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Revisiting the Net Benefits of Freddie Mac and Fannie Mae

The Policy Debate Over GSE Activities

Over the past decade critics of Freddie Mac and Fannie Mae have focused on two issues. One is whether the GSEs continue to provide material benefits to homeowners. The other is whether their retained portfolios should be capped, cur- tailed, or eliminated because they pose significant risks to the financial system while providing little benefit to the housing market.

The first line of criticism maintains that the benefit the GSEs provide to the housing market, through both securitization and portfolio operations, is confined to their effect on mortgage interest rates. Critics argue that the savings the GSEs pass through to homeowners are small relative to the cost savings the GSEs receive by virtue of their federal sponsorship. The second line of criticism maintains that the GSEs’ retained port- folios of mortgages and mortgage securities are so large and contain such high levels of risk from changes in interest rates that they threaten the stability of the financial system. Critics argue that the retained portfolios have no effect on mortgage markets, while GSE capital is insufficient given their methods for managing interest rate risk.

In this section we discuss the assumptions and logic underlying these criticisms. We first focus on the claim that the only benefit of GSE activities is lower interest rates on conforming loans. We then turn to the risks and benefits associated with the retained portfolios.

The Residential Mortgage-backed Securities Market

Mortgage securitization was uncommon before 1970. It evolved in stages in the different segments of the mortgage market. The govern- ment-insured segment was the first to be heavily securitized, with Ginnie Mae securities carrying an explicit federal guarantee. By 1980, almost 80 percent of fixed-rate FHA-insured loans were securitized. The fixed-rate conforming, conventional segment became heavily securitized during the 1980s.18 Pooling of jumbo loans into securities did not become common until the early 1990s.19 Securities backed by jumbo loans are often termed “private-label” securities because they carry no association with Ginnie Mae or the GSEs.

The development of the private-label MBS market and of markets for securities backed by other retail credit products, such as auto loans, has led some observers to infer that firms with no government ties can provide the full benefits of GSE securitization. From there, it is only a short step to critics’ claims that Freddie Mac and Fannie Mae generate little benefit to mortgage borrowers.

Consequently, the critics’ argument rests on a single assumption—that eliminating the GSEs’ federal sponsorship would lead extricably, seamlessly, and quickly to a secondary market

18

Hendershott and Van Order (1989).

19

Cotterman and Pearce (1996).

The Policy Debate Over GSE Activities

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