Fussing and fuming over Fannie Mae and Freddie Mac

Fussing and fuming over Fannie Mae and Freddie Mac

Fannie Mae and Freddie Mac are the second- and third-largest U.S. companies and play a central role in housing finance markets. Both companies are considered government-sponsored enterprises (GSEs) because they maintain federal charters that confer a number of rights and responsibilities on them. The largest benefit to Fannie Mae and Freddie Mac of their GSE status is the financial market’s perception that the federal government backs their financial obligations even though it explicitly does not.

Authors W. Scott Frame and Lawrence J. White describe the importance of this market perception and then examine five related research and public policy issues. These issues include the efficiency implications of Fannie Mae and Freddie Mac for mortgage markets and the macro-economy as well as the federal government’s safety-and-soundness supervision of the companies and the systemic risk that these GSEs could pose to the U.S. economy.

Offering ideas for policy improvements, Frame and White suggest that Fannie Mae and Freddie Mac become privately owned companies with no special privileges. The authors argue that this approach would have only a modest effect on residential mortgage interest rates (a 20-25 basis point increase). If privatization is not feasible, the authors’ research suggests that public officials should disavow any public backing for Fannie Mae or Freddie Mac, force the companies to increasingly serve low–and moderate-income borrowers, and strengthen their safety-and-soundness oversight.

Working Paper 2004-26

October 2004

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