Final answer:
Fannie Mae resolved the 'difficult to evaluate' problem by pooling mortgages to create pass-through securities, servicing them to ensure a steady cash flow, and requiring government-insured loans to ensure the securities' quality, which helped create a more stable and predictable secondary mortgage market.
Step-by-step explanation:
In addressing the creation of a secondary mortgage market, Fannie Mae helped to standardize loans and improve the evaluation process by several means. The organization initially helped solve the "difficult to evaluate" problem by 1) pooling mortgages together and creating a new financial instrument called a mortgage pass-through, which simplified and standardized the investment product. 2) Functioning as the loan servicer, Fannie Mae further stabilized the investment by collecting the payments from various mortgages and passing them onto investors, thus creating a consistent and predictable stream of income. This process made the mortgage-backed securities more attractive and reduced the perceivable risk. Additionally, 3) by requiring that only government-insured or government-guaranteed mortgages (like those from the FHA or VA) were included in the mortgage pools, Fannie Mae mitigated the risk even further, assuring investors of the quality and reliability of the instruments they were purchasing.
Although not directly mentioned in the context of this specific question, another entity, Ginnie Mae, and later Freddie Mac were created to serve similar functions and diversify the market for these securities. The role of these government-sponsored enterprises became particularly significant as a way of mitigating and distributing mortgage risk across a broader set of financial institutions and investors. This move was fundamental in transforming the modern mortgage financing landscape.
However, in the lead-up to the financial crisis of 2008, the securitization process, housing market assumptions, and over-reliance on credit ratings led to a proliferation of mortgage-backed securities without proper oversight or evaluation of the inherent risks. These practices led to an accumulation of so-called "toxic assets" on the balance sheets of financial institutions when the housing market collapsed. Recognizing the severity of the situation, during Quantitative Easing (QE), the Federal Reserve stepped in to purchase these securities to stabilize the market and the financial system.