Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Federal National Mortgage Association (Fannie Mae)

What it is:

Established in 1938, the Federal National Mortgage Association or (Fannie Mae) has the purpose of creating a secondary market for the trading of mortgages. In 1968, Fannie Mae transitioned from a government entity to a quasi-governmental, federally chartered corporation in order to buy mortgages other than those insured by the Federal Housing Administration (FHA).

How it works (Example):

The Federal National Mortgage Association purchases pools of mortgages from lenders and resells them in the form of mortgage-backed and other securities to investors. Purchases are generally restricted to conforming loans.  These loans meet certain size limits and other conditions.

The concept behind the Federal National Mortgage Association seems complicated, but it's actually quite straightforward. It purchases mortgages from banks, bundles them and sells them off on the market as larger, consolidated financial instruments. This process was established by the federal government to enable banks to wipe debt off of their books, while at the same time allowing the Federal National Mortgage Association to profit from relatively low investments.

Fannie Mae's mortgage-backed securities are similar to bonds and have varying maturities and coupon rates. The securities generally pay monthly interest as well as principal to investors.  This means investors earn interest on a decreasing principal amount over time.

Fannie Mae is exempt from Securities and Exchange Commission (SEC) regulations and is not subject to state or local income taxes. Also, the U.S. president appoints five of Fannie Mae's 18 board members, and the U.S. Treasury Department approves all Fannie Mae debt issues.

[If you're ready to buy a home, use our Mortgage Calculator to see what your monthly principal and interest payment will be.]

Why it Matters:

The Federal National Mortgage Association's purchasing activity increases the funding available for mortgage lending by providing lenders with cash to make additional loans. As a result, Fannie Mae's conditions for loan purchases affect the availability and interest rates on certain types of conforming and nonconforming loans.

Fannie Mae guarantees the payment of interest and principal on its mortgage-backed securities; if there are defaults on the underlying mortgages, Fannie Mae will make the required monthly payments on the securities. It is important to note, however, that Fannie Mae securities are not guaranteed by the U.S. government. This means that investors may have no recourse if Fannie Mae cannot fulfill its responsibilities as a guarantor.

Shares of Fannie Mae are traded on the OTC under the ticker FNMA. Fannie Mae shares generally have an inverse relationship with interest rates; its stock typically increases when interest rates fall, and vice versa. Fannie Mae frequently attempts to hedge its exposure to interest rate changes by purchasing derivative securities, such as interest rate swaps.

There are huge barriers to entry that protect Fannie Mae from competition. Considering the sheer amounts of capital needed to get into this market, Fannie Mae is largely protected from competition. The ruinous after effects of the 2008-2009 credit crisis also make it unlikely that major competitors will emerge. That said, Fannie Mae remains troubled, even after shedding much of its toxic securities. As of this writing, it has gone from a blue-chip "safe" investment to a highly risky penny stock.