Fed Economists Point to Financial System Risks from Housing GSEs
The two largest portfolios of residential mortgage debt in the United States are held by Fannie Mae and Freddie Mac, which are government-sponsored enterprises (GSEs). Together, their portfolios account for about 20 percent of a $7.7 trillion market. Operating with unique congressional charters, which have created a perception in financial markets that their obligations are guaranteed by the federal government, these two entities maintain investment portfolios that have become increasingly controversial because of their size, their management, and the systemic risks they pose to the financial system, according to three Atlanta Fed research economists.
Clarity sought on GSE risk
In a recent Atlanta Fed working paper (Working Paper 2006-2), authors Robert Eisenbeis, research director of the Atlanta Fed, and economists Scott Frame and Larry Wall discuss these large investment portfolios’ risk. They note that the Fannie Mae and Freddie Mac mortgage portfolios have become the central policy issue in the congressional debate in terms of the GSEs’ overall safety and soundness and an appropriate approach to supervising and regulating them.
Tracing the evolution of the GSEs
The authors provide a historic framework regarding Fannie Mae (formerly known as the Federal National Mortgage Association), created in 1938, and Freddie Mac (also known as the Federal Home Loan Mortgage Corp.), an entity created by Congress in 1970. They also describe the dramatic growth of the GSEs, noting that Fannie Mae (with more than $1 trillion in assets in 2003) and Freddie Mac ($803 billion in assets in 2003) are the second- and third-largest U.S. companies in terms of asset size.
The authors also evaluate a number of policy options for reducing Fannie Mae and Freddie Mac’s enormous mortgage-related investment portfolios. The authors conclude that limits on the portfolio size—either assets or liabilities—would be the most effective approach to mitigating the portfolios’ inherent systemic risk.