Which of the Following Is an Example of a Government-Sponsored Enterprise (GSE)?

Government-sponsored enterprises (GSEs) play a crucial role in the U.S. economy by supporting access to credit and liquidity, particularly in housing finance. These entities operate with federal benefits but are not directly managed as government agencies. Their activities influence mortgage markets, homeownership rates, and financial stability.

Federal Charter and Sponsorship

GSEs operate under a federal charter established through congressional acts, defining their purpose and regulatory oversight. These charters grant specific authorities while imposing restrictions. Unlike private financial institutions, GSEs benefit from implicit government backing, allowing them to borrow at lower interest rates and maintain investor confidence. While no formal guarantee exists, markets generally assume federal intervention in times of financial distress.

Federal sponsorship provides GSEs with privileges that enhance their ability to fulfill their mandates. They are exempt from state and local income taxes, reducing costs and improving financial efficiency. Additionally, they are not required to register their securities with the Securities and Exchange Commission (SEC), streamlining the issuance of debt and mortgage-backed securities. These advantages help GSEs channel funds more effectively into housing finance.

Key GSEs

Several GSEs operate in the U.S. financial system, primarily focusing on housing finance. They provide liquidity to mortgage markets by purchasing loans from lenders, packaging them into securities, and selling them to investors. This process stabilizes interest rates and expands access to homeownership. The most prominent GSEs include Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System.

Federal National Mortgage Association

Fannie Mae was established in 1938 as part of the New Deal to expand home financing during the Great Depression. It operates under a congressional charter and is regulated by the Federal Housing Finance Agency (FHFA). Fannie Mae purchases mortgages from lenders, pools them into mortgage-backed securities (MBS), and sells these securities to investors, increasing liquidity and enabling lenders to issue new loans.

It primarily deals with conforming loans that meet criteria set by the FHFA, including loan limits adjusted annually. For 2024, the baseline conforming loan limit for a single-family home is $766,550 in most areas, with higher limits in high-cost regions. Fannie Mae follows Generally Accepted Accounting Principles (GAAP), particularly ASC 860 for securitization transactions. Its financial statements reflect significant holdings of MBS, with risk management strategies focused on interest rate and credit risk exposure.

Federal Home Loan Mortgage Corporation

Freddie Mac was created in 1970 under the Emergency Home Finance Act to provide competition to Fannie Mae and enhance mortgage market liquidity. Like Fannie Mae, it purchases mortgages from lenders, securitizes them, and sells the resulting MBS to investors, maintaining a steady flow of capital in the housing finance system.

Freddie Mac operates under FHFA oversight and adheres to GAAP financial reporting requirements. It follows the same loan limits as Fannie Mae but primarily sources loans from smaller banks and credit unions, whereas Fannie Mae works more with larger financial institutions. Risk management strategies include hedging against interest rate fluctuations. Freddie Mac also issues debt securities, known as Reference Notes and Reference Bills, to fund operations, benefiting from lower borrowing costs due to its GSE status.

Federal Home Loan Bank System

The Federal Home Loan Bank (FHLB) System was established in 1932 under the Federal Home Loan Bank Act to provide liquidity to savings and loan institutions. Unlike Fannie Mae and Freddie Mac, which focus on purchasing and securitizing mortgages, the FHLB System consists of 11 regional banks that offer low-cost funding to member institutions, including commercial banks, credit unions, and insurance companies.

FHLBs raise capital by issuing debt securities in global financial markets, benefiting from their GSE status, which allows them to borrow at favorable rates. These funds are distributed to member institutions as secured loans, known as advances, which support mortgage lending and community development. The system is regulated by the FHFA and follows GAAP financial reporting standards, with disclosures on credit risk, interest rate exposure, and capital adequacy. As of 2023, the FHLB System had over 6,500 member institutions and provided more than $1 trillion in outstanding advances.

Mortgage Purchase Programs

GSEs ensure that banks and credit unions have a steady flow of capital to issue new home loans by purchasing mortgages from lenders. Without these programs, financial institutions would be constrained by the amount of money they could lend, limiting homeownership opportunities.

After purchasing mortgages, GSEs bundle them into mortgage-backed securities (MBS), which are then sold to investors. This process transforms individual home loans into tradable financial assets, allowing institutional investors such as pension funds, insurance companies, and mutual funds to participate in the housing market. The returns on these securities come from the underlying mortgage payments made by homeowners, offering investors steady income streams while spreading risk across multiple loans.

GSEs establish underwriting standards that determine which loans qualify for purchase. These guidelines include borrower credit scores, debt-to-income (DTI) ratios, and loan-to-value (LTV) limits to ensure acceptable risk levels. As of 2024, conventional loans eligible for GSE purchase typically require a minimum credit score of 620, while borrowers with higher DTI ratios may need compensating factors such as larger down payments or substantial cash reserves.

Beyond traditional mortgage purchases, GSEs support affordability initiatives by acquiring loans tailored to low- and moderate-income borrowers. Programs like HomeReady and Home Possible allow qualifying buyers to secure mortgages with down payments as low as 3%. These programs also offer flexible income sources, including rental income from accessory dwelling units (ADUs), to improve borrower eligibility.

Regulatory Framework

GSEs operate under a structured regulatory environment to ensure financial stability, transparency, and compliance with federal mandates. Oversight falls under the Federal Housing Finance Agency (FHFA), established under the Housing and Economic Recovery Act of 2008 (HERA) following the subprime mortgage crisis. The FHFA has authority to set capital requirements, conduct stress testing, and place GSEs into conservatorship if necessary, as demonstrated in 2008 when Fannie Mae and Freddie Mac were placed under federal control due to financial distress.

Capital adequacy is a key regulatory concern, with the FHFA implementing the Enterprise Regulatory Capital Framework (ERCF) to establish risk-based capital requirements. The ERCF mandates a minimum leverage ratio of 2.5% and a risk-based capital requirement that varies based on loan characteristics, credit risk exposure, and market conditions. These thresholds ensure GSEs maintain sufficient reserves to absorb potential losses while continuing to fulfill their mission. GSEs must also comply with liquidity requirements, ensuring they have enough high-quality liquid assets to meet short-term obligations.