Mac, Fannie Mae is also a government-sponsored enterprise created by Congress. Both of these entities serve similar functions in that they buy mortgages from lenders and securitize them for investors. However, they operate separately and are distinct corporations.
Related Entrepreneurship Terms
- Secondary Mortgage Market
- Federal Home Loan Mortgage Corporation (FHLMC)
- Mortgage-Backed Securities (MBS)
- Government-sponsored Enterprise (GSE)
- Loan-To-Value Ratio (LTV)
