Government-sponsored Enterprises Research Articles

Housing Finance Reform: Private Markets Versus Government Guarantees

This paper evaluates the major alternative proposals for reforming the U.S. home mortgage market assuming that the government sponsored enterprises (GSEs), Fannie Mae and Freddie Mae, will be closed. The paper compares proposals that advocate primary reliance on private markets to take on the GSE functions with proposals that advocate government mortgage guarantees, including a discussion of how these plans differ in terms of duration, scope, and risk-sharing. The paper concludes with a discussion of current government attempts to expedite the modification or refinancing of existing mortgages, including a plan for the transition from the current situation to the long-term reforms.

Diversified Mortgage Guarantee Model: Securitizationthrough TBA

s the debate continues around the future of housing finance in general and the role of the government-sponsored enterprises (GSEs) in particular, we have seen a proliferation of thought on how to modify the financing framework to attract private capital and reduce the burden of the risk currently being borne by the GSEs and the Federal Housing Administration (FHA). The broad outlines of change have been addressed by the Treasury white paper, while various industry groups such as the Mortgage Bankers Association (MBA) and the Center for American Progress (CAP) among others, have expressed more specific ideas to replace the GSEs. (Proposals from the MBA, CAP, and others are summarized in Brinkmann et al. [2011]). In this article we step back and start by first identifying the principals and the intermediaries or facilitators among the various participants in the entire spectrum of housing finance, recognizing their interests and then making an attempt to optimize their collective goals. The borrowers, the investors who provide the funding, and the taxpayer or the government that always bears the catastrophic risk, under any system, are considered the principals. The intermediaries are the originators, seller/servicers, guarantors, and regulators. The interests of the principals need to be optimized by designing the most efficient framework for the intermediaries.

Housing and the Macroeconomy: The Role of Implicit Guarantees for Government-Sponsored Enterprises

This paper evaluates the macroeconomic and distributional effects of government bailout guarantees for Government Sponsored Enterprises (such as Fannie Mae and Freddy Mac) in the mortgage market. In order to do so we construct a model with heterogeneous, infinitely lived households and competitive housing and mortgage markets. Households have the option to default on their mortgages, with the consequence of having their homes foreclosed. We model the bailout guarantee as a government provided and tax-financed mortgage interest rate subsidy. We find that eliminating this subsidy leads to substantially lower equilibrium mortgage origination and increases aggregate welfare, but has little effect on foreclosure rates and housing investment. The interest rate subsidy is a regressive policy: eliminating it benefits low-income and low-asset households who did not own homes or had small mortgages, while lowering the welfare of high-income, high-asset households.

The credit default swap market and the settlement of large defaults

Résumé L’ampleur des positions prises sur le marché des swaps de défaut de crédit (CDS) a soulevé des inquiétudes sur la capacité du marché à régler les défauts lorsque ceux-ci concernent de très gros emprunteurs. La quasi-faillite de AIG et la faillite avérée de Lehman Brothers en 2008 ont révélé l’exposition des acheteurs de CDS au risque de contrepartie et mis en évidence la nécessité d’organiser le marché, ce qui a déclenché un processus de réformes. Premièrement, nous analysons les vulnérabilités du marché au moment de l’éclatement de la crise. Deuxièmement, pour comprendre sa résilience malgré des faillites majeures, nous analysons le processus d’enchères qui a permis de régler ces défauts, les stratégies des acheteurs et des vendeurs, ainsi que le lien avec le marché des obligations. Nous étudions ensuite la façon dont ces enchères ont précisément fonctionné dans le cas de défauts majeurs, tels que Lehman Brothers, Washington Mutual, CIT et Thomson, ainsi que pour Fannie Mae et Freddie Mac. Troisièmement, nous analysons le processus de réformes en cours. Classification JEL : D44 ; G01 ; G15 ; G33.

Guaranteed to fail: Fannie Mae, Freddie Mac, and the debacle of mortgage finance

The financial collapse of Fannie Mae and Freddie Mac in 2008 led to one of the most sweeping government interventions in private financial markets in history. The bailout has already cost American taxpayers close to $150 billion, and substantially more will be needed. The U.S. economy--and by extension, the global financial system--has a lot riding on Fannie and Freddie. They cannot fail, yet that is precisely what these mortgage giants are guaranteed to do. How can we limit the damage to our economy, and avoid making the same mistakes in the future?Guaranteed to Fail explains how poorly designed government guarantees for Fannie Mae and Freddie Mac led to the debacle of mortgage finance in the United States, weighs different reform proposals, and provides sensible, practical recommendations. Despite repeated calls for tougher action, Washington has expanded the scope of its guarantees to Fannie and Freddie, fueling more and more housing and mortgages all across the economy--and putting all of us at risk. This book unravels the dizzyingly immense, highly interconnected businesses of Fannie and Freddie. It proposes a unique model of reform that emphasizes public-private partnership, one that can serve as a blueprint for better organizing and managing government-sponsored enterprises like Fannie Mae and Freddie Mac. In doing so, Guaranteed to Fail strikes a cautionary note about excessive government intervention in markets.

Policy Tenure Under the U.S. National Flood Insurance Program (NFIP)

In the United States, insurance against flood hazard (inland flooding or storm surge from hurricanes) has been provided mainly through the National Flood Insurance Program (NFIP) since 1968. The NFIP covers $1.23 trillion of assets today. This article provides the first analysis of flood insurance tenure ever undertaken: that is, the number of years that people keep their flood insurance policy before letting it lapse. Our analysis of the entire portfolio of the NFIP over the period 2001-2009 reveals that the median tenure of new policies during that time is between two and four years; it is also relatively stable over time and levels of flood hazard. Prior flood experience can affect tenure: people who have experienced small flood claims tend to hold onto their insurance longer; people who have experienced large flood claims tend to let their insurance lapse sooner. To overcome the policy and governance challenges posed by homeowners' inadequate insurance coverage, we discuss policy recommendations that include for banks and government-sponsored enterprises (GSEs) strengthening their requirements and the introduction of multiyear flood insurance contracts attached to the property, both of which are likely to provide more coverage stability and encourage investments in risk-reduction measures.

Further Investigations into the Origin of Credit Score Cutoff Rules

Keys, Mukherjee, and Vig (2010a) argue that the evidence presented in Bubb and Kaufman (2009) is based on an inappropriate pooling of loans sold to private-label securitizers with loans sold to the government sponsored enterprises (GSEs). In this paper we investigate the issues raised by the authors and conclude that they do not change our basic analytical approach or conclusions. We examine samples that do not pool together loans sold to these two types of purchasers—a sample of loans bought by the GSEs, a sample of loans originated in 2008–2009 after the private-label market collapsed, and a sample of jumbo loans—and find discontinuities in the number and default rate of loans at credit score cutoffs in the absence of corresponding discontinuities in the securitization rate. We also examine a key assumption underlying their estimates—that no loans are both at risk of being sold to the GSEs and at risk of being sold to private-label securitizers—and show that the data are inconsistent with that assumption. We find that 18 percent of conforming loans in our sample at some time switched between GSE and private-label ownership, demonstrating that the GSEs and private-label securitizers competed for the same loans. Additionally, we show that lender screening cutoffs grew steadily over the period 1997–2010 during which the private-label market rose and collapsed.

The Legislative Framework for U.S. CoveredBonds: Facts and Myths

The clamor for covered bonds has remained steady since Representative Scott Garrett introduced his initial proposal for a legislative framework nearly three years ago. Covered bonds occupy a middle ground between the government-sponsored enterprise (GSE) and securitization markets. Although the balance sheets of financial institutions cannot replace the multi-trillion dollar securitization market, covered bonds can bridge funding gaps in the short term and can supply a much needed source of complementary liquidity in the long term. Similarly, while covered bonds are not a comprehensive solution for the difficult policy issues implicated by GSE reform, a robust covered-bond market would immediately attract private capital without need of a federal subsidy and would ultimately contribute to a more stable system of mortgage finance. This article highlights some essential facts and dispels lingering myths about the covered bond market and the proposed U.S. legislative framework. <b>TOPICS:</b>Legal and regulatory issues for structured finance, information providers/credit ratings

Causes of the economic crisis: Can the flap of a butterfly wing in Brazil destroy the Coliseum … after 30 years?

The current US-made economic crisis was caused by unintended perverse consequences of remote well-meaning political decisions, such as the 1977 Community Reinvestment Act and the demagogic exploitation of government-sponsored enterprises (GSEs) such as Fannie Mae etc that began in the 1990s. The fivefold interest rate increases in the USA between 2003 and 2008 that charged an additional US$70bn to the three million holders of adjustable rate mortgages (ARMs) triggered the crash.

Legislative Proposals to Address the Negative Consequences of the Dodd-Frank Whistleblower Provisions: Written Testimony Submitted to the U.S. House Committee on Financial Services, Subcommittee on Capital Markets and Government Sponsored Enterprises

The author testified at a U.S. House Committee on Financial Services, Subcommittee on Capital Markets and Government Sponsored Enterprises hearing on May 11, 2011. The hearing explored a discussion draft of legislation which would modify the whistleblower bounty provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The author's testimony suggested that the proposed reforms, which included a requirement of internal reporting to preserve a whistleblower's bounty eligibility, a change from mandatory to discretionary bounties, and a prohibition on contingency fees, would dull the incentives Dodd-Frank's bounty provision was meant to foster.

Was the financial crisis the result of ineffective policy and too much regulation? An empirical investigation

Every major financial crisis in the United States has been followed with a regulatory response meant to keep another crisis at bay. The current crisis is no different; on 21 July 2010, a sweeping regulation was passed designed to prevent another financial crisis. If history is a reliable guide, the regulatory response is likely to contribute to the next financial crisis unless some sound understanding of the causes of the crises is determined. The purpose of this article is to empirically test the perspective that too much regulation and poor policy choices contributed to the first financial crisis of the twenty-first century. We find statistical evidence to indicate that policies at the Government Sponsored Enterprises, monetary policy and the Community Reinvestment Act all compromised large bank performance for the 1999 through 2008 period.

International Capital Flows and the Return to Safe Assets in the United States, 2003-2007

A broad array of domestic institutional factors ‐including problems with the originate-to-distribute model for mortgage loans, deteriorating lending standards, defi ciencies in risk management, confl icting incentives for the government-sponsored enterprises (GSEs), and shortcomings of supervision and regulation‐ were the primary sources of the US housing boom and bust and the associated fi nancial crisis. In addition, the extended rise in US house prices was likely also supported by long-term interest rates (including mortgage rates) that were surprisingly low, given the level of short-term rates and other macro fundamentals ‐a development that Greenspan (2005) dubbed a “conundrum.” The “global saving glut” (GSG) hypothesis (Bernanke, 2005 and 2007) argues that increased capital infl ows to the United States from countries in which desired saving greatly exceeded desired investment ‐including Asian emerging markets and commodity exporters‐ were an important reason that US longer-term interest rates during this period were lower than expected. This essay investigates further the effects of capital infl ows to the United States on US longer-term interest rates; however, we look beyond the overall size of the infl ows emphasised by the GSG hypothesis to examine the implications for US yields of the portfolio preferences of foreign creditors. We present evidence that, in the spirit of Caballero and Krishnamurthy (2009), foreign investors during this period tended to prefer US assets perceived to be safe. In particular, foreign investors ‐especially the GSG countries‐ acquired a substantial share of the new issues of US Treasuries, Agency debt, and Agency-sponsored mortgage-backed securities. The downward pressure on yields exerted by infl ows from the GSG countries was reinforced by the portfolio preferences of other foreign investors. We focus particularly on the case of Europe: although Europe did not run a large current account surplus as did the GSG countries, we show that it leveraged up its international balance sheet, issuing external liabilities to fi nance substantial purchases of apparently safe US “private label” mortgage-backed securities and other fi xed-income products. The strong demand for apparently safe assets by both domestic and foreign investors not only served to reduce yields on these assets but also provided additional incentives for the US fiservices industry to develop structured investment products that “transformed” risky loans into highly-rated securities. Our fi ndings do not challenge the view that domestic factors, including those listed above, were the primary sources of the housing boom and bust in the United States. However, examining how changes in the pattern of international capital fl ows affected yields on US assets helps provide a deeper understanding of the origins and dynamics of the crisis.

Regulating Wall Street: the Dodd-Frank Act and the new architecture of global finance

Foreword. Preface. PROLOGUE: A BIRD'S-EYE VIEW. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Viral V. Acharya, Thomas Cooley, Matthew Richardson, Richard Sylla, and Ingo Walter). PART ONE: Financial Architecture. CHAPTER 1: The Architecture of Financial Regulation (Thomas Cooley and Ingo Walter). CHAPTER 2: The Power of Central Banks and the Future of the Federal Reserve System (Thomas Cooley, Kermit Schoenholtz, George David Smith, Richard Sylla, and Paul Wachtel). CHAPTER 3: Consumer Finance Protection (Thomas Cooley, Xavier Gabaix, Samuel Lee, Thomas Mertens, Vicki Morwitz, Shelle Santana, Anjolein Schmeits, Stijn Van Nieuwerburgh, and Robert Whitelaw). PART TWO: Systemic Risk. CHAPTER 4: Measuring Systemic Risk (Viral V. Acharya, Christian Brownlees, Robert Engle, Farhang Farazmand, and Matthew Richardson). CHAPTER 5: Taxing Systemic Risk (Viral V. Acharya, Lasse Pedersen, Thomas Philippon, and Matthew Richardson). CHAPTER 6: Capital, Contingent Capital, and Liquidity Requirements (Viral V. Acharya, Nirupama Kulkarni, and Matthew Richardson). CHAPTER 7: Large Banks and the Volcker Rule (Matthew Richardson, Roy C. Smith, and Ingo Walter). CHAPTER 8: Resolution Authority (Viral V. Acharya, Barry Adler, Matthew Richardson, and Nouriel Roubini). CHAPTER 9: Systemic Risk and the Regulation of Insurance Companies (Viral V. Acharya, John Biggs, Hanh Le, Matthew Richardson, and Stephen Ryan). PART THREE: Shadow Banking. CHAPTER 10: Money Market Funds: How to Avoid Breaking the Buck (Marcin Kacperczyk and Philipp Schnabl). CHAPTER 11: The Repurchase Agreement (Repo) Market (Viral V. Acharya and T. Sabri Oncu). CHAPTER 12: Hedge Funds, Mutual Funds, and ETFs (Stephen Brown, Anthony Lynch, and Antti Petajisto). CHAPTER 13: Regulating OTC Derivatives (Viral V. Acharya, Or Shachar, and Marti Subrahmanyam0. PART FOUR: Credit Markets. CHAPTER 14: The Government-Sponsored Enterprises (Viral V. Acharya, T. Sabri Oncu, Matthew Richardson, Stijn Van Nieuwerburgh, and Lawrence J. White). CHAPTER 15: Regulation of Rating Agencies (Edward I. Altman, T. Sabri Oncu, Matthew Richardson, Anjolein Schmeits, and Lawrence J. White). CHAPTER 16: Securitization Reform (Matthew Richardson, Joshua Ronen, and Marti Subrahmanyam). PART FIVE: Corporate Control. CHAPTER 17: Reforming Compensation and Corporate Governance (Jennifer Carpenter, Thomas Cooley, and Ingo Walter). CHAPTER 18: Accounting and Financial Reform (Joshua Ronen and Stephen Ryan). Epilogue. About the Authors. About the Blog. Index.

The financial crisis: imperfect markets and imperfect regulation

PurposeThis paper seeks to examine the role that regulation and regulatory agencies played in the creating of the subprime mortgage market, and the subsequent crash of the mortgage market. The paper has two goals. First, it seeks to document the degree to which the US housing markets, and the US housing finance market, were regulated prior to the crash. Second, it seeks to show that regulatory bodies set policies which created both incentives and explicit requirements for Fannie Mae and Freddie Mac, as well as depository institutions, to enter the subprime market.Design/methodology/approachThe paper examines the regulatory environment of the subprime market. It uses regulatory filings and other documents as primary sources.FindingsThe popular perception that the subprime mortgage market arose because housing finance was largely unregulated is incorrect. In point of fact, the housing finance market was very heavily regulated. Indeed, the paper shows that the creation of the subprime market was a formal goal of the federal government, and that federal regulatory agencies explicitly required participation by the Government Sponsored Enterprises (GSEs).Originality/valueThe paper's primary implication is that incentive conflicts within the US housing finance system significantly contributed to the mortgage crisis. These incentive conflicts were not just within private firms, but also extend to the GSEs and regulatory agencies. Regulatory agencies not only failed to anticipate the crisis; they actively encouraged the policies which created it. As a result, the primary focus of reform efforts should be on identifying and eliminating such conflicts.

The Way Forward: U.S. Residential Mortgage Finance in a Post-GSE World

The “government-sponsored enterprise” (GSE) system of residential mortgage finance is clearly broken. But what will replace it remains an unanswered question. This paper lays out a vision for how private markets would – if given the opportunity – replace the GSEs and provide a fully functioning secondary market for residential mortgages. In the event that the private sector is deemed inadequate for the task, this paper also proposes a “side-by-side” private/government form of mortgage guarantee that would be superior to the “tail risk” or “catastrophe” government insurance proposals that have circulated as alternatives to the GSEs.

Why is the Market Share of Adjustable-Rate Mortgages so Low?

Over the past several years, U.S. homebuyers have increasingly favored fixed-rate mortgages over adjustable-rate mortgages (ARMs). Indeed, ARMs have dropped to less than 10 percent of all residential mortgage originations, a near-record low. One might speculate that the decline in the ARM share has been driven by one-off factors relating to the financial crisis. However, a statistical analysis suggests that recent trends can largely be explained by the same factors that have historically shaped mortgage choice - most notably, the term structure of interest rates and its effects on the relative price of different types of mortgages. Supply-side factors, in particular a rise in the share of mortgages eligible to be securitized by the housing government-sponsored enterprises, also play a role in the low current ARM share.

Home Sweet Home: Government's Role in Reaching the American Dream

This paper investigates the role of government intervention in achieving the American dream of homeownership. The study analyzes the role of tax deductions in housing finance, including their impact on homeownership and housing consumption. The role of the Government Sponsored Enterprises in facilitating the creation of a secondary market for mortgage-backed securities is also analyzed as well as the role of the Federal Housing Administration. Cross-country comparisons of how housing is financed in other industrial countries is also provided, emphasizing how other countries have been able to achieve comparable homeownership rates as the United States in a less complicated and fiscally cheaper system. Country experiences of successfully phasing out government intervention are also analyzed.

Home Sweet Home: Government's Role in Reaching the American Dream

This paper investigates the role of government intervention in achieving the American dream of homeownership. The study analyzes the role of tax deductions in housing finance, including their impact on homeownership and housing consumption. The role of the Government Sponsored Enterprises in facilitating the creation of a secondary market for mortgage-backed securities is also analyzed as well as the role of the Federal Housing Administration. Cross-country comparisons of how housing is financed in other industrial countries is also provided, emphasizing how other countries have been able to achieve comparable homeownership rates as the United States in a less complicated and fiscally cheaper system. Country experiences of successfully phasing out government intervention are also analyzed.

Housing and the Macroeconomy: The Role of Bailout Guarantees for Government Sponsored Enterprises

This paper evaluates the macroeconomic and distributional effects of government bailout guarantees for Government Sponsored Enterprises (such as Fannie Mae and Freddy Mac) in the mortgage market. In order to do so we construct a model with heterogeneous, infinitely lived households and competitive housing and mortgage markets. Households have the option to default on their mortgages, with the consequence of having their homes foreclosed. We model the bailout guarantee as a government provided and tax-financed mortgage interest rate subsidy. We find that eliminating this subsidy leads to substantially lower equilibrium mortgage origination and increases aggregate welfare, but has little effect on foreclosure rates and housing investment. The interest rate subsidy is a regressive policy: eliminating it benefits low-income and low-asset households who did not own homes or had small mortgages, while lowering the welfare of high-income, high-asset households.

Mortgage Credit Ratings and the Financial Crisis: The Need for a State-Run Mortgage Security Credit Rating Agency

With the exception of the investment banks, there probably has been no other financial actor with as great a hand in causing the current financial crisis as the major credit rating agencies (CRAs). CRAs gave residential mortgage backed securities (RMBSs) and RMBS-collateralized debt obligations (R-CDOs) inflated credit ratings, enabling financial institutions and other investors to buy trillions of dollars worth of these securities. Eventually, it became apparent that these securities were overvalued, which—because of mark-to-market accounting rules—forced huge write-downs for those who owned them. Consequently, the balance sheets of many financial institutions were decimated, some became insolvent, and the whole financial system was pushed to the brink of collapse. Today the private mortgage securitization market is virtually non-existent, and only mortgage securities guaranteed by the Government Sponsored Enterprises (GSEs), Fannie Mae, Freddie Mac, and Ginnie Mae, are bought by investors. Responsibility for the frozen private mortgage securitization market has been widely assigned to the CRAs. Because mortgage securitization is so important to reviving the economy, the federal government, through its acquisition and subsidization of the GSEs, has become an underwriter and purchaser of RMBSs and R-CDOs. It is not a desirable solution, however, for the government to act as a long-term mortgage security investor. This Note’s proposal hopes to revive private mortgage securitization with significantly less expansive government intervention. To restart the non-GSE RMBS and R-CDO market and to ensure its continued functioning, this Note argues that a federal government entity (“the Agency”) needs to take the place of the CRAs in rating RMBSs and R-CDOs. Inaccurate RMBS and R-CDO ratings are caused in large part by the “issuer pays” system of financing, whereby issuers of securities pay the CRAs for credit ratings, thus creating an obvious conflict of interests. However, some academics and the CRAs claim that the CRAs’ incentive to maintain a strong reputation (“reputational capital”) outweighs their desire in any individual case to profit from inflated ratings. The current financial crisis, however, disproves this claim and instead indicates that the conflict of interests inherent in issuer financing have overcome the reputational capital constraint and resulted in inflated RMBS and R-CDO ratings. Since the issuer pays model is unlikely to change, the CRAs will continue to be incentivized to inflate RMBS and R-CDO ratings, and investors and regulators will probably distrust CRA ratings of R-CDOs and RMBSs for the foreseeable future. On the other hand, this Note will show that a government entity can effectively rate R-CDOs and RMBSs.