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Revisiting the Net Benefits of Freddie Mac and Fannie Mae

had securitized or held in their retained portfo- lios some 44 percent (in value terms) of all home loans outstanding and 47 percent of all conven- tional loans.15

Both GSEs are shareholder-owned, and their shares trade on the major exchanges.16 By law, the U.S. Treasury may purchase a limited amount of the GSEs’ securities, under terms and condi- tions imposed by the Treasury Secretary. More- over, federally chartered banks are able to use the GSEs’ securities in meeting reserve require- ments imposed by the Federal Reserve System (and members of the FHLB System can use GSE securities as well as whole loans to collateralize advances).

purchase mortgages, package them into securi- ties and sell the securities into the market with a GSE guarantee of timely principal and interest payments, and (2) managing a retained portfolio of whole residential loans and MBS funded by debt in the form of uncollateralized debentures. The portfolio business appeals to the segment of investors, particularly foreign ones, which prefer debt to MBS. By financing retained portfolios, investor purchases of Freddie Mac and Fannie Mae debt issuances provide an additional source of funds to the U.S. mortgage market. Both guar- antee and portfolio activities involve transforming mortgages into assets that are attractive to dis- tinct groups of investors. These transformations add value to the market.

The GSEs’ securities are AAA-rated, in part because of their federal charters. Unlike Ginnie Mae securities and federally insured deposits, however, Freddie Mac’s and Fannie Mae’s securi- ties do not carry an explicit federal guarantee. In fact, the GSEs are required by law to disclaim such a guarantee in their offerings of securities. As a result, although Freddie Mac and Fannie Mae securities trade at yields below those of securities issued by their fully private counter- parts, their yields are above comparable Treasury and Ginnie Mae yields.

The GSEs have two primary lines of business— (1) a guarantee business whereby the GSEs

Pooling loans into securities fundamentally changes the characteristics of mortgages from the standpoint of a secondary market participant. A portfolio of mortgages carries risks of default and prepayment, and requires expenditures to collect payments of principal and interest. In the absence of securitization, the degree of risk and the arrangements for servicing would vary from one portfolio to another. Such portfolios are traded infrequently, because each transac- tion requires research to establish loan quality and servicing costs. Pooling bundles of loans into securities, which have been credit enhanced by a GSE and which do not require investors to

15

Calculated by dividing the GSEs’ purchases held in portfolio or their securitized pools held by other investors by total single-family mortgage debt outstanding. GSE portfolio holdings are from monthly volume summaries for each of the companies ending December 31, 2005. Single-family mortgage debt outstanding is from the Federal Reserve Flow of Funds. Mortgage debt outstanding held by the GSEs in their retained portfolios represents 17 percent of mortgage debt outstanding for conventional single-family mortgages.

16

Under their charters, each company has up to 18 members on its Boards of Directors—up to 13 elected by shareholders and up to five appointed by the President.

Today’s Mortgage Markets

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