The term 'Government Sponsored Enterprise (GSE)' is included in the Banking edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Check for lowest price here...
A government sponsored enterprise is a financial service operations that the U.S. Congress created by law. Their purpose is to improve the amount of credit that flows into specific areas of the American economy. They were also intended to help those parts of the capital markets become more transparent and efficient as well as to lessen risks for investors and capital suppliers.
The wish of Congress in establishing them was to increase the available finance and lower the cost of obtaining it for certain specific segments of the economy. This was to be accomplished by encouraging investors via lowering the risks of losses to those involved.
The main components of the economy where these were set up were home finance, agriculture, and education. Among these, two of the government sponsored enterprises are best known. These are Fannie Mae, the Federal National Mortgage Association and Freddie Mac, the Federal Home Loan Mortgage Corporation.
The year 1916 saw the first government sponsored enterprise that Congress established. This was the Farm Credit System. Congress moved GSEs into housing finance in 1932 when it established the Federal Home Loan Banks. It focused on education costs and finance when in 1972 Congress chartered Sallie Mae. In 1995, Congress passed a law and permitted this educational GSE to give up its government sponsorship so that it could transform into a fully private company.
The segment of the economy for residential mortgages and borrowing proves to be substantially the largest industry where the government sponsored enterprises function. In mortgages, these GSEs own or pool around $5 trillion in home mortgages.
The way that Congress came up with to boost capital market efficiency and get past the imperfections of the market was to help funds migrate more effortlessly from fund suppliers to fund borrowers in major loan demand areas of the economy. They accomplished this with a type of government guarantee which limited the loss risks for those who offered the funds.
These government sponsored enterprises now mostly serve as intermediaries between agricultural and home borrowers and lenders. Freddie Mac and Fannie Mae remain the two best known and most influential GSEs today. They buy up mortgages and issue them through affiliated companies. Once this is accomplished, they pack them up as MBS mortgage backed securities. These securities come with the important financial backing from Freddie Mac or Fannie Mae. Investors allowed to trade in the TBA to be announced markets find these investments appealing when they carry government sponsored enterprises backing.
These housing GSEs also established a secondary market for loans with their guarantees, securitizing, and bonding. It has helped the main issuers of primary market mortgages to boost their volume of loans at the same time as they reduce the risks of single loans. It also gives investors a wide market of instruments which are securitized and standardized.
The government sponsored enterprise does not actually come with the government’s hard guarantee of their credit. Despite this, lenders have always given them better interest rates at the same time that investors in the securities have paid high prices. This stems from the government’s implicit guarantee that these critical organizations will not default or fail. It has helped the two main GSEs to save on borrowing costs to the tune of around $2 billion each year.
The subprime mortgage crisis and financial crisis reached a fevered pitch and embroiled Freddie Mac and Fannie Mae in 2007 and 2008. The American government demonstrated the value of the implicit guarantee then by bailing out and putting the two GSEs into conservatorship in September of 2008.