Financial Update (Second Quarter 2002)
Fannie Mae’s and Freddie Mac’s Changing Roles and Reform Initiatives
hree government-sponsored enterprises (GSEs) — Fannie Mae, Freddie Mac and the Federal Home Loan Bank System — were created to make home mortgage financing more readily available by supplementing local funding. But today retail lenders can tap national markets, so the main contribution of the three housing GSEs is now providing homebuyers an interest rate subsidy.
Two articles in the Atlanta Fed’s Economic Review (First Quarter 2002) examine a number of issues concerning these three GSEs, especially Fannie Mae and Freddie Mac. In the first article, W. Scott Frame and Larry D. Wall, financial economists at the Atlanta Fed, look at the economic issues arising from the housing GSEs’ provision of interest rate subsidies. The GSEs can provide lower rates to home mortgage borrowers mainly because of the subsidies the GSEs receive from the federal government. The largest subsidy is the financial markets’ perception that the GSEs’ securities are implicitly guaranteed by their special relationship with the government.
The authors focus on two policy debates sparked by this special relationship. The first is whether the GSEs are efficient mechanisms for subsidizing housing. The second relates to the GSEs’ safety and soundness and questions whether implicit guarantees of their liabilities are the best way to subsidize them.
In their second article, Frame and Wall evaluate six voluntary initiatives that Fannie Mae and Freddie Mac announced in 2000. One initiative would enhance market discipline by having the GSEs issue subordinated debt. A second would boost liquidity by having them maintain a more liquid securities portfolio. The other initiatives would increase transparency by having the GSEs disclose certain credit and interest rate losses, obtain and disclose annual credit ratings, and disclose compliance with certain capital adequacy standards.
Frame and Wall evaluate the initiatives from the perspective of current banking standards. Their analysis suggests that the initiatives are beneficial but could be made more effective. The contribution of the subordinated debt initiative depends largely on whether investors believe the implicit guarantee extends to subordinated debtholders. The need for the liquidity initiative has not been established. The most important of the disclosure initiatives, the one for interest rate risk, could be more informative if it summarized a wider set of interest rate scenarios.