paper about MBS

Yet fannie and freddie barely register as news in the

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Unformatted text preview: Yet Fannie and Freddie barely register as news. In the most sweeping financial legislation since the 1930s, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 barely mentions them, simply calling for a study of how to reform them. Now there is a chance that the support that has been thrown at the banks – $550 billion of direct capital, $285 billion of loan guarantees, and insurance of $418 billion of assets – will be eventually paid off. In fact, a number of banks have repaid their loans with interest, albeit along a trail of real economy devastation. And even the poster child for financial excess, AIG, may be able to fully pay off the government if the housing market doesn’t deteriorate further. But the chances are slim to none that either Fannie or Freddie will be able to pay back the funds. When the history of the crisis is all written, these institutions will turn out to be the most costly of the financial sector, and this sector includes some of the most tarnished financial institutions in America. So where is the outrage? There is no outrage because Fannie and Freddie have become a political football between the left and right wing of American politics. On the left, they were vehicles for promoting affordable housing for all, while on the right they furthered the idea of the ownership society. And they were a politician’s dream: They reduced monthly mortgage costs without requiring any federal budgetary outlays. 5 Now that they have failed, and we have learned that the meal has been costly indeed, conservative think tanks blame Fannie and Freddie for being ground zero of the subprime crisis. However, the liberal groups say that their role in the crisis is overblown and that it is simply a diversionary tactic away from what they consider to be the true causes of the housing bust: deregulation and the excesses of Wall Street. There is probably a little truth to both views. But these arguments are beside the point. Fannie Mae and Freddie Mac are where they are because they were run as the largest hedge fund on the planet. A little calculation illustrates their business model. Suppose that we offered you the following opportunity: We will invest $1, you lend us $39. With this $40, we will buy bank-originated pools of mortgages that are not easy to sell and face significant long-term risks. Although we’ll attempt to limit that risk by using sophisticated financial hedging instruments, our models have large error and uncertainty. We’ll invest 15% of the funds in low-quality mortgages that households will be unable to pay in a recession or a severe housing downturn. And to make it even more interesting, we’ll become the largest financial institution in terms of assets that are related to mortgages and together buy around $1.7 trillion worth, making us truly too-big-to-fail....
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Yet Fannie and Freddie barely register as news In the most...

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