paper about MBS

But then why do the gses still buy these loans even

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Unformatted text preview: But then why do the GSEs still buy these loans? Even though to a private sector financial firm these loans are poor quality, the loans may still be worthwhile investments for the GSEs because they have access to cheap debt financing due to the implicit government guarantee. And ironically the more of these types of loans that they purchase, the more likely that the implicit guarantee becomes even stronger. A poor loan here or there, a distortion once in a while, is not disastrous; but the implicit guarantee of the U.S. government allowed the GSEs to grow unencumbered for decades. The light regulatory capital requirements - 2.50% for portfolio holdings and 0.45% for default 57 guarantees – may have seemed reasonable when set back in 1992 (although they were lower than the comparable capital requirements for banks and thrifts, as was explained in Chapter 1), but the mortgage-backed assets of the GSEs of 2007 had a far riskier credit profile than those of 15 years earlier. In 1996, a Congressional Budget Office (CBO) study entitled “Assessing the Public Costs and Benefits of Fannie Mae and Freddie Mac” made the case for full privatization of the GSEs but recognized the problem of doing so when the economy had become so reliant on them. And this was back in 1996, not 2007. The report provides the analogy of the bear in the canoe with which we started this chapter.” 29 4.1.3 Running for the Exit Since the GSEs are currently under the conservatorship of the government, it would be crazy not to kill off the “bear” and move forward with a model that did not again create a too-big-to-fail, and more likely a too-big-to-reform, monster. A senior executive at the now defunct Salomon Brothers used to say that when trading, never panic; but if you do panic, panic first. A few months after the financial crisis had started, on September 14, 2007, a curious thing began to happen at the 76 branches of the UK-based firm Northern Rock. Right out of a scene from the Jimmy Stewart movie “It’s a Wonderful Life”, lines began to develop outside the bank branches as people began to withdraw their life savings. It was a classic run on the bank. The triggering event was ironically the revelation that the Bank of England was going to provide financial support to Northern Rock. To regulators at the time, this financial support was intended to calm markets, and their view was that Northern Rock customers were panicking. But the truth is that, with any uncertainty about bank solvency or timely administration of the government support, it is rational for customers to “panic” first, withdraw their funds, and place them elsewhere. Of course, everyone thinks that way, and a run starts. In an article describing the run on Northern Rock in The Sunday Times , this point is perhaps best illustrated by one particular savings customer lining up outside a branch: “I don’t want to be the mug left without my savings.” 30 As Fannie and Freddie were running aground in early September 2008, and the issue was whether or not to confirm what everybody knew – their government guarantee – Fannie...
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But then why do the GSEs still buy these loans Even though...

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