Wiki:

Fannie Mae (and Freddie Mac) buy loans from mortgage originators, such as banks and non-bank mortgage firms. It repackages the loans, as mortgage backed securities, and sells them on the secondary mortgage market, with a guarantee that the interest and principal will be paid, whether or not the original borrower pays. Also, Fannie Mae may hold the purchased mortgages for its own portfolio. By purchasing the mortgages, Fannie Mae and Freddie Mac provide banks and other financial institutions with fresh money to make new loans. This gives the United States housing and credit markets flexibility and liquidity.

In order for Fannie Mae to provide its guarantee to mortgage backed securities it issues, it sets the guidelines for the loans that it will accept for purchase, called "conforming" loans. Mortgages that don't follow the guidelines are called "non-conforming"; typically the secondary market for non-conforming loans deals in mortgages larger (termed "jumbo") than the maximum mortgage that Fannie Mae and Freddie Mac will purchase.

This was not written by me:
"I have worked in the mortgage industry for many years and have personally witnessed the contributions that Fannie and Freddie have made to the current mortgage crisis. Their automated underwriting systems (AUSs) have encouraged lenders to throw common sense out the window. Lenders feed info into the AUSs and as long as the loan receives a robotic stamp of approval, it gets pushed through, often without requiring sufficient documentation to substantiate the info that was used to arrive at the automated decision. That is simply asking for trouble!"