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What Exactly Does Freddie Mac Do?

By Brendan I. Koerner
Posted Thursday, June 12, 2003, at 5:34 PM ET

Federal prosecutors are investigating the Federal Home Loan Mortgage Corp. (FHLMC), better known as Freddie Mac, for alleged deceptive accounting. What does Freddie Mac do, exactly?

Freddie Mac plays a vital, albeit esoteric, role in the American home-buying process. The company is a key player in the secondary mortgage market, which means it purchases mortgages from banks. Freddie Mac then bundles together several thousand such mortgages into a tradable security and sells the package to an institutional investor.

Say you just obtained a $200,000 mortgage with a fixed rate of 5 percent. There's about a one in six chance that your bank will turn around and sell that mortgage to Freddie Mac, which in turn will package it with thousands of other mortgages with similar rates. That collection, which may be valued at $500 million or more, is converted into a bondlike security and sold to large investors who prefer relatively safe, steady assets. (Freddie Mac securities are popular among European and Asian pension funds, for example.) The return on the security may be only 4.75 percent; the other quarter point makes for Freddie Mac's cut.

The transactions obviously enrich Freddie Mac, but the company was created by congressional mandate, and the process is intended to benefit American homebuyers. The idea is that banks will use the money they obtain from selling mortgages to fund additional mortgages; the system has increased the nation's home-ownership rate. Also, the hope is that banks will feel more comfortable offering mortgages for homes in low-income areas, since they know they can turn right around and sell the mortgage to Freddie Mac. (Freddie Mac does not purchase mortgages over $322,700 in value.)

Despite its bureaucratic-sounding acronym, Freddie Mac is not technically a government agency. Rather, it's a government-sponsored enterprise, founded at Congress' request but publicly owned by shareholders. Freddie Mac was chartered in 1970 to provide competition for the Federal National Mortgage Association (FNMA), or Fannie Mae, another GSE, which was formed in 1938 to mitigate the effects of the Great Depression (though not privatized until 30 years later). The companies are virtually indistinguishable to the layman, as they both purchase and secure mortgages for the statutory purpose of increasing home ownership.

The two companies benefit substantially from their GSE status. They do not pay state or local taxes, nor are they required to submit filings to the Securities and Exchange Commission. They also enjoy $2.25 billion lines of credit with the Treasury Department, which boosts investor confidence in the safety of their securities. The perks often attract the ire of fiscal conservatives, who characterize Freddie and Fannie as government-created monopolies.

Bonus Explainer: As for the homespun nicknames, FNMA got its moniker because of its acronym; when you try to pronounce it as a word, it comes out sounding something like "Fannie Mae." When it came time to nickname the competitor, however, FHLMC didn't naturally sound like a recognizable name. "Freddie," then, is a take on "federal," and "Mac" a reference to the terminal "MC."

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Brendan I. Koerner is a contributing editor at Wired and a columnist for Gizmodo. His first book, Now the Hell Will Start, is out now.
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