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Strategies & Market Trends : The Residential Real Estate Crash Index -- Ignore unavailable to you. Want to Upgrade?

To: Ramsey Su who wrote (15575)	12/22/2003 4:21:56 PM
From: ild	Read Replies (1) \| Respond to of 306849

Introduction and Summary The housing-related government-sponsored enterprises Fannie Mae and Freddie Mac (the “GSEs”) have an ambiguous relationship with the federal government. Most purchasers of the GSEs’ debt securities believe that this debt is implicitly backed by the U.S. government despite the lack of a legal basis for such a belief and despite the fact that the prospectus for each GSE security clearly states that GSE debt is not backed by the government. The markets’ impression that the government implicitly backs Fannie Mae and Freddie Mac is based on the GSEs’ history, on the size of their portfolios, on the fact that the government mandates housing goals for these firms, and on the many indicia of explicit government support. For example, the government provides the GSEs with a line of credit from the Department of the Treasury, fiscal agency services through the Federal Reserve, U.S. agency status for GSE securities, exemptions from securities registration requirements, exemptions from bank regulations on security holdings, and tax exemptions. The result is an ambiguous relationship between the GSEs and the federal government in which investors infer government support while government officials deny it.2 In this paper, I estimate how much GSE shareholders gain from this ambiguous government relationship. In particular, I use a standard discounted earnings model to estimate the proportion of Fannie Mae’s and Freddie Mac’s market value that can be attributed to their GSE status. I refer to this estimated amount as their implicit government subsidy.3,4 I draw six conclusions from my study: ! The perception that the federal government backs the obligations of Fannie Mae and Freddie Mac has resulted in a funding advantage for the GSEs over private sector institutions; this advantage has averaged roughly 40 basis points from 1998 through the first half of 2003. ! The actions of GSEs result in slightly lower mortgage rates for some homeowners; my best estimate suggests a reduction of around 7 basis points. Fannie Mae’s and Freddie Mac’s ambiguous relationship to the government imparts an implicit subsidy to GSE shareholders and homeowners. In dollar terms, the gross value of this subsidy is estimated to be between $119 billion and $164 billion, of which the shareholders retain between $50 billion and $97 billion. Under my “middle-of-the-road” assumptions, the GSE shareholders retain roughly 52 percent of the gains from their ambiguous government relationship or about $72 billion. ! My calculation also suggests that roughly 42 percent to 81 percent of the GSEs’ market value is due to their implicit government subsidy. Of course, if the GSEs’ implicit subsidy is eliminated, their market value may not fall as much as suggested by these estimates because they would reorganize themselves. Indeed, without the “political risk” of changes in their GSE status, their price-to-earnings ratios might actually rise. ! If the GSEs were purely private, in the sense that their returns on equity and their returns on assets were similar to those of other large financial institutions, they would hold far fewer of their own mortgage-backed securities in portfolio and, as a consequence, would be much smaller organizations. Their capital-to-asset ratios would be more than double their current capital-to-asset ratios. ! The GSEs’ implicit subsidy does not appear to have substantially increased homeownership or homebuilding because the estimated effect of the GSEs on mortgage rates is small. My estimates span a wide range because the data that are currently available do not allow more precise estimates. However, while better data on mortgage rates and agency debt spreads would yield a more precise estimate of the GSEs’ implicit subsidy, even on the basis of current data I conclude that the value of the federal government’s ambiguous relationship to GSE shareholders is positive, very large, and does not seem to result in either a substantial reduction in mortgage rates or an increase in homeownership.