What Is A Government-Sponsored Enterprise (GSE)?
Sa El3 minute read
December 10, 2020
Believe it or not, if you live in the U.S., you probably already have some sort of relationship with a government-sponsored enterprise (GSE).
However, when you try to understand better how they work, the jargon can confuse you and make something simple seem very complicated.
In this post, I will give you the answers in plain English as to a GSE government-sponsored enterprise is and how it works.
What Does A Government-Sponsored Enterprise (GSE) Do?
A government-sponsored enterprise (GSE) is a quasi-governmental, privately held agency established by Congress to improve credit flow in some regions of the United States' economy.
A GSE provides financial services to the public for various things, particularly mortgages, through capital market liquidity.
Now, to give it to you in plain English, a government sponsored enterprise is a company that's supported by the government but ran privately to help improve specific areas of the U.S. economy.They do this by guaranteeing to purchase a specific type and amount of loans and then selling them as mortgage-backed securities to investors in the secondary market to boost capital flow in the real estate market.
Think of it like this, if a lender only had enough money to fund 30 mortgages at $100,000 who all had a 30-year term, they would have to wait 30 years before they could offer additional $100,000 mortgages.
To avoid this issue, the GSE's will purchase loans from third-party lenders, giving them more cash flow to lend.
Below we will review some examples of how they work in different sectors.
How GSEs Work With Mortgages
In 1932 the Federal Home Loan Bank (FHLB) system was created by Congress as a GSE for the mortgage industry with the primary purpose of stimulating the housing market.
Now, here’s how it works:
Fannie Mae and Freddie Mac don’t actually issue you a loan; instead, they provide loan purchasing guarantees to third-party lenders, which allow the lenders more flexibility to lend.
It also makes it easier for the borrower to get approved because loans that are guaranteed by Fannie Mae and Freddie Mac usually have a lower down payment requirement and a lower credit score requirement.
Thus, increasing the number of homes purchased and increasing money flow in the real estate industry.
GSE Bonds Vs. Treasury Bonds
When it comes to the mortgage bond market, both private companies and the Treasury can issue bonds; however, there are some differences.
One of the significant differences between a GSE Bond and a Treasury Bond is that GSEs are not backed by the full faith and credit of the U.S. government, while U.S. Treasury bonds are.
Now, full faith and credit means that the government is pledged to pay interest and principal back to the investor when the bond matures.
GSE bonds will have both credit risk and default risk, and the yield on these bonds is usually a bit higher than with a U.S. Treasury bond.
List Of Government-Sponsored Enterprises
While this article's focus was primarily on mortgage GSEs, other industries receive assistance through government sponsored enterprises.
We have discussed the below companies a bit above already, but for mortgage GSEs you have:
- Federal Home Loan Banks: Founded in 1932 and made up of various banks and lenders, the Federal Home Loan Banks were the first mortgage-based GSEs. The Federal Home Loan Banks system is the only GSE that can directly issue mortgages.
- Fannie Mae: The Federal National Mortgage Association (Fannie Mae) was founded in 1938 and provides mortgage funding by buying them from large commercial banks to sell to investors.
- Freddie Mac: The Federal Home Loan Mortgage Corporation (Freddie Mac) was founded in 1970 and is similar to Fannie Mae, except that it purchases mortgages from smaller banks and lenders.
Student Loan GSEs
- Sallie Mae: The Student Loan Marketing Association formerly collected student loans on behalf of the U.S. Department of Education, but since 2004 has been an entirely private student loan servicer.
- Farm Credit System: The first GSE, created in 1916, provided credit for farmers and ranchers to support the country’s agriculture. It is made up of a network of cooperating lenders and associations.
- Farmer Mac: The Federal Agricultural Mortgage Corporation, or Farmer Mac, was established by Congress in 1987 and guarantees repayment to agricultural investors.
Without government sponsored enterprises in the mortgage space, it would be super hard to buy a home; especially if you had a low income or a low credit score.
Because of GSEs and mortgage investors, the U.S. economy can have a mortgage market that has access to liquidity and stability at all times.
If you don’t know how mortgage investors work, you should read up because without these investors purchasing these loans on the secondary market, cash flow could dry up fast.
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