Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Government Sponsored Enterprise (GSE)

What it is:

In the US, government sponsored enterprises, or GSEs, are quasi-governmental, privately-held entities established to improve, and at times make possible, the flow of credit to specific sectors of the economy or to otherwise provide essential services to the public.  GSEs are established by Congress.

How it works (Example):

Government sponsored enterprises have been established in key areas of the economy.  For example in the housing sector, Congress created the Federal Home Loan Bank in 1932, to act as a wholesale bank providing support for housing mortgages issued by private banks.  Today, the network of 12 Federal Home Loan Banks provides loans to local banks at preferred interbank lending rates to enhance commercial and mortgage bank liquidity.  In education, Congress established the Student Loan Marketing Association, known as Sallie Mae, to guarantee student loans issued by local financial institutions.   The Federal National Mortgage Association, known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, known as Freddie Mac, provide guarantees and low cost credit that allow housing loans.

None of these GSEs directly lend money to the public.  Instead, they provide capital market liquidity by guaranteeing third-party loans, purchasing loans in the secondary market, and providing loans to financial institutions.  As for-profit financial entities, they issue stock as well as short and long term debt, and collect fees for their financing services.   While GSEs are not "subsidized," their implied federal guarantee allows them to trade more competitively than strictly private securities. 

Why it Matters:

While GSEs are privately held corporations, they have the implicit backing of the US Government.  However, they do not carry government guarantees, and as a result, they trade competitively in the capital markets.
 
Since GSEs aggregate loans in the secondary markets and have come to dominate the securitized mortgage industry through selling their securities in global financial markets, GSEs are the largest financial institutions in the US.
  
Problems in the market faced by Freddie Mac and Fannie Mae, two of the largest GSEs, were a result of the 2008 subprime lending crisis. This has led to unprecedented disruptions in the capital markets as well as spillover effects worldwide and the subsequent Federal government interventions to exercise its rights to take control of the management and their assets.