Introduction to Finance

subprime mortgage
is a home loan to a borrower with a relatively 
poor credit score, indicating a higher likelihood the borrower will miss mortgage payments when 
due. Making mortgage loans to subprime borrowers is a risky business in that an event such as 
an economic downturn in the form of a recession could result in a large percentage of subprime 
mortgage borrowers missing their mortgage payments and even defaulting on their home loans.
Major Participants in the Secondary Mortgage Markets
As previously discussed, banks and other fi nancial institutions originate mortgage loans and 
sometimes package mortgages to create mortgage-backed securities that often are sold in the 
secondary mortgage markets. Also, recall that the federal government has played an active 
role in the development of secondary mortgage markets. The Federal National Mortgage 
Association (Fannie Mae) was created in 1938 to support the fi nancial markets by purchas-
ing home mortgages from banks so that the resulting funds could be lent to other borrowers. 
The Government National Mortgage Association (Ginnie Mae) was created in 1968. 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 to purchase and hold mortgage loans. Freddie Mac acquired 
both prime mortgages and subprime mortgages over time. 
Ginnie Mae and Fannie Mae issue mortgage-backed securities to fund their mortgage 
purchases and holdings. The securitization of mortgage loans by pooling and packaging the 
loans into mortgage-backed securities by Ginnie Mae and Fannie Mae aided in the develop-
ment of the secondary mortgage markets. 
As default rates on mortgage loans and mortgage-backed securities increased sharply after 
the housing price bubble burst, both Ginnie Mae and Freddie Mac suff ered liquidity problems. 
In mid-2008, in an eff ort to avoid a fi nancial meltdown, the Fed provided rescue funds for both 
Ginnie Mae and Freddie Mac, and the federal government took over control of both organizations.