GSEs Are Arbitage Funds, Not Thrifts

To the editor:

I read with interest your article ("The Fannie/Freddie Conundrum") in the December issue. Basically, I don't disagree with your point that, given the situation in which we find ourselves, the nation is not in a position to simply shut down Fannie and Freddie. But I do take issue with your characterization of the GSEs as "giant savings and loan institutions."

A better description would be that they are giant arbitrage funds. They take dirt-cheap money (thanks to the always-implicit federal guarantee and now also the direct Treasury injections) and invest it in mortgage-backed securities that have a higher yield. In the past this was a recipe for outsized (indeed, some would say unconscionable) profits, until they got stupid and greedy and, as you noted, stopped paying any attention to the quality of the loans and got burned.

Granted that the U.S. continues to need some mechanism (i.e., securitization) for moving mortgage loans off banks' balance sheets, and granted, further, that the GSEs are, at present, the only game in town for accomplishing this (thanks in large measure to the GSEs' own culpability in blowing up the private MBS market), I concede that there does indeed remain a place for the GSEs. That doesn't mean, however, that they should be permitted to continue in their present form, even with the reforms you suggested.

The only reason for keeping the GSEs alive is to provide liquidity to the residential mortgage market, primarily the purchase-money residential mortgage market. This means that the GSEs should continue to buy and securitize conforming residential mortgages, but it does not mean that they should invest in the securities they create. It also does not mean that they should remain major players in markets unrelated to residential mortgage loans (such as multifamily housing, second liens, non-mortgage transactions, or even [in my opinion] refinancings). Accordingly, I would break each of the GSEs into the following three separate pieces:

1) Mortgage acquisition and securitization (their core function). 2) Noncore lending functions (those listed above), which should be spun off and sold into the private market. 3) The MBS portfolio.

At the end we'd wind up with two (or maybe just one) GSEs stripped to their core function of providing liquidity to the residential mortgage market (but not the securities or other markets).

Laird Minor, Managing Director

Nautilus Capital LLC

Mauldin, SC

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