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Federal Reserve Economist Study Makes Waves

JANUARY 2, 2004


Federal Reserve Economist Study Makes Waves

During the Christmas week news lag, the Federal Reserve released an academic study labeled as a "preliminary draft" that added fuel to the fire of the housing GSE political and ideological debate. Wayne Passmore, the author of "The GSE Implicit Subsidy and the Value of Government Ambiguity" highlighted that he found the federal government implicit subsidy of Fannie Mae and Freddie Mac results in funding advantages averaging 40 basis points for the GSEs over private sector institutions, that the actions of GSE's result in slightly lower mortgage rates (seven basis points) for some homeowners, that the government's ambiguous relationship with Fannie and Freddie imparts a substantial implicit subsidy to GSE shareholders (between 42% and 81% of the companies' stock value) and that the GSE's implicit subsidy does not appear to have substantially increased homeownership or homebuilding.

Fighting words designed for maximum political impact. The Federal Reserve is supporting the Treasury's legislative push to bring the housing GSEs under new and tougher regulation and supervision, while generally trying to rein in many government programs, including deposit insurance, that are assigned the "subsidy" label.

Both Fannie and Freddie immediately disputed the Fed's findings that they provide only minimal benefits for mortgage markets and homeowners, citing the difference in rates between conforming and jumbo loans. The Fed's findings also do not agree with other studies on the benefits provided by Fannie and Freddie. Earlier this fall, a Congressional Budget Office study found a 25-basis-point reduction in mortgage rates, much higher than the seven basis point findings in the Fed study, while an Office of Management and Budget study concluded that borrowers receive approximately $4 in benefits for every one dollar of federal subsidy to the two GSEs.

It was no surprise that the editorial page of the Wall Street Journal was delighted with the study. Doing in Fannie and Freddie, as well as federal deposit insurance, has been part of its ongoing ideological mantra. Almost totally overlooked by the press were the study's two last sentences calling for more research on the relative efficiency of different institutions for the delivery of subsidies to homebuyers (like the too-big-to-fail financial institutions leading the political war against Fannie and Freddie on the Hill, ICBA would add) while opening the door to consideration of expansion of "more direct and targeted government mechanisms such as FHA" lending to reach first-time and lower income homebuyers.

The timing of this study, however preliminary, no doubt will add further fuel to the political and ideological debate over the regulation and mission of the housing GSEs, including the Federal Home Loan Banks. Community bankers have a major stake in how this debate is resolved.