Exhibit 9 Banks Have Grown Their Market Share More Quickly Than Fannie Mae As shown in the table above, the largest banks have increased their investment in mortgage assets at a rate more than twice as fast as the growth in the underlying mortgage market, and have rapidly increased their share of total mortgage debt outstanding. Their share has increased by four percentage points from 2000 through the third quarter of 2003. Fannie Mae has grown in line with the market, increasing our share by only two percentage points over this time frame. Impact of Portfolio Limits There are some who would argue that the government through regulation or legislation should place an artificial limit on the growth of Fannie Mae's portfolio. We do not believe that such an approach is in the interest of homeowners. The question for policymakers is to ascertain where mortgage interest rate risk is best managed. The alternatives are institutions that are not focused exclusively on the mortgage market, banks which can go in and out of the mortgage market based upon prevailing returns, and homeowners themselves. If Fannie Mae were limited in our ability to invest in mortgages, the interest rate risks inherent in mortgages would not go away, they would be borne by other institutions, primarily commercial banks and thrifts, or by homeowners. If risk migrated from Fannie Mae to the banking system, there is no doubt that taxpayers would be at higher risk. Commercial banks and thrifts take insured deposits that have an explicit guarantee from the government. Our debt securities have an explicit disavowal of any government support. Because banks can use deposits as their primary funding for mortgages, their mortgage asset cash flows may not match up well against their deposit liabilities when interest rates change. In general, to maintain an overall asset-liability match, banks fund mortgages with short-term deposits and adjust the relative weighting of mortgages within their portfolios. In particular, banks do not use callable debt to fund or hedge mortgage investments. Because they hedge to a lesser extent, banks investing in mortgages retain a good portion of the prepayment risk. But when interest rates move up significantly, they may have to sell mortgages into the market. The market will ultimately adapt in one of two ways. Either banks will face higher risks, because they continue to hold fixed-rate mortgage assets without a liquid secondary market or any other market outlet, or banks will reduce the availability of 30-year, fixedrate loans. Consumers would be left with only adjustable-rate products that expose them to uncertainty and interest rate volatility. If interest rate risk is not managed in the financial system, it has to be managed by individual mortgage borrowers, forced to take adjustable-rate mortgages. In fact, this is what the IMF explicitly advocated in its Global Financial Stability report, saying, "A more fundamental way for mortgage lenders to reduce their hedging needs would be to price adjustable-rate mortgage more aggressively to limit the creation of new fixed-rate mortgages with prepayment rights, although persuading borrowers to accept adjustable-rate mortgages when fixed rates are still at historically low levels would undoubtedly be difficult." As Dr. Todd Buchholz has noted, "One of the most beneficial financial revolutions in recent memory has been in the housing sector, namely, the creation of secondary mortgage markets...the secondary mortgage market has been a vital technological and financial innovation that has helped spread risk, dampen economic crises, and attract more investors into the housing market... Without the secondary market, banks would have less liquidity available and would make fewer loans and charge higher interest rates." A limit on our portfolio growth would eliminate our function as an outlet for banks in this situation. With Fannie Mae in place as backstop, ready and able to purchases mortgage assets should banks wish to unload them from their portfolios, the system works. When mortgages present a profitable opportunity for banks, banks invest, and Fannie Mae's portfolio is stable or declines. When mortgages are no longer profitable for banks relative to the many other assets they are able to invest in, banks can offload their mortgages to Fannie Mae and Freddie Mac. That is a benefit to the system, to banks, and to consumers. Any arbitrary constraint on our portfolio would remove an important bid for mortgages from the market, which would lead to higher and more volatile mortgage rates for homeowners. It would also increase risk to the taxpayer, as mortgage interest rate risk migrates from Fannie Mae and Freddie Mac to commercial banks, which fund themselves with government-insured deposits. Finally, it would increase risk to the financial system, removing Fannie Mae and Freddie Mac's ability to act as stabilizer during financial crises. CONCLUSION I applaud every member of this committee for the time and effort you have put into examining the options for strengthening our regulatory regime and carefully considering the implications of the different choices you may make. Our mortgage finance system today is the envy of the world - the only system in the world that has made long-term, refinanceable fixed-rate mortgages the standard consumer product. And the efficiency of our system has created an enormously liquid mortgage market that reduces mortgage rates for millions of homebuyers. A recent paper by a Federal Reserve Board economist has questioned the benefits our current system brings to consumers, estimating that the GSES only reduce mortgage rates by seven basis points.21 To measure the extent to which Fannie Mae and Freddie Mac reduce conforming mortgage rates, the author constructs a complex equation (Exhibit 6) that does not reflect the way the mortgage market works. He also uses data that he himself characterizes as "not up to the task." Not surprisingly, his resulting estimate that Fannie Mae and Freddie Mac reduce conforming mortgage rates by only 7 basis points has little statistical significance and is at odds with everyday experience in the mortgage markets. Exhibit 10 Calculated GSE Effect on Jumbo- a1 = ẞ 。 + B1GA + B2RT+ ẞ2CR + ẞ ̧PR + 8=1. Source: The GSE Implicit Subsidy and Valuc of Government Ambiguity Wayne Fass more, Board of Governors of the Federal Reserve System The Fed study, like a study in 2001 by the Congressional Budget Office, is based on the presumption that Fannie Mae and Freddie Mac receive a “subsidy” from the government, which is the sole determinant of the enterprises' ability to attract low cost funding. We asked David Gross of Lexecon to examine this premise. Ile noted that "By ignoring the fact that debt issued by banking organizations differs from debt issued by Fannie Mae and Freddie Mac for reasons other than the presence of a guarantee, the CBO overestimates the expected cost of government guarantees. In particular, to the extent that part of the reason that GSE debt has low interest rates is because of high levels of liquidity, the CBO methodology will overestimate the expected cost of government guarantees.' 22 21 The GSE Implicit Subsidy and Value of Government Ambiguity, Wayne Passmore, Board of Governors of the Federal Reserve System, December 2003, available at http://www.federalreserve.gov/pubs/feds/2003/200364/200364pap.pdf. 22 The Government Role in Promoting Financial Sector Stability, David Gross, Fannie Mae Papers (Volume II, Issue 3) July 2003, available at http://www.fanniemae.com/commentary/pdf/fmpv2i3.pdf Fannie Mae's economists and econometricians reviewed the methodology of the Fed study, and found reason to be concerned that the analysis did not support the stated findings. The findings are attached. Specifically, they noted that both the data and techniques used caused a serious downward bias in trying to measure our effect on mortgage rates. We also asked several eminent economists outside of Fannie Mae to take a look at the Fed study. Dr. William Greene, a prominent econometrician, examined the methodology employed in the Fed study and concluded, “Based on my review of the model specification, I conclude that the results in the Passmore study may well be seriously flawed...I believe the study should be subjected to extensive scrutiny before being used as a guide to the magnitude of Fannie Mae and Freddie Mac's impact on conforming mortgage rates." I've attached his comments for the record. Last year, we commissioned a study from Professor R. Glenn Hubbard, former Chairman of the Council of Economic Advisers and a Professor at Columbia University, on Fannie Mae's management of liquidity risk. We recently asked for his views on the Fed study. In a letter, which I would like to enter into the record, he noted, "In the study I conducted last year, I found that Fannie Mae's return on assets and net interest margin have been less volatile historically than those of large commercial banks. This finding is consistent with the possibility that Fannie Mae's overall business risk is lower as well. This possibility and its implications for differences in funding costs between Fannie Mae and other financial institutions have not been fully explored in recent studies, including a recent Federal Reserve working paper." We have also asked Professor Alan Blinder of Princeton, a former Vice Chairman of the Board of Governors of the Federal Reserve System for his reaction to the study. In a letter which is attached for the record, he states that there are a number of questions that could be asked with respect to such an analysis. "Passmore's conclusions depend sensitively on both his assumptions and the details of his estimation methods, many of which can be legitimately questioned," Blinder wrote. Real world observations also differ from the econometric estimates in the Fed study. Many local newspapers publish mortgage rate charts every weekend, like the example from the Washington Post (Exhibit 7), listing the rates offered by many lenders. |