Mortgage Matters

Why the two mortgage giants became wards of the federal government.

The U.S. Government took control of sister companies Fannie Mae and Freddie Mac, two massive public companies at the heart of the nation's mortgage system. Together, Fannie and Freddie own or guarantee more than half of the U.S. mortgage market - that's more than $5 trillion in loans.

Why did the government take control? In simple terms, banks loan money to home buyers. Many banks then sell those mortgages - assuming they meet certain credit standards - to Fannie Mae or Freddie Mac. Banks then use the money they get from the sale of those mortgages to make new loans. Fannie and Freddie, meanwhile, bundle those loans, attach a payment guarantee to them, and resell them as bonds.

The system provided a continuous supply of relatively low-interest cash, allowing banks and mortgage companies to keep making affordable loans to home buyers.

But as home prices dropped, mortgage defaults soared, making it harder for Fannie and Freddie to raise money, thus raising mortgage rates.

So, in an emergency move in July, Treasury Secretary Henry Paulson said the government stood ready to provide direct financial support to Fannie and Freddie, if needed. He said he hoped it wouldn't be needed.

But without an "explicit" guarantee from the U.S. government, the stock of both companies continued to drop, and major investors - including the central banks of Russia and China - started selling Fannie and Freddie bonds fast. That made it harder, and more expensive, for Fannie and Freddie to raise money.

The guarantee that investors wanted is now explicit. The U.S. government is now in the business of buying and reselling mortgages, and Paulson and his associates hope that sends the message that Fannie and Freddie are safe.