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The first step would be a reduction in new loan

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The first step would be a reduction in new loan purchases . Given the fragile state of the housing market, a cold turkey approach that immediately stops any new purchases seems imprudent. Thus, GSE reform should start with the firm intention to reduce new GSE purchases for investment purposes to zero over the first 3-5 years of the transition.
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107 The second step is to reduce the existing assets in the retained portfolio. Part of the reduction in portfolio will occur automatically as mortgage loans mature, default, or are prepaid. This could occur rather quickly. The average annual pay-down rate of the GSEs’ portfolios from 1997 to 2004 was about 25 percent. In addition, we recommend that the GSEs draw firm plans actively to sell assets in portfolio to a variety of private market participants, such as hedge funds, pension funds, sovereign wealth funds, or other institutional investors. As part of the conservatorship agreement, the Treasury has put forth a plan along these lines. The original conservatorship agreement stipulated that each of the GSEs should reduce its retained portfolio to $850 billion by December 31, 2009. Afterwards, it envisioned a 10% annual reduction each year until each portfolio was reduced to $250 billion. In May 2009, the limit for 2009 was raised to $900 billion, probably in anticipation of an early breach of the original agreement. Indeed, at the end of 2009, Fannie’s retained portfolio was $869 billion (down only $43 billion from 2008), while Freddie’s was $840 billion (down $9 billion). The new rules imply a December 31, 2010, limit on the portfolio of each GSE of $810 billion. The 10% reduction in this asset limit will lead to a 2011 limit of $729 billion, a 2012 limit of $656 billion, and so forth. Under this schedule, the portfolio will fall below $250 billion in 2021. We believe that the gradual wind-down is a good plan. By putting a cap on the overall size of the portfolio, it allows for some new purchases to the extent that the existing portfolio shrinks fast enough. By announcing an average annual percentage reduction in the portfolio, the private market can form expectations about future conditions in the mortgage market and plan accordingly. However, the swift modification of the agreement in 2009, less than a year after the agreement had been in place, does not bode well for the future. It highlights the potential for future backsliding at the discretion of the politicians in charge. We recommend that a firm plan be included in a GSE reform bill, with strict enforcement, and that the plan be kept in place until the entire portfolio is sold off. The FHFA should be given authority to exercise strict oversight over this wind-down. Finally, we recommend that the reduction of the portfolio should be accelerated beyond the 10% annual reduction whenever market conditions allow. As housing market conditions improve and foreclosures return to normal levels, the prices for mortgage-backed securities (MBS) will stabilize and improve as well. When this happens, the GSE RTC should accelerate its sales to private market participants. While the cost of an accelerated exit may be to affect prices
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