Introduction to Finance

Government National Mortgage Association (Ginnie Mae)
was created in 1968 as 
a government-owned corporation. Ginnie Mae issues its own debt securities to obtain funds that 
are invested in mortgages made to low to moderate income home purchasers. The 
Federal Home 
Loan Mortgage Corporation (Freddie Mac)
was formed in 1970, also as a government-owned 
corporation to aid the mortgage markets by purchasing and holding mortgage loans. In 1989, 
Freddie Mac also became a GSE when it became a public, investor-owned company. 
Ginnie Mae and Fannie Mae issue mortgage-backed securities to fund their mortgage 
purchases and holdings. Ginnie Mae purchases Federal Housing Administration (FHA) 
and Department of Veterans Aff airs (VA) federally insured mortgages, packages them into 
mortgage-backed securities that are sold to investors. Ginnie Mae guarantees the payment 
of interest and principal on the mortgages held in the pool. Fannie Mae purchases individual 
mortgages or mortgage pools from fi nancial institutions and packages or repackages them into 
mortgage-backed securities as ways to aid development of the secondary mortgage markets. 
Freddie Mac purchases and holds mortgage loans. 
As housing prices continued to increase, these mortgage-support activities by Ginnie 
Mae, Fannie Mae, and Freddie Mac aided the government’s goal of increased home own-
ership. However, after the housing price bubble burst in mid-2006 and housing-related jobs 
declined sharply, mortgage borrowers found it more diffi
cult to meet interest and principal 
payments, causing the values of mortgage-backed securities to decline sharply. To make the 
housing-related developments worse, Fannie Mae and Freddie Mac held large amounts of low 
quality, subprime mortgages that had higher likelihoods of loan defaults. As default rates on 
these mortgage loans increased, both Fannie and Freddie suff ered cash and liquidity crises. 
To avoid a meltdown, the Federal Reserve provided rescue funds in July 2008, and the U.S. 
government assumed control of both fi rms in September 2008.
The Federal Reserve, sometimes with the aid of the U.S. Treasury, helped a number of 
fi nancial institutions on the verge of failing, due to the collapse in value of mortgage-backed 
securities, to merge with other fi rms. Examples included the Fed’s eff orts in aiding the March 
2008 acquisition of Bear Stearns by the JPMorgan Chase bank and the sale of Merrill Lynch 
to Bank of America during the latter part of 2008. However, Lehman Brothers, a major invest-
ment bank, was allowed to fail in September 2008. Shortly after the Lehman bankruptcy and 
the Merrill sale, American International Group (AIG), the largest insurance fi rm in the United 
States, was “bailed out” by the Federal Reserve with the U.S. government receiving an own-
ership interest in the company. Like Merrill, Fannie, and Freddie, AIG was considered “too 
large to fail,” due to the potential impact of this on the global fi nancial markets. 
In addition to direct intervention, the Fed also engaged in quantitative easing actions to 
help avoid a fi nancial system collapse in 2008, and to stimulate economic growth after the 
2008–09 recession. We will discuss the Fed’s quantitative easing actions later in the chapter.