Fed Study Says Fannie, Freddie Lower Consumer Mortgage Costs by Only 7 BPS

According to The GSE Implicit Subsidy and Value of Government Ambiguity report released Monday by the Federal Reserve, Fannie’s and Freddie’s virtual subsidy — resulting from the perception that the GSEs’ debt issues are government-guaranteed — is valued to be between $119 billion and $164 billion, of which shareholders retain about $50 billion to $97 billion.

As for homeowners, the mortgage giants’ function in the secondary market lower costs for borrowers by an average of only 7 basis points, or seventh-tenths of one percent, according to Wayne Passmore — author of the report. The figure is minuscule compared to a previous study’s estimate of 25 basis points.

“Attempting to use government-sponsored enterprises to lower mortgage rates is indirect and, perhaps, less effective than a direct subsidy would be,” wrote the report’s author Wayne Passover, a staff member of the Federal Reserve. “The GSEs implicit subsidy mainly takes the form of lower funding costs. To pass these lower costs on to homeowners requires that GSE shareholders not capture this subsidy in the form of increased profits.”

A Freddie spokesman said the report used “incorrect methodology” and reached “incorrect conclusions.” He pointed out that an in-depth study on this subject, performed in 2001 by Dr. Jim Miller, a former director of the Office of Management and Budget and Dr. Jim Pearce, “found that Freddie Mac and Fannie Mae provide consumer benefits of up to four dollars for every one dollar of implied benefits the GSEs receive.”

In his report, Passmore pointed out that the Pearce and Miller study was one of various previous studies sponsored by the mortgage giants that criticized the analysis of the GSEs’ ambiguous relationship with the government, and the value to its shareowners versus its borrowers.

In an e-mailed statement, Fannie’s communications senior vice president Chuck Greener said that “at first blush, the findings in the discussion draft [from the Federal Reserve] appear to be highly theoretical and bear no resemblance to the reality experienced in the housing industry and capital markets every day.”

“However, we will study the paper and provide Dr. Passmore with a complete set of comments,” added Greener.

Passmore found that investor perception that the government backs the GSEs’ debt issues, fueled by many factors including the mortgage giants’ exemptions from bank regulations on security holdings, tax exemptions and a line of credit from the Department of Treasury, has lead to the GSEs’ funding advantage over private sector institutions — roughly 40 basis points from 1998 through the first half of 2003. If private, in the sense that their returns on equity and on assets were similar to those of other large financial institutions, the GSEs would hold far fewer of their own mortgage-backed securities in their portfolio and their capital-to-asset ratios would be more than double of what they currently are.

Additionally, the Fed economist said that roughly 42 percent to 81 percent of the GSEs market value is due to their implicit government subsidy.

The report comes at a vulnerable time for the two GSEs — which are dealing with the repercussions of Freddie’s accounting fraud disclosures during a period when the government and litigators are trying to reign in slack corporate governance, illegal securities trading, and fraudulent accounting for a range of industries.