Revisiting the Net Benefits of Freddie Mac and Fannie Mae
Risks of GSE Retained Portfolios
Critics of the GSEs, such as former Federal Reserve Chairman Alan Greenspan, Treasury Secretary John Snow, and some academics,27 call for limiting the GSEs’ retained portfolios. They argue that the GSEs’ large portfolios provide minimal benefits to homeowners and subject the Treasury to risk that is not present in the GSEs’ securitization activities. Moreover, they maintain that the size of the portfolios and the complexity of their management introduce systemic risk—the risk that loss of confidence in, or failure of, one entity would spread to others, reducing or pos- sibly creating a collapse in financial liquidity and undermining economic activity generally.28 These critics recommend that the GSEs’ portfolios be curtailed or even eliminated.
The proponents of portfolio restrictions overstate the risks and understate the benefits of the re- tained portfolio. They tend to discount the effec- tiveness and stringency of the capital standards and regulatory structure that govern the GSEs. Whereas the major depository institutions are regulated and examined by the Federal Deposit Insurance Corporation and/or one of the other federal or state banking agencies, the GSEs are regulated for safety and soundness purposes by the Office of Federal Housing Enterprise Over- sight (OFHEO), a separate office within HUD, sub- stantially independent of the HUD secretary. The regulatory framework includes minimum and risk-based capital standards, safety and sound- ness supervision, and periodic examination by
OFHEO. The GSEs are also separately regulated for their adherence to their housing mission by HUD. As discussed below, some prominent economists have reviewed the capital standard and its associated stress test and concluded that compliance with them implies a low likelihood of GSE default.
Imposing limits legislatively without regard to a financial institution’s risk management and control capabilities tends to limit competition and may increases mortgage rates, which leads to a de- crease in the liquidity and the affordability of credit in the mortgage market. Because, the regulatory framework for the GSEs is relatively new com- pared with that of the depositories, its adequacy, at times, has been called into question. Nonethe- less, without legislatively defined rules, OFHEO has required both GSEs to hold surpluses and, more recently, imposed portfolio growth limits on Fannie Mae. Nevertheless, as with other regula- tors and regulated institutions, the performance of OFHEO and the system in which the GSEs operate should be monitored continually and improved as appropriate.
Given the regulatory structure of Freddie Mac and Fannie Mae, exactly how and why the GSE portfolios might pose a high level of systemic risk is not clear from the available studies. Systemic risk has been a topic of research for only the past 25 years or so. Surveys of the literature, which focuses mainly on banking, find that there is no consensus of the causes of systemic risk. For example, George Kauffman wrote, “Although
See, for example, Dwight M. Jaffe (2005) and John M. Quigley (2006).
The Bank for International Settlements defines systemic risk as: “the risk that the failure of one participant in a transfer system, or in financial markets generally, to meet its required obligations will cause other participants or financial institutions to be unable to meet their obligations (including settlement obligations in a transfer system) when due.” Committee on Payment and Settlement Systems (CPSS) Glossary (2003), 48.
The Policy Debate Over GSE Activities