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paper about MBS

We believe that they do not need continued liquidity

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Unformatted text preview: We believe that they do not need continued liquidity support in the form of proprietary trading purchases from the GSEs. It is potentially false, because there is no evidence for a direct link between the size of the GSE portfolios and the liquidity of secondary mortgage markets. 52 In reality, the retained portfolio management business became the cash cow of the GSEs. Rather than making markets more liquid, it had as its true objective to make money for the shareholders, traders, and CEOs of the GSEs, just as is true of any other hedge fund. The CEOs gained enormously: Richard Syron of Freddie Mac and Daniel Mudd of Fannie Mae each took home $28 million in 2006 and 2007 alone. Ominously, these were exactly the years that the GSEs ramped up the risk of their portfolios the most. Even under the current conservatorship, compensation seems excessive. For 2010, the Treasury Department and the Federal Housing Finance Agency approved CEO compensation of $6 million each, including $2 million incentive payments for each executive. In sharp contrast, Benjamin Bernanke, the chairman of the Federal Reserve earns $191,000 per year, or 30 times less. The nature of the retained portfolio business invites comparison with the hedge fund industry. To put the GSEs’ $1.7 trillion retained portfolio into perspective, the total assets under management of the entire hedge fund industry were $2 trillion at the end of 2009. Given aggregate leverage ratios around five, this means that hedge function industry has a balance sheet on the order of $10 trillion. The largest hedge fund in 2009 was Bridgewater Associates with $38 billion. Freddie and Fannie’s trading operation therefore was around 20% as large as 105 the entire hedge fund industry, and the two GSEs were magnitudes bigger than the largest hedge fund. The level of sophistication of the GSEs’ trading function rivaled that of premier hedge funds. They employed sophisticated quantitative models for predicting the performance of mortgage loans, and they used large derivative positions to manage interest rate and default risk. This trading function generated enormous revenues: about $28 billion in each of 2002, 2003, and 2004. After a dip, the 2009 trading revenue was $31 billion in 2009. In fact, throughout its history net interest income (from such investment activities) has surpassed guarantee fee income (from the traditional guarantee business). Over the past 15 years, trading revenues represented on average 73% of all revenues. Like many hedge funds, the GSEs increased the riskiness of their mortgage portfolios in the years leading up to the crisis. They purchased $227 billion worth of subprime and Alt-A mortgage-backed securities in 2006 and 2007, in addition to possibly $500 billion more of high- risk mortgages that were not classified as such....
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We believe that they do not need continued liquidity...

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