Updated: May 20, 2021
Fannie Mae and Freddie Mac are known as government sponsored enterprise (GSE). Their function is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient and transparent. During the Great Depression, borrowers were defaulting on mortgages thus putting pressure on the banks due to the lack of cash.
The Great Depression
In times of despair the government often makes sweeping changes and/or reforms to prevent history from repeating itself. Hence, in 1938 President Franklin D. Roosevelt and Congress created Fannie Mae to buy mortgages from lenders to free up capital that could go to other borrowers. This relief provided a path for people to become homeowners and foster the American Dream as it allowed lenders to loan money to low-to-middle income buyers who typically would not have been considered as “credit worthy.” In 1968,
President Lyndon Johnson removed Fannie Mae's debt from the government balance sheet and it was converted into a public company. Freddie Mac was chartered by Congress in 1970 to provide the same services and to keep Fannie Mae from becoming a monopoly.
Technically conventional loans are not guaranteed or insured by the federal government; however, Fannie and Freddie raise cash to buy mortgages from sources such as pension funds, mutual funds and foreign governments and by doing this they create guidelines that lenders will conform to so that Fannie and Freddie will purchase the loans. In short, the guidelines speak of conforming loans which are understood in the United States to be any loan that is structured as a mortgage loan and meets the requirements laid out in GSE guidelines.
When loans are issued that do not comply with the provisions set by the GSE guidelines, the transaction is understood to be non-conforming loans. Many conventional mortgages are structured as non-conforming loans, although all mortgage loans that are conducted under the auspices of the Fannie Mae and Freddie Mac government sponsorship must be in the form of a conforming loan.