Revisiting the Net Benefits of Freddie Mac and Fannie Mae
larger. From this evidence, Schnure concluded that “The change in mortgage market structure from a system based on balance sheet lending by depositories to a market-based system of secu- ritized mortgage finance has capped the volatility of financing flows and real activity.”
David Miles (2003, 2004) conducted an in-depth study of the British mortgage market for the United Kingdom Treasury, and the staff of the International Monetary Fund (2004) investigated mortgage contracts within a larger study of home price appreciation around the world. Both studies found that the underlying structure of a country’s institutions for funding mortgages determines what type of mortgage contracts prevails. Countries relying heavily on depositories to fund mortgages tend to have more adjustable-rate and short-term mortgage loans, while countries with well-developed institutions facilitating investment and trading in mortgage-related securities tend to have more fixed-rate lending. The IMF study cites the U.S. as “the most obvious case” of the second type, with the existence of MBS and long-term funding of mortgages in general aided by the GSEs and their low cost of funds.
In their study of the broader effects of GSE activities, Naranjo and Toevs (2002) found a negative and statistically significant correlation between month-to-month changes in conforming mortgage rates and Fannie Mae purchases. In other words, Fannie Mae’s activities may reduce mortgage rate volatility. Their analysis included variables controlling for variation in liquidity, risks associated with prepayments, changes in interest rates, and borrower default. Their study, and a similar analysis by Gonzalez-Rivera (2001), pro- vided formal support for the patterns in summary statistics identified by Peek and Wilcox.
Studies by non-U.S. researchers also provide useful perspective on the contributions of the GSEs to the stability of the mortgage market. Of particular interest are two studies that focus on the role of fixed-rate mortgages in reducing fluctuations in home prices and in the overall economy. Most other developed countries rely more heavily on short-term or adjustable-rate mortgages than the United States, so it is valuable to compare the performance of mort- gage markets and economies across countries. These studies show that the U.S. institutional structure in general, and the GSEs in particular, contribute to a relatively stable environment in the United States.
The studies also note the positive relationship between the share of mortgage financing carrying long-term, fixed-rate contracts and the volatility of home prices and general economic activity. Miles analyzed the sensitivity of the British housing market and its economy to shocks in short-term interest rates and concluded that both would be more stable under a regime that supported more fixed-rate lending. The IMF analysis covered 18 countries and showed roughly a three percentage-point difference in home price volatility between countries with a very low incidence of fixed-rate mortgages and countries where fixed-rate mortgages predominate.48
Not all analysts agree that greater reliance on fixed-rate loans contributes to economic and financial stability. For example, Perli and Sack (2003) conclude that mortgage-related hedging has increased interest-rate volatility. Chang, McManus, and Ramagopal (2005) address this issue by focusing on volatility in derivative instruments used in hedging. They find an insignificant relationship between proxies for mortgage hedging and interest-rate volatility. They observe that the Perli-Sack result is very sensitive to the inclusion of a few extreme observations around the time of the collapse of Long Term Capital Management in 1998 and the terrorist attacks on September 11, 2001. Overall, they conclude that the evidence does not support the hypothesis that mortgage hedging has increased interest-rate volatility.
The Freddie Mac and Fannie Mae Contributions to National Goals