Revisiting the Net Benefits of Freddie Mac and Fannie Mae
service them—makes MBS much more attractive for investors to hold in their portfolios.17
This transformation has two effects. First, it broadens the investor base for mortgage-related assets. An investor no longer needs to be able to evaluate default risk, as this risk is very remote and similar from one security to another. Because the securities are relatively homogeneous, they are more liquid than a pool of unsecuritized loans, and the greater liquidity increases their appeal to investors. Second, the transformation can make other policies that support the mortgage market more effective.
Former U.S. Congressional Budget Office (CBO) Director Rudolph Penner and William Silber (1973) made this point over 30 years ago, draw- ing the distinction between “wedge-type” policies that directly subsidize interest rates and policies that change the characteristics of mortgages. They noted that the latter category can improve the effectiveness of the former by making mort- gages a better substitute for other fixed-income assets. For example, securitization of FHA and VA loans by Ginnie Mae increases the effective- ness of the assistance to the particular classes of borrowers that these programs support. Similarly,
securitization of conventional loans increases the effectiveness of support to the mortgage market provided by the current insurance and regulatory regime for depositories, which combines access to insured deposits (at subsidized insurance premiums) with risk-based capital standards that favor mortgages and mortgage securities.
The GSEs’ management of portfolios of mort- gages and mortgage securities supplement the benefits generated from their guarantee business- es. By standing ready to buy their securities at any time, the GSEs increase the liquidity of their outstanding MBS. In addition, portfolio operations can transform mortgages into securities that may appeal to investors who are unable to hedge the prepayment risk carried by MBS. By funding their portfolios with debt that has either no call option or a call option that is more predictable than the prepayment behavior of individual homeowners, the GSEs transform mortgages into securities that are even more substitutable for other invest- ment-grade assets (such as bonds) than MBS.
Black, Garbade, and Silber (1981) provide a good discussion of these points in their description of how Ginnie Mae securitization adds liquidity to FHA-insured loans that already carry federal backing.
Today’s Mortgage Markets