Government-Sponsored Enterprise (GSE)

Definition

A Government-Sponsored Enterprise (GSE) is a type of financial services corporation created by the United States Congress. These enterprises are privately owned but were established to enhance the flow of credit to specific sectors of the economy such as agriculture, education, and housing. GSEs benefit from the implicit backing of the federal government, which allows them to raise funds at interest rates lower than those available to wholly private-sector entities.

Examples

Federal National Mortgage Association (FNMA or Fannie Mae): Created in 1938, Fannie Mae provides liquidity to the mortgage market by buying mortgages from lenders, enabling them to lend more money to homebuyers.
Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac): Established in 1970, Freddie Mac operates similarly to Fannie Mae, buying residential mortgages, and then issuing mortgage-backed securities.

Frequently Asked Questions

Q1: What is the main function of a GSE?
A1: The primary function of a GSE is to enhance the flow of credit to targeted economic sectors. This is achieved by guaranteeing or directly providing funding, which lowers the cost and increases the availability of credit.

Q2: How does the implicit backing from the U.S. Treasury benefit GSEs?
A2: The implicit backing allows GSEs to raise funds at lower interest rates compared to other private-sector entities, due to the reduced perceived risk of their debt securities.

Q3: Are GSEs publicly traded entities?
A3: Yes, GSEs like Fannie Mae and Freddie Mac are publicly traded companies, although they were originally established by the government.

Q4: What happened to Fannie Mae and Freddie Mac during the 2008 financial crisis?
A4: On September 6, 2008, the U.S. government took control of 80% of both enterprises to stabilize the financial system during the housing market collapse.

Mortgage-Backed Securities (MBS): Financial instruments that are secured by a mortgage or collection of mortgages. GSEs often purchase these instruments in order to provide liquidity to the mortgage market.

Implicit Guarantee: The unstated assumption that the government will provide financial backing if the GSEs face insolvency, although it is not enshrined in law.

Securitization: The process of pooling various types of debt (including mortgages) and selling them as bonds to investors.

Liquidity: The ability to quickly convert assets into cash with minimal loss in value; GSEs provide market liquidity by purchasing loans and creating MBS.

Online References

Suggested Books

“The Big Short: Inside the Doomsday Machine” by Michael Lewis
“Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again” by Peter J. Wallison
“Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon” by Gretchen Morgenson and Joshua Rosner
“All the Devils Are Here: The Hidden History of the Financial Crisis” by Bethany McLean and Joe Nocera

Fundamentals of Government-Sponsored Enterprise: Finance Basics Quiz

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