paper about MBS

Recall that the gses currently perform two

Info iconThis preview shows pages 105–107. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Recall that the GSEs currently perform two functions: (1) Portfolio or investment function , in which they buy and retain mortgages and mortgage-backed securities; and (2) Guarantee function , in which they underwrite the credit risk of mortgages to facilitate the pass- through of their interest and principal payments to capital market participants and financial firms. Also, the GSEs operate in two markets: (1) Conforming mortgages (subject to size limits, low LTVs, high credit scores, good income coverage ratios, etc.); and (2) Nonconforming mortgages (the rest). We will explain below that these two functions and the two markets require slightly different reforms to ensure that our efficiency criteria are met. Our preferred reform proposal involves the following steps: First, the proprietary trading function of the GSEs needs to be discontinued entirely. Second, we discuss how to structure the guarantee function of the GSEs. It should be reworked to better balance systemic risk, efficient pricing, and market discipline. One of the conclusions is that public guarantees should be restricted to conforming mortgages. Therefore, the final set of recommendations discusses how to deal with non-conforming mortgages and, in particular, where these mortgages fit into the broader regulatory structure of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. In Chapter 9, we discuss the economics of subsidizing home ownership. We recommend that the government’s affordable home ownership objectives be substantially shrunk in size, remain pre-funded at all times, and be housed in the Federal Housing Administration (FHA) and/or elsewhere in the Department of Housing and Urban Development (HUD) instead of being entangled with the objective of developing a healthy secondary market for mortgage securitization. 104 8.1 Discontinue the Investment Function of the GSEs As we discussed in detail in Chapter 1, the GSEs not only guarantee conforming mortgages held by other investors, but they also actively invest in a large portfolio of mortgage assets: the so-called retained portfolio. At the end of 2009, Freddie and Fannie either guaranteed or owned $5.39 trillion dollars in mortgages, fully $1.71 trillion of which (27% of the total) was owned in portfolio. This 27% retained mortgage share is down from 44% in 2002, but is only slightly below the 2008 all-time dollar high of $1.76 trillion. The rationale for this retained portfolio was to promote liquidity in the secondary mortgage market. Higher liquidity, it was believed, could make secondary mortgage markets more efficient and would ultimately trickle down to homeowners in the form of lower mortgage rates. We believe that this reasoning is obsolete at best and probably false. It is obsolete because the market for conforming mortgage-backed securities is one of the largest and most liquid fixed income markets in the world. By now, markets have had almost 40 years of experience in trading conforming mortgage-backed securities. We believe that they do not need continued trading conforming mortgage-backed securities....
View Full Document

{[ snackBarMessage ]}

Page105 / 151

Recall that the GSEs currently perform two functions(1...

This preview shows document pages 105 - 107. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online