Federal National Mortgage Association ( Freddie Mac )

1034 WordsDec 7, 20165 Pages
In 2008 two government sponsored enterprise (GSE), Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), received the second-largest bailout in the United States, totaling $187 billion. The bailout of Fannie Mae and Freddie Mac drew attention to the problems with "too big to fail" (TBTF) entities and government guarantees. The bailout highlighted the lack of market discipline and encouraged moral hazard. The erosion of the prerequisites of market discipline by GSEs creates moral hazard. According Tony Fiennes (2016), market discipline is the way in which market participants influence a financial institution to act in the best interest of shareholders, through monitoring its risk profile and financial position (Fiennes,1). Fiennes (2013) states that three conditions must be present for market discipline to exist and be effective. Market participants must have access to relevant information and have incentives to monitor corporations. Additionally, the market must have a competitive environment so that investors can decide on the best investment (Fiennes, 1). Moral hazard is the idea that, under certain circumstances, individuals will alter their behavior and take on more risk (Pettinger,1). This paper will examine how market discipline is destroyed in the mortgage industry by Fannie Mae 's and Freddie Mac 's “too big to fail” size and government backing. History of the U.S. Mortgage Industry To understand how
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