Revisiting the Net Benefits of Freddie Mac and Fannie Mae
history. Studies that do investigate these issues either generate estimates that are within the range noted above (Ambrose, LaCour-Little, and Sanders (2004), using data that include credit scores; and Flannery and Lockhart, who include variables for prepayment risk and other factors) or have narrow applicability (Ambrose, Buttimer, and Thibodeau (2001), who studied differences in home-price volatility among loans secured by homes in Dallas, Texas).
A second concern is whether the GSEs affect rates on jumbo loans as well as on conforming loans. If the GSEs reduce rates on jumbo loans, the estimated jumbo-conforming spread will understate their effect on conforming loan rates. We offered a theoretical basis for estimating an impact on jumbo loans in our 2001 report (Pearce and Miller, 12-13). Naranjo and Toevs (2002) find that GSE purchases and securitization activity re- duce rates on both jumbo and conforming loans.
A third concern is the effect of subsidies avail- able to other participants in the mortgage market, particularly depositories. The issue here is that the residential mortgage market receives multiple layers of federal support. Depositories are the principal non-GSE investors in mortgage-related assets, and they have access to insured depos- its—access that many economists regard as a funding advantage similar to that conferred on the GSEs by their federal charters.43 Added to that advantage is the option of membership in FHLB System, which provides low-cost advances, funded by debt issued by the System in the GSE market.
Thus, before Freddie Mac and Fannie Mae can even enter the mortgage market, they must reduce interest rates by some minimum amount to be competitive with the terms offered by depositories. This issue has received little attention in the literature, with a study by Anthony Sanders being a recent exception. Hypothesiz- ing a real estate investment trust (REIT) structure and adding rough estimates of the various costs of funding mortgages, Sanders (2005) concludes that 43 basis points should be added to the conventionally measured jumbo-conforming spread to arrive at the effect the GSEs have on conforming mortgage rates.
Our conclusions from this literature are that the jumbo-conforming spread averages between 24 and 30 basis points, and this range under- states the full effect of the GSEs on conforming mortgage interest rates. However, for those who would use the spread to forecast the change in interest rates if federal sponsorship were fully withdrawn from Freddie Mac and Fannie Mae, we add a precautionary note. Although estimates of the spread provide useful information on the effect of changes in certain parameters within the current regime of mortgage market institutions, they are much less useful in inferring the effect of major changes in the regime itself. For exam- ple, we would consider the spread to be a good estimate of the effect of reducing the conforming loan limit on interest rates for loans that would no longer be eligible for GSE purchase, but a poor estimate of the effect of complete withdrawal of federal sponsorship.44
Greenspan (2001) described federal deposit insurance, at the premiums generally charged, as a subsidy.
This point was made in the conclusion of Cotterman and Pearce (1996). An important concern here is whether the market would absorb a greatly expanded supply of subordinated tranches of private-label pools if federal sponsorship were withdrawn from Freddie Mac and Fannie Mae.
The Freddie Mac and Fannie Mae Contributions to National Goals