Susan Woodard and Robert Hall on what should happen to Fannie and Freddie:
What to do about Fannie Mae and Freddie Mac?, by Woodard and Hall: Here are our recommendations. A discussion follows.
- The GSEs should be preserved, mainly because they are the most effective institutions for providing liquidity to the mortgage market. Most mortgage investors, including depositories, prefer to hold liquid securities rather than illiquid whole loans. Wall Street securitization is not a substitute.
- Fannie and Freddie should be chartered as special-purpose banks, playing their historical roles of securitizing mortgages and holding some portfolio of loans. Their debt should be federally insured or guaranteed, as are the deposits of banks, and as with banks, the equity of the institutions should be the first backup to bondholders as the capital (or equity) of banks is the first backup to deposits. Their insured or guaranteed debt should not be counted as part of federal debt, as the insured deposits of banks are not. They should be subject to capital standards and supervision of their activities, and subject to restrictions on their activities, like banks. The capital standards, activity restrictions, and supervision need not be identical to those of banks.
- It is important to have two GSEs to assure competitive pricing of the guarantees on mortgages which go into MBS pools. Guarantee fees are not posted prices, but negotiated in secret. As a result, the pricing of guarantee fees is not collusive but close to perfect (Bertrand) competition with two GSEs. In the trade-off of standardization and homogeneity to promote liquidity (which calls for fewer GSEs) vs. competition to assure competitive pricing (which calls for more), two gets an excellent result, likely the best result.
- There are three choices for F&F ownership: 1) owned by the government, like FHA and Ginnie Mae; 2) owned as a cooperative, by member institutions, as both once were, and 3) owned by the general public. Fannie and Freddie should be owned by public shareholders, as banks are. We advocate ownership as public companies, but with explicit and priced federal backing, like banks.
[Update: Arnold Kling comments on Woodard and Hall's analysis (agrees) and policy proposals (disagrees).]
[Update: See also On the GSEs (again), by Richard Green.]