NCPA - National Center for Policy Analysis

What Will Replace Government-Sponsored Enterprises in the Mortgage Market?

March 10, 2011

The insolvencies and conservatorships of Fannie Mae and Freddie Mac in September 2008 have established the inappropriateness of the "government-sponsored enterprise" (GSE) model for residential mortgage finance in the United States.  Two-and-a-half years later, however, the question of how to replace their presence in the secondary mortgage market remains open, says Lawrence J. White, a professor at New York University's Stern School of Business.

The private markets can -- if given the opportunity -- replace the GSEs and provide a fully functioning secondary market for residential mortgages.  There are two clear paths to crowding in (that is, reducing the crowding out of) the private sector and they are not mutually exclusive.

Reduce the GSEs' conforming loan limits:

  • A schedule of annual reductions -- say 10 percent per year -- should be established.
  • This would gradually increase the range of jumbo mortgages that would be out of the domain of the GSEs.

Increase the GSEs' guarantee fees:

  • The GSEs have typically charged about 20-25 basis points (0.20-0.25 percentage points) per year on the unpaid principal balance of their mortgage-backed securities (MBS), in return for the guarantee against credit risk that they provide to their MBS investors.
  • A schedule of annual increases on new MBS -- say,5 basis points per year -- should be established.
  • As the guarantee fee increases, the GSE MBS would be less attractive to investors, which would open opportunities for private-label securities MBS and depository institutions.
  • This would also have the advantage of, in the interim, earning a bit more income for the GSEs and thus reducing the burden that will eventually have to be absorbed by the U.S. taxpayer.

Source: Lawrence J. White, "U.S. Residential Mortgage Finance in a Post-GSE World," Mercatus Center, March 2011.

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