An Overview Of The Mortgage Cycle

Out of the three main players in the mortgage industry (Ginnie, Fannie, & Freddie), only Ginnie Mae is a self-sustaining, profitable and wholly-owned government corporation. Ginnie Mae is located within the U.S. Department of Housing and Urban Development (HUD), and was created as the final crowning jewel in what we've now come to know as the mortgage cycle.

The Mortgage Cycle

Just like in the water cycle, mortgages go through stages of condensation, precipitation, and evaporation. While real estate is not a liquid asset, the mortgage cycle has made it possible for real estate to have a certain amount of liquidity.

Market liquidity is when you can buy and sell an asset without the prices changing drastically. It gives the market stability and boosts consumer and investor confidence. However, market liquidity fluctuates in the mortgage industry, since the US economy runs parallel to housing.

Think of it like this: while The Fed dictates monetary policy and sets interest rates, it can’t control every aspect of our economy. The result is a trickle down effect. Whatever happens to the US economy affects housing and vice versa. But for the most part, the mortgage cycle was created to better protect home buyers from inflation and inventory shortages.

Back in the day, it took a great deal of money and effort to build, buy or sell a home. That’s because interest rates weren’t fixed (so your mortgage payment changed every year), banks were too small to fund mortgages for everyone, and we had no secondary marketplace to buy and sell homes after they had first been bought.

Fast forward many decades, and we now have the three pillars of the mortgage industry: Fannie Mae, Freddie Mac, and Ginnie Mae.

Fannie Mae

The largest of the three pillars, Fannie Mae (created in 1938) was initially created to help the Federal Housing Administration (FHA) improve home buying for Americans. In fact, the FHA (created in 1934) replaced the earlier Home Owners Loan Corporation (HOLC was created in 1933), which bought back about 1 million mortgages that were in foreclosure during the Great Depression.

As the FHA’s big sister, Fannie stepped in to work with large commercial banks. Fannie became the focal point for buying and trading conventional mortgages, so that all big banks and home buyers started to turn to Fannie Mae more and more for a mortgage as time went on.

Freddie Mac

Freddie Mac was created in 1970 during a time when interest rates were very high and market liquidity had stalled. The FHA and Fannie Mae had reached a tipping point, and negotiations had to be made with smaller, local banks across the country.

The reason that housing had reached crisis levels was because interest rates were high, and in many parts of the country that had smaller, rural populations, people seemed more interested in saving their money rather than investing it.

This meant that across the country, thousands of small banks were struggling to house the wealth of smaller, local communities, which didn’t necessarily have access to big government agencies. These untapped pockets of wealth made it so that money wasn’t moving properly around the country.

While it was initially proposed that Fannie Mae take over the mortgages on the balance sheets of smaller banks—they refused. As a point of pride, the Federal Home Loan Bank System, which oversaw small banks across the country, didn’t want to give in to what they saw as a big government takeover.

As a result, Freddie Mac was created to replace the Federal Home Loan Bank System, and still operates to this day as Fannie Mae’s separate, younger brother.

Ginnie Mae

But before the inflation crisis that caused the Emergency Home Finance Act to be signed in 1970, creating Freddie Mac, there was Ginnie Mae.

Established in 1968, Ginnie Mae was set up to be the housing ace up the government’s sleeve.

By setting up several risk buffers through the use of homeowner’s equity, government mortgage insurance, and the corporate resources of lenders before asking Ginnie Mae to step in when a loan defaulted, Ginnie Mae was able to start offering USDA, VA, FHA, and NADLP loans at lower rates that were fully backed by the US government.

To be clear, Fannie Mae and Freddie Mac are the ones that issue these loans. However, unlike Ginnie Mae, Fannie and Freddie are public companies (even if under government control), and they can’t back loans with the full faith and credit of the US government the way Ginnie can.

But what’s so extraordinary about Ginnie isn’t that it fully backs loans—it’s that it runs the MBS program.

MBS or mortgage-backed securities were first launched in 1970. It was an attempt to make mortgages easier to trade, kind of like how stocks are traded on the stock market. Except that rather than percentages, MBS are bundles of mortgages with similar characteristics that can be traded in bulk. Instead of percentages of stock, you trade and buy MBS.

The MBS was an industry game changer, because it made it possible for real estate to be traded on futures markets and create capital and liquidity ahead of time, before units were even built. That made it possible for real estate investments to get full funding as they were being created, rather than having to go all in and hope that somehow, some way, investors would be able to win their money back.

So while Ginnie Mae doesn’t buy or sell mortgages, it does oversee the creation of MBS. It’s also the last line of defense when it comes to government backed mortgages, and will take on the portfolios of investors who default on their Ginnie Mae commitments.

Make It Rain Mortgages

Naturally, the list of lenders that Ginnie Mae has approved to buy MBS is very strict because of this. Ginnie Mae would never want to be financially responsible for investors defaulting on the MBS they buy, mainly because that’s not Ginnie Mae’s largest role.

Ginnie Mae loans only back about 12 million of the approximately 139 million homes in the US—that’s about 8.6% of national housing. The criteria to qualify for loans backed by Ginnie Mae are strict, and it’s for a reason—the loans they back are specialized, and again—Ginnie Mae’s main goal is to focus on maintaining the standards and mechanisms of the MBS system up to par. Ginnie Mae’s obsession with quality MBS lies in the fact that they want other countries to see Ginnie Mae MBS as good investments for their sovereign wealth funds. SWFs are alternative investments in global capital that complement a nation’s other assets.

So, how do Fannie, Freddie, and Ginnie come together? Well, a home buyer seeks out a mortgage broker, gets pre-approved for a set loan amount, and then the broker runs a dual AUS check to see if the buyer qualifies for a loan from Freddie Mac or Fannie Mae. Ginnie Mae oversees everything in the background, making sure that the MBS system and standards are up to par, all of which make Fannie and Freddie run like clockwork.