27/12/2019 Government-Sponsored Enterprise (GSE) Definition

ECONOMY GOVERNMENT & POLICY

Government-Sponsored Enterprise
Definition
By TROY SEGAL | Updated Apr 30, 2019

What Is a Government-Sponsored Enterprise?

A government-sponsored enterprise is a quasi-governmental entity established to enhance
the flow of credit to specific sectors of the American economy. Created by acts of Congress,
these agencies, though privately held, provide public financial services. GSEs help to
facilitate borrowing for all sorts of individuals, from students to farmers to homeowners.

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For example, the agency Federal Home Loan Mortgage Corporation (Freddie Mac) was
originally created as a GSE in the housing sector to encourage homeownership among the
middle class and working class. Other mortgage GSEs, as they are called, include Federal
National Mortgage Association (Fannie Mae) and Government National Mortgage Association
(Ginnie Mae), which were introduced to improve the flow of credit in the housing market,
while also reducing the cost of that credit.

How a Government-Sponsored Enterprise Works

Government-sponsored enterprises do not lend money to the public directly. Instead, they
guarantee third-party loans and purchase loans in the secondary market, thereby providing
money to lenders and financial institutions.
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GSEs also issue short- and long-term bonds referred to as agency bonds. The degree to
which an agency bond issuer is considered independent of the federal government impacts
the level of its default risk. Bond investors holding most but not all types of agency bonds
have their interest payments exempt from state and local taxes.

Although GSE bonds carry the implicit backing of the U.S. government, they are not direct
obligations of it, unlike Treasury bonds. For this reason, these securities will offer a slightly
higher yield than Treasuries, since they have somewhat if slightly, higher credit risk and
default risk.

KEY TAKEAWAYS
A government-sponsored enterprise (GSE) is a quasi-governmental entity
established to enhance the flow of credit to specific sectors of the American
economy.
Government-sponsored enterprises do not lend money to the public directly;
instead, they guarantee third-party loans and purchase loans in the secondary
market, ensuring liquidity.
GSEs also issue short- and long-term bonds (agency bonds) that carry the implicit
backing of the U.S. government, for example with the case of mortgage issuers
Fannie Mae and Freddie Mac.

The History of Government-Sponsored Enterprises

The first GSE created was in the farming sector with the inception of Farm Credit System
(FCS) in 1916. The Farm Credit System is a network of federally chartered borrower-owned
lending institutions tasked with providing an accessible source of credit to farmers, ranchers,
and others involved in agriculture.

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The FCS gets its huge funding capital from the Federal Farm Credit Banks Funding
Corporation, which sells bonds on securities markets. Another farming GSE, Federal
Agricultural Mortgage Association (Farmer Mac), was created in 1988 and guarantees the
timely repayment of principal and interest to agricultural bond investors.

To stimulate the housing segment, in 1932, the government established the Federal Home
Loan Banks (FHLB) which is owned by over 8,000 community financial institutions. Fannie
Mae, Ginnie Mae, and Freddie Mac were later chartered in 1938, 1968, and 1970, respectively.
The housing GSEs purchase mortgages from lenders on the secondary mortgage markets.
The proceeds from the sale are used by lenders to provide more credit to borrowers or
mortgagors.

SLM Corporation (Sallie Mae) was set up in 1972 to target the education sector. The
establishment originally serviced and collected federal student loans on behalf of the
Department of Education. It ended its ties to the government in 2004 and now offers student
loans privately, along with advice on financing higher education and federal loan programs.

Economic Importance of the Government-Sponsored Enterprise

Their aggregate loans in the secondary market make GSEs the largest financial institutions in
the U.S. A collapse of even one GSE could lead to a downward spiral in the markets, which
could lead to an economic disaster. Since they have an implicit guarantee from the
government that they will not be allowed to fail, GSEs are considered by critics to be stealth
recipients of corporate welfare.

In fact, following the 2008 subprime mortgage crisis, Fannie Mae and Freddie Mac received
$187 billion worth of federal assistance almost immediately to mitigate the negative impact
that the wave of defaults was wrecking on the housing market and the national economy.
They were also placed into government conservatorship. Both agencies have repaid their
respective bailouts since then, though they remain under the control by the Federal Housing
Finance Agency.

Related Terms
House Price Index (HPI) Definition
The House Price Index (HPI) is a broad measure of the movement of single-family house prices in the
United States. more

Agency Security

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An agency security is a low-risk debt obligation that is issued by a U.S. government-sponsored

enterprise (GSE) or other federally related entity. more

Freddie Mac - Federal Home Loan Mortgage Corp – FHLMC

Freddie Mac (Federal Home Loan Mortgage Corp, or FHLMC) is a stockholder-owned, government-
sponsored enterprise (GSE) chartered by Congress in 1970 to keep money flowing to mortgage lenders
in support of homeownership and rental housing for middle-income Americans. more

Agency Debentures
Agency debentures are debt issued by either a federal agency or a government-sponsored enterprise
(GSE) for financing purposes. more

Federal Agricultural Mortgage Corporation (FAMC)

Farmer Mac, the Federal Agricultural Mortgage Corporation, was founded by and act of Congress in
1988. more

Office Fed. Housing Enterprise Oversight (OFHEO)

The Office of Federal Housing Enterprise Oversight (OFHEO) was a federal agency that oversaw
Freddie Mac and Fannie Mae from 1992- 2008. more

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