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Freddie Mac and Fannie Mae are the United States two core institutions in the mortgage sector; it should be noted that they are not lending firms but instead they act as the “investment bankers” previously discussed in which they would sell the mortgages sold to them by the lenders to other investors. Hence, these two companies served as important links between lenders, who have a more direct access to potential home buyers, and the investors.
These two institutions would be badly affected by the financial crisis primarily because they are the key players in the sub-prime mortgage arrangements.
Freddie Mac and Fannie Mae played a significant role in creating the CDO arrangements that it would sell to other investors and financial institutions despite its risky nature, and at the same time, as a mortgage company, Freddie Mac and Fannie Mae would further encourage lending in order to increase its business and profits.
As a result, as mortgage payments did not come through as sub-prime homeowners could not afford their loans, Freddie Mac and Fannie Mae would instead have a portfolio-full of worthless properties which banks and other investors do not want to buy; moreover, these banks and investors themselves, due to its bad decisions in buying and packaging high-risk securities, would also find themselves as bankrupt.
Another problem faced by Freddie Mac and Fannie Mae is that both companies are fuelled by shareholders; with the turn of events for these firms, their values have drastically decline and the companies would experience critically losses, notably at $3 billion from April to June 2008, excluding its other outstanding debts and more recent losses.
What is interesting is that recent debates as to the fate of the two firms have been pointed at the lack of regulation in the mortgage market; the deregulation which was initially endorsed by the past U. S. administration would prove to have liberalised too much the practices of mortgage institutions to the point that it would encourage more sub-prime lending as a means to increase profit, and more irresponsible practices which would eventually lead to its current situation.
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