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rate spreads. The authors find (1) portfolio pur- chases have a greater role in reducing mortgage rates than securitization activities; (2) purchases and securitizations lower mortgage rates for con- forming and non-conforming borrowers alike; and (3) portfolio purchases of the GSEs reduce the volatility of mortgage rates.

Richard Roll, “Benefits to Homeowners from Mortgage Portfolios Retained by Fannie Mae and Freddie Mac” (2003). Professor Roll presents a nontechnical discussion of the benefits of federal support to Freddie Mac and Fannie Mae MBS. He then describes the contributions of the retained portfolios of the GSEs. His discus- sion emphasizes the complexity of investing in mortgages, either through whole loans or MBS, and clearly describes how the portfolio opera- tions expand the range of investors in mortgage related assets. He concludes that foreign capital that would otherwise not invest in the American mortgage market is channeled into that market through the GSEs’ retained portfolios.

Systemic Risk and the Retained Portfolio

CapAnalysis Group, “OFHEO Risk-Based Capital Stress Test Applied to U.S. Thrift Industry” (2003). The authors of this study simulate the thrift industry and apply to it the risk- based capital (RBC) stress test recently promul- gated by OFHEO to apply to the GSEs. They find that the thrift industry is more likely to fail under the RBC test than under the capital-to-asset ratio test traditionally favored by financial regulators. This suggests that the RBC test applied to the GSEs is quite stringent (especially in view of their extensive hedging) and that calls to replace it with a more traditional capital-to-asset ratio test are not sound.

Revisiting the Net Benefits of Freddie Mac and Fannie Mae

Yan Chang, Douglas A. McManus, and Buchi Ramagopal, “Does Mortgage Hedging Raise Long-Term Interest Rate Volatility?” (2005). In response to Perli and Sack’s (2003) finding that hedging strategies employed by the GSEs increase long-term inter- est-rate volatility, the researchers find that drop- ping outlier events —namely the LTCM crises and the tragedy of September 11, 2001—generates estimates that suggest little relationship, or even an inverse relationship, between hedging and market volatility.

Christopher L. Culp, “Demystifying Derivatives in Mortgage Markets and Fannie Mae,” (2003). Dr. Culp describes the derivatives used by Fannie Mae and addresses the arguments that the scale of the GSEs’ partici- pation in key derivatives markets poses systemic risk. He concludes that Fannie Mae’s manage- ment of credit risk in the derivatives markets is sound and that the size of its positions is not so large that a failure by Fannie Mae would bring down the rest of the market.

Federal Reserve Board of Governors and the Federal Reserve Bank of New York, “Concentration and Risk in the OTC Market for U.S. Dollar Interest Rate Options” (2005). This report analyzes the risks associated with OTC markets for US dollar interest-rate options on market participants, namely the GSEs and derivative dealers. Potential risks to the GSEs stem from dealer concentration in this market, such that a sudden exit of a leading dealer could diminish market liquidity in the options market. In addition, the report investigates the effect of a GSE or dealer failure on counterparty credit losses. After interviewing staff at the GSEs and leading OTC dealers, the authors conclude that

Appendix: Recent Literature



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