What Is A Government-Sponsored Enterprise (GSE)?

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).

In this article, we’ll define government-sponsored enterprises, and we’ll tell you how they work.

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.

They provide financial services to the public for various things, particularly mortgages, through capital market liquidity.

A government-sponsored enterprise is a company that’s supported by the government to help improve specific areas of the U.S. economy, but run privately. They do this by guaranteeing to purchase a specific type and number 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 that 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, a GSE purchases loans from third-party lenders, therefore giving them more cash flow to lend.

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.

The most notable GSEs in the mortgage industry today are Fannie Mae and Freddie Mac.

How Do GSE Mortgage Loans Work?

GSEs like Fannie Mae and Freddie Mac don’t actually issue you a mortgage loan directly. Instead, they provide third-party loans and purchasing guarantees in the secondary mortgage market, which provides lenders more flexibility and money 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, a lower credit score requirement and a better interest rate.

GSEs therefore increase the number of homes purchased and increase money flowing in the real estate industry.

GSE Bonds Vs. Treasury Bonds

When it comes to the mortgage bond market, both private companies and the U.S. 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.

Full faith and credit means that the government has 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.

While this article's focus is primarily on mortgage GSEs, other industries receive assistance through government sponsored enterprises. Let’s take a look at these industries and their GSEs.

Mortgage GSEs

We’ve discussed the below companies a bit already, but for mortgage GSEs, there are:

• 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.
• Federal National Mortgage Association (FNMA or Fannie Mae): This GSE was founded in 1938 and provides mortgage funding by buying them from large commercial banks to sell to investors.
• Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac): This GSE 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.

Agricultural GSEs

• Farm Credit System: The first GSE, created in 1916, provided credit for farmers and ranchers to support the country’s agriculture. It’s made up of a network of cooperating lenders and associations.
• Federal Agricultural Mortgage Corporation (FAMC or Farmer Mac): This GSE was established by Congress in 1987 and guarantees repayment to agricultural investors.

Without government-sponsored enterprises in the mortgage space, it would be really 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 has a mortgage market that has access to liquidity and stability at all times.

To better understand how mortgages are bought and sold, learn more about the secondary mortgage market and how it affects homeowners.