Tuesday, September 30

US Govt- Different strokes for different folks?

The US Government, through the US Treasury and Federal Reserve, stepped in to save the Fannie Mae and Freddie Mac; refused to do anything about Lehman Brothers, let Bank of America help Merrill Lynch save itself and threw AIG a lifeline. Why this partiality? There’s reason ! Lets see why!

The Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA), and the Federal Home Loan Mortgage Corporation (FHLMC) all are Government Sponsored Entities (GSEs) and they are known by the names Ginnie Mae, Fannie Mae, and Freddie Mac. Each purchases mortgages from lenders to provide funds for mortgage loans.
The agencies issue three types of mortgage-backed securities: mortgage Pass-through securities and collateralized mortgage obligations. and stripped mortgage-backed-securities. This process of combining many similar debt obligations as the collateral for issuing securities is called securitization. The primary reason for mortgage securitization is to increase the debt's attractiveness to investors and to decrease investor required rates of return, increasing the availability of funds for home mortgages.

Ginnie Mae, Fannie Mae, and Freddie Mac all guarantee the timely payment of scheduled interest and principal payments from their mortgage-backed securities. They are able to do this because they only purchase or underwrite loans that conform to certain standards regarding borrower credit ratings, loan size, and the ratio of each loan to the value of the property securing it.

The US Government, through the US Treasury and Federal Reserve, stepped in to save the Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac account for almost half of the $12 trillion mortgage market. By law, they are not allowed to hold sub-prime mortgages or refinance them. But they are listed companies and when the market value of their capital base falls below the mandated capital adequacy levels, how good the assets are is irrelevant.

As GSEs, many foreign central banks (including Japan, China, India) have invested their reserves in the bonds of these agencies. So it was very unlikely that the US govt was going to let its own GSEs go bankrupt.

Reference: Businessworld, CFA Institute Level 1 curriculum

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