Definition
A Government-Sponsored Enterprise (GSE) is a quasi-governmental organization created by an act of Congress to enhance the flow of credit to specific sectors of the economy, such as housing or agriculture. Although GSEs are privately owned, they receive certain advantages and imply some level of governmental backing, which can help them operate more efficiently or raise funds at lower costs. This implicit government support can come in various forms, including subsidies or exemptions from certain types of regulations.
Examples
1. Federal National Mortgage Association (Fannie Mae)
Established in 1938, Fannie Mae purchases and guarantees mortgages made by lenders so they have more funds to lend to customers. Fannie Mae’s role diminishes the risk to lenders and increases the flow of capital into the housing market.
2. Federal Home Loan Mortgage Corporation (Freddie Mac)
Founded in 1970, Freddie Mac also buys and pools mortgages. By doing so, it enhances the availability and affordability of mortgage credit for specific segments of the American population.
3. Federal Home Loan Banks (FHLBanks)
A collective name for 11 regional banks that provide funding to financial institutions to support home mortgage lending, promote community investment, and facilitate rural development.
Frequently Asked Questions (FAQs)
What benefits do GSEs offer?
GSEs provide stability and liquidity to primary markets, often in the form of financing. This assistance can lower borrowing costs and makes mortgages more accessible to the public. Moreover, they support their specific sectors through targeted financial instruments and resources.
Are GSEs government-owned?
GSEs are not government-owned but are privately held corporations that serve a public purpose dictated by Congress. However, they benefit from special operational exemptions by virtue of their charter and are thought to have implied governmental backing.
How are GSEs funded?
GSEs raise funds through issuing financial instruments such as bonds, which enjoy a higher credit rating due to implied government support, enabling them to borrow at lower interest rates compared to purely private entities.
Are the obligations of GSEs guaranteed by the government?
The obligations of GSEs are not explicitly guaranteed by the government. However, during financial crises, such as in 2008, governmental intervention and support become likely to maintain market stability.
What role did GSEs play in the 2008 financial crisis?
During the 2008 financial crisis, Fannie Mae and Freddie Mac faced significant financial distress, leading to the U.S. government placing them into conservatorship. This move involved massive capital infusions to stabilize these institutions, although future reforms are expected to clarify the formal extent of government backing.
Conservatorship
A legal status wherein an entity is taken over by an guardian, often due to financial instability. In the context of GSEs, it refers to federal takeovers to stabilize operations.
Lender
A financial institution or individual that provides loans to borrowers to be repaid with interest.
Mortgage-Backed Securities (MBS)
A type of asset-backed security composed of a bundle of home loans bought from the banks that issued them. Fannie Mae and Freddie Mac issue or guarantee these securities.
Secondary Mortgage Market
The market where home loans and servicing rights are sold between lenders and investors. GSEs like Fannie Mae and Freddie Mac operate predominantly in this market.
Online Resources
References
- Hendershott, P.H., “The Future of Fannie Mae and Freddie Mac”, Journal of Real Estate Economics, 2015.
- Federal Housing Finance Agency, Annual Reports. Available at: FHFA Reports
- U.S. Government Accountability Office, “Fannie Mae and Freddie Mac: Analysis of Options for Revising the Housing Enterprises’ Long-term Structures.” Available at: GAO Report
Suggested Books for Further Studies
- American Nightmare: How the Federal Government Destroyed the Housing Market by Peter J. Wallison
- Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again by Peter J. Wallison
- House Lust: America’s Obsession with Our Homes by Daniel McGinn
### What is a Government-Sponsored Enterprise (GSE)?
- [x] A quasi-governmental organization created by Congress to enhance the flow of credit.
- [ ] A fully government-owned entity that distributes credit to all business sectors.
- [ ] A completely private bank with special financial privileges.
- [ ] An NGO providing micro-credit loans to underserved communities.
> **Explanation:** A GSE is a quasi-governmental organization that enhances credit flow to target sectors like housing and agriculture. It is privately owned but created by the government and enjoys certain privileges.
### Which organization is an example of a GSE?
- [ ] Federal Deposit Insurance Corporation (FDIC)
- [x] Federal National Mortgage Association (Fannie Mae)
- [ ] Securities and Exchange Commission (SEC)
- [ ] Internal Revenue Service (IRS)
> **Explanation:** Fannie Mae (Federal National Mortgage Association) is a GSE that buys and guarantees mortgages to help ensure liquidity within the housing market.
### When was Freddic Mac established?
- [x] 1970
- [ ] 1938
- [ ] 1929
- [ ] 2008
> **Explanation:** Freddie Mac was established in 1970 to further bolster the secondary mortgage market and increase the availability of funds for homebuyer loans.
### What sector do Federal Home Loan Banks primarily support?
- [ ] Industrial manufacturing
- [ ] Technology startups
- [ ] Retail businesses
- [x] Housing finance
> **Explanation:** Federal Home Loan Banks primarily support the housing finance sector by providing liquidity to financial institutions.
### Why can GSEs issue debt at lower interest rates?
- [ ] They have direct governmental backing.
- [ ] Their debt is bought exclusively by government entities.
- [ ] They operate within a structured national coding system.
- [x] They have implied government support or bailout assumption.
> **Explanation:** GSEs can issue debt at lower interest rates due to the market's belief that the government would step in to support them financially in crises, known as implied government backing.
### What happened to Fannie Mae and Freddie Mac during the 2008 financial crisis?
- [x] They were placed into conservatorship.
- [ ] They declared bankruptcy and ceased operations.
- [ ] They successfully raised capital through private investors.
- [ ] They spun off independent subsidiaries.
> **Explanation:** In response to severe financial stress, Fannie Mae and Freddie Mac were placed into conservatorship during the 2008 financial crisis ensuring their operations continued with govermental support.
### What form of securities do Fannie Mae and Freddie Mac issue or guarantee?
- [ ] Collateralized debt obligations (CDOs)
- [x] Mortgage-backed securities (MBS)
- [ ] Stocks and shares
- [ ] Municipal bonds
> **Explanation:** Fannie Mae and Freddie Mac issue or guarantee mortgage-backed securities (MBS), which group together mortgages to provide liquidity and stability in the home loan market.
### What is the main advantage of having an implied government backing for GSEs?
- [x] The ability to raise funds or issue debts at lower interest rates.
- [ ] Exclusive rights to specific business segments.
- [ ] Guaranteed profits regardless of market conditions.
- [ ] Autonomy to violate specific national laws.
> **Explanation:** Implied government backing allows GSEs to raise funds at lower interest rates compared to their purely private counterparts, as the risk for investors is perceived to be lower.
### What is the primary purpose behind the establishment of GSEs?
- [x] To enhance the flow of credit to specific sectors of the economy.
- [ ] To subsidize private entities across all business sectors.
- [ ] To provide financial backing solely for state governments.
- [ ] To generate maximum shareholder value through governmental support.
> **Explanation:** GSEs were established to enhance the flow of credit to targeted sectors like housing and agriculture, ensuring stable economic growth and equivalent opportunities in crucial areas.
### Are the obligations issued by GSEs explicitly guaranteed by the U.S. government?
- [ ] Yes, all GSE obligations come with an official government guarantee.
- [ ] They are guarantees depending on the yearly fiscal budget.
- [ ] Only in events of an economic downturn.
- [x] No, but they have implied support that suggests potential government intervention.
> **Explanation:** The obligations of GSEs are not explicitly guaranteed, but they benefit from an implied promise of support from the government – this means investors assume that the government would step in if the GSE runs into trouble.
