Fed study questions benefits of Fannie, Freddie
By MortgageDaily.com staff
1/17/2005

A study by the Federal Reserve says Freddie Mac and Fannie Mae have "negligible" effects on reducing costs for mortgage borrowers.

The findings by Fed economists Andreas Lehnert, Wayne Passmore and Shane Sherlund were outlined in a draft of the document GSEs, Mortgage Rates, and Secondary Market Activities.

The economists analyzed the effect of portfolio purchases and mortgage securitization by the two government-sponsored enterprises on mortgage rate spreads during 1994 through 2003.

By 2003, the portfolios of Fannie and Freddie, at nearly $1.5 trillion, made up more than 22 percent of the entire residential mortgage market, according to the report.

While "earnings from mortgages held in portfolio clearly benefit GSE shareholders," one of the researchers' main findings was that the GSE portfolio purchases and issuance of mortgage-backed securities "have negligible effects on primary or secondary mortgage spreads. That is, a sudden increase in GSE portfolio purchases or MBS issuance has essentially no long-or short-run effects on mortgage spreads," the report said.

But the National Association of Home Builders, a strong ally of Fannie and Freddie, came out in support of the two companies at its annual convention in Orlando, Fla.

NAHB said it will oppose steps that would undermine the government's "implied guarantee" of the two mortgage companies' $1.7 trillion in debt, according to the Wall Street Journal. Instead, the group prefers that more competition is created for the two companies which are based in the Washington, D.C.-area.

Freddie's CEO, Richard F. Syron, spoke at the home builders' gathering.

According to the Fed's economists, the GSEs "purchases are not more effective at reducing mortgage market spreads than securitization activities."

The economists estimated that if the GSEs unexpectedly increased their portfolio purchases by $10 billion, the secondary market spread would decline about 0.3 basis points (0.003%) and the primary market spread would inch down about 0.1 BPS over the long-run. But, if they instead unexpectedly increased their securitization activity by $10 billion, the secondary market spread would decline about 0.8 BPS and the primary about 0.7 BPS, according to the draft.

The economists also examined the 1998 liquidity crisis, when financial markets saw volatility due to Russian bond defaults and turmoil in the Asian markets. At that time, primary market spreads reportedly widened about 80 BPS, secondary market spreads widened about 70 BPS, securitization volume decreased 5 percent and portfolio purchases jumped 76 percent. But, it was found "that GSE portfolio purchases did little to affect interest rates paid by borrowers," the researchers said.

"GSE actions during the liquidity crisis of 1998 were not extraordinary; further, had GSEs done nothing during this period, primary and secondary market spreads would have evolved in about the same way," the economists wrote.

"What is unique about the GSEs is not that they buy assets when they expect a large return on equity, but that, unlike a purely private investor, GSEs can issue debt that other investors treat as implicitly insured by the government," the researchers said. "Clearly, during a time of crisis, such debt might be better received in the markets than purely private debt and, ironically, financial crises may allow GSE shareholders extraordinary profit opportunities."

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