A secondary mortgage market permits mortgage originators to be more responsive to dynamic mortgage demand and to lower mortgage rates for some homeowners when mortgage demand is higher. According to Koppell (2001): Government-sponsored enterprises (GSEs) are hybrids -- part public, part private -- that affect the lives of most Americans. Anyone who has borrowed money to purchase a home, farm, or pay for college, or invested in a mutual fund has likely been touched by government-sponsored enterprises. Fannie Mae and Freddie Mac are public in several respects. Created by Congress to serve public purposes, they are exempt from state and local taxes, exempt from registration requirements of the Securities and Exchange Commission, and have a $2.25 billion line of credit with the United States Treasury. They are not, however, subject to regulations that govern the activities of federal agencies. Their staffs are not considered government employees. (p. 468)

When Congress created the GSE charters, they provided the GSEs with a variety of special benefits. Initially, many viewed these benefits as a way to enhance the GSEs' efforts in establishing a secondary mortgage market; however, with the secondary mortgage market well established and with many other well-functioning purely private secondary markets, the justification for the GSEs' benefits has shifted to the GSEs' success in lowering mortgage rates and in encouraging affordable housing (Geisst, 1990). Likewise, Koppell (2001) points out that Fannie Mae and Freddie Mac, known formally as the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, respectively, are stockholder-owned, profit-seeking corporations that were originally created by Congress to help address America's housing needs; GSEs are one type of mixed organization that combines characteristics of public- and private-sector entities.

While these funding avenues are increasingly popular at the local, state, and national levels of government, hybrids such as GSEs have received less attention. The GSEs benefit from the government-sponsored status because purchasers of their debt assume that the government will not allow the GSEs to fail, even though the government has made no explicit promise to bail out the GSEs should problems arise. This ambiguous government relationship creates an implicit government subsidy to the GSEs that is worth billions of dollars (Burgess, Passmore & Sherlund, 2005).

Congress created the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), with the goal of providing banks, thrifts and other mortgage originators with a liquid secondary market that would provide an alternative to funding mortgages with deposits. A secondary mortgage market allows mortgage originators to respond more quickly to fluctuating mortgage demand and to lower mortgage rates for some homeowners when mortgage demand is high.

When Congress created the GSE charters, they provided the GSEs with a variety of special benefits. Initially, many viewed these benefits as a way to enhance the GSEs' efforts in establishing a secondary mortgage market; with the secondary mortgage market well established and with many other well-functioning purely private secondary markets, though, the justification for the GSEs' benefits has shifted to the GSEs' success in lowering mortgage rates and in encouraging affordable housing.

The GSEs benefit from the government-sponsored status because purchasers of their debt assume that the government will not allow the GSEs to fail, even though the government has made no explicit promise to bail out the GSEs should problems arise. This ambiguous government relationship creates an implicit government subsidy to the GSEs that is worth billions of dollars (Burgess, Passmore & Sherlund, 2005).

In his chapter, "Financing the Castle: The Mortgage Agencies," Geisst (1990) reports that, "Quality, single-family housing has become the most tangible element of the American dream, symbolizing freedom and space to grow. Spurred by the crowded conditions of nineteenth-century Europe, new immigrants placed housing high on their list of priorities and considered it the epitome of what their adopted country had to offer. Over the years, many individuals have continued to place the individual castle at the top of their list of material needs. Perhaps no other single material goal has come to symbolize the American dream so succinctly. As a result, housing has become one of the United States' most vital industries and statistics related to it are closely watched signs indicating the health of the economy" (p. 83).

The story of housing is more complicated than simply building upon a dream and a hope, though. There are some important factors involved that should be taken...

For example, the availability of credit, the term structure of interest rates, the ability of mortgage-granting institutions to cope with economic conditions, and the individual's ability to service his or her mortgage debt all must be factored into the general discussion so that the peculiarly American method of funding mortgages since the mid-1930s can be properly understood (Geisst, 1990).
In addition, beyond these standard factors that affect mortgage markets anywhere in the United States, the mortgage industry in America also enjoys a unique level of assistance from the federal government. This assistance is offered through the vehicle known as the "agency" function, whereby a government-created agency intervenes in the marketplace in order to provide liquidity to the lenders of mortgage money. While this function may appear simple, it is in fact a complicated process that has come to be repeated many times in twentieth-century U.S. financial history. The soundness of the concept also proved itself internationally beginning in the 1950s, when it became the model for many international development agencies. The concept of agency financing is American for all intents and purposes although it was quickly recognized that the same function that provided liquidity for the mortgage market could also be redefined to help provide funds for Third and Fourth World development.

The development of mortgage agencies originally occurred, and has remained, at the wholesale level of mortgage funding. The agencies that have been created since the mid-1930s have operated between mortgage grantor, or "originator" in financial parlance, and the capital markets. On the retail, or individual, level mortgage borrowing has remained a private transaction between the individual and the banking institution. How and why banking institutions involve the agencies in the mortgage process involves both the fulfillment of a commitment as well as a response to monetary conditions, which sometimes can prove pernicious to the market as a whole (Geisst, 1990).

Despite the growing presence of agencies through the middle part of this century, housing finance has remained in the private sector. Individuals have sought mortgages from the traditional sources of funds: commercial banks and especially savings and loan associations or savings banks. Thrift institutions have been integrally involved in mortgage lending since the nineteenth century and have in recent years suffered most because of their limited nature as depository/lending institutions dedicated almost solely to redirecting savers' funds into the housing market. Their plight over the years helped prompt the banking legislation of the early 1980s designed to help them cope with the interest rate effects of restrictive monetary policies and the subsequent damage caused to the expansion of the housing market as a whole (Geisst, 1990).

In the nineteenth century, depository institutions that were dedicated to granting mortgage loans only were called building associations. The first was established in Philadelphia in 1831 and was called the Oxford Provident Building Association. The nomenclature used was English in origin, and U.S. building associations were modeled after the English building societies developed about 50 years earlier. The English institutions and their U.S. counterparts were organized as mutual societies; that is, the institutions were owned by depositors. They were not capitalized by the sale of stock and thus there were no public shareholders as such. The current capital structure of U.S. savings and loan associations still reflects this original model. In the mid1980s, about 80% of all S & Ls were still operating as mutual societies (Geisst, 1990).

The ownership of thrifts is not as important as are the organizational problems they pose for the housing market as a whole. Being mutual means that thrifts were, and still for the most part are, local institutions whose influence does not extend beyond the geographical area in which they operate. On the negative side, this means that mortgage lending is primarily local in nature, subject to a lack of standardization in lending rates. On the positive side, it suggests that credit analysis of potential homebuyers should be left to indigenous institutions that know the local market best. (Geisst, 1990, p. 84).

During the period that ultimately resulted in the stock market crash of 1929 and the major depression that followed, thrift institutions and banks became the primary sources of mortgage money. Loans made were booked as assets by the lending institution and remained on the books until final payment was made. But out of the financial turmoil of the 1930s rose myriad new financial institutions designed to provide a…