FANNIE MAE and Freddie Mac have long occupied a unique place within the US financial system, trading as publicly listed companies with what investors perceived was an implicit guarantee from the treasury department.
Both companies have a government charter to increase the amount of affordable housing in the US and their activities and regulation have long been a major point of debate in Congress.
Fannie - the Federal National Mortgage Association - was created in 1938 to help the housing market during the Great Depression.
In 1968, Fannie was given a new charter by Congress and became a publicly traded company that could seek funding from the private sector.
In 1970 Congress created Freddie Mac - the Federal Home Loan Mortgage Corporation - as a competitor for Fannie, and over the ensuing three decades, these so-called government sponsored enterprises (GSEs) grew rapidly.
Between them, they hold outstanding debt of $1,600 billion (€1,007 billion) and have debt and guarantees on mortgages in the region of $5,000 billion. That compares with the US treasury market of $4,500 billion.
They are also big users of interest rate derivatives in order to protect their portfolios against large changes in market rates.
The GSEs hold $2,300 billion in notional derivative contracts with the banking system.
Their business model involves the sale of debt, a mixture of short-term notes and long-dated bonds, to investors, and using the proceeds to purchase mortgages.
As both have a $2.5 billion line of credit with the US treasury, investors have long considered them to have the implicit backing of the federal government.
They also hold triple-A credit ratings, and this enables them to issue debt at cheaper levels than the yield on the mortgages they buy.
Their sheer size, however, has long been seen as constituting a systemic threat for the financial system, as their core capital represents around 1.5 per cent of their $5,000 billion in total debt exposure. This degree of leverage places both GSEs in a precarious capital position, as the housing market continues to deteriorate and foreclosure rates keep rising.
In 2004, both companies were caught in an accounting scandal over their use of derivatives and were compelled to reduce the size of their mortgage assets.
As the housing market has declined over the past year, the GSEs received permission this year to buy more mortgages. Their capital constraints were also relaxed as Congress sought to use them to shore up the mortgage market.
Both companies have reported hefty losses in recent quarters, hurt by the adverse housing market and losses from derivatives. That has forced them to raise more capital, but their overall capital position still remains very low. The stock prices for both companies have plunged this year as investors expect further capital raising, which will dilute their equity value.
In turn, the expectation among investors that they are "too big to fail" reassures bondholders of GSE debt that any government rescue would emphasise the mortgage and agency debt guarantee.
