FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009
The US government placed Fannie Mae and Freddie Mac into conservatorship in September 2008. Which statement best explains why their failure was significant for the crisis?
Fannie Mae and Freddie Mac guaranteed or held a huge share of US mortgage credit with very thin capital and implicit government backing. Mounting mortgage losses threatened mortgage finance and the many banks and foreign investors holding their debt and MBS, so conservatorship was used to stabilize the market.
- AThey were the largest issuers of credit default swaps, and conservatorship voided those contracts
- BThey had guaranteed or held a very large share of US mortgage credit with thin capital, so losses threatened the mortgage market and holders of their debt and MBS worldwideCorrect
- CThey were commercial banks whose failure triggered an immediate run on insured deposits
- DThey were primarily subprime originators that had no government link, so their failure changed the rating of sovereign debt
Explanation
Fannie and Freddie guaranteed or held trillions of dollars of mortgage assets with very little capital relative to exposure and carried an implicit government backing. Rising mortgage losses eroded their capital, and their debt and MBS were widely held by banks and foreign investors. Conservatorship was used to stabilize mortgage funding and these holders.
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