St. Louis Fed: GSE Shock Could Freeze Market

A severe shock to one of the housing government-sponsored enterprises could bring the mortgage market to a standstill, according to economists at the St. Louis Federal Reserve Bank.Risk-taking by Fannie Mae, Freddie Mac, and the Federal Home Loan Bank could "undermine the financial system because so many banks depend on them for liquidity," according to an article in the FRB's monthly publication, The Regional Economist. Commercial banks have one-half of their securities portfolios invested in GSE mortgage-backed securities and debt, the authors point out. And commercial banks are comfortable holding real estate loans because they can serve as collateral for FHLBank advances or be sold to Fannie or Freddie. "A severe shock to one or more of the housing GSEs could lead to a market lockup, in which investors become reluctant to hold GSEs' direct or indirect obligations," the article says. "This could, in turn, lead to a temporary suspension of mortgage purchasing, mortgage securitizing or mortgage 'advancing,' thereby forcing the Federal Reserve to intervene to re-liquefy the mortgage markets." The article, "The Housing Giants in Plain View," discusses ways to increase GSE competition and limit their borrowing and growth. The authors also warn that privatization would not eliminate the systemic risk posed by the GSEs. "That is, a fully privatized Fannie Mae still might be considered too big to fail by the Federal Reserve and by the Treasury," the authors say.