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Revisiting the Net Benefits of Freddie Mac and Fannie Mae

Loans exactly at the limit represent borrowers who, in the absence of support by the GSEs, would have taken out larger loans on less favor- able terms. Because GSE activities improve terms on conforming loans relative to those on noncon- forming loans, some borrowers adjust the size of their loans to take advantage of this benefit. Thus, the level of concentration reflects a marketplace response to the improvement in loan terms generated from the activities of the GSEs.

Increasing Macroeconomic Stability

The GSEs contribute to stability in the U.S. economy by reducing cyclical fluctuations in the housing market. Historically, home building and mortgage lending have varied pro-cyclically— rising when the economy expands and falling when it contracts. The consequent cyclical vari- ability of home sales and home values adds to fluctuations in income and employment over the business cycle.

Recent research suggests that the GSEs have helped reduce temporal variation in housing prices and thus variations in the economy overall. They accomplish this partly by stabilizing the flow of funds through mortgage markets and partly by supporting fixed-rate mortgage lending. Analyses addressing these issues fall into two groups: (1) studies of the relationship over time between the GSEs’ activities and mortgage market variables, and (2) international comparisons relating the institutional characteristics of mortgage finance in a country to the volatility of mortgage flows and home prices in that country.

Among the major studies of the U.S. mort- gage market, one presented informal statistical comparisons while others use formal statistical

techniques. Joe Peek and James Wilcox (2004) presented an informal analysis of mortgage flows and economic fluctuations. They find that out- standing residential mortgage balances in the U.S. have become less pro-cyclical since the 1970s. In addition, Peek and Wilcox found that total intermediation (the GSEs’ holdings of MBS and mortgages in portfolio) increased during recessions. This counter-cyclical behavior offsets declines in mortgage holdings of banks and other mortgage investors during recessions. Thus, the growth of the secondary mortgage market combined with the counter-cyclical behavior of the GSEs, has likely dampened the amount of cyclical fluctuation in funds flowing into mortgage markets.

Peek and Wilcox (2006) also provided some formal statistical evidence in a subsequent study that examines the sensitivity of aggregate U.S. expenditures on home construction to fluctua- tions in mortgage interest rates and aggregate income. They found that as the secondary mortgage market grew in size between 1988 and 2004, aggregate expenditures on housing became less sensitive to fluctuations in income and mortgage rates.

The Peek-Wilcox result is consistent with find- ings by Calvin Schnure (2005), who analyzed the ability of aggregate income, unemployment, and inflation to explain indexes of home prices between 1978 and 2004. Schnure found that the relationships between home prices and these factors varied over the period, and that devia- tions between actual prices and levels that would be expected given income, unemployment, and inflation were smaller after 1989, when mortgage securitization was well-developed, than before 1989. He also found that the deviations became smaller as the share of mortgages in MBS grew



The Freddie Mac and Fannie Mae Contributions to National Goals

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