The GSEs: Where Do We Stand?

Article excerpt

This article was originally presented as a speech to the Chartered Financial Analysts of St. Louis, St. Louis, Missouri, January 17, 2007.

One of the Federal Reserve's most important responsibilities is maintenance of financial stability. The job obviously, and sometimes dramatically, encompasses crisis response. However, the very existence of a crisis, when one occurs, often demonstrates a failure of some sort, on the part of the firms involved, the government, or the Federal Reserve. It would not be difficult to cite examples of such failures.

Not long after coming to the St. Louis Fed in 1998, I became interested in government-sponsored enterprises, or GSEs. My interest arose when I began digging into aggregate data on the financial markets and discovered how large these firms are. The bulk of all GSE assets are in the housing GSEs--Fannie Mae, Freddie Mac, and the 12 federal home loan banks (FHLBs). Using information as of September 30, 2006--the latest available as of this writing--these 14 firms have total assets of $2.67 trillion; given their thin capital positions, their total liabilities are only a little smaller. Just two firms--Fannie Mae and Freddie Mac--account for $1.65 trillion of the assets, or 62 percent of all housing GSE assets. Moreover, Fannie Mae and Freddie Mac have guaranteed mortgage-backed securities outstanding of $2.82 trillion. Thus, the housing GSE liabilities on their balance sheets and guaranteed obligations off their balance sheets are about $4.47 trillion, which may be compared with U.S. government debt in the hands of the public of $4.83 trillion.

In what follows, I'll confine most of my comments to Fannie Mae and Freddie Mac, where the largest issues arise. My purpose is to make the case once again that failure to reform these firms leaves in place a potential source of financial crisis. Although there is pending legislation in Congress, a major restructuring of these firms and genuine reform appear to be as distant as ever. My initial curiosity about the GSEs was stoked simply by the size of these firms. As I investigated further, I became concerned about their thin capital positions and the realization that if any of them got into financial trouble the markets and the federal government would look to the Federal Reserve to deal with the problem. As I worked through the issues, I began to speak on the subject; my first such speech was in October 2001 (Poole, 2001). I last spoke on a GSE topic two years ago, before the St. Louis Society of Financial Analysts.

My title then was "GSE Risks" (Poole, 2005). Given that the risks did not seem likely to disappear any time soon, about six months ago I settled on a GSE topic once again.

Today I want to look back over the past few years to summarize a few of the changes that have occurred at the GSEs and in the regulatory environment they face. It is no exaggeration to say these have been event-filled years for the GSEs, primarily because of disclosures of accounting irregularities at Fannie Mae and Freddie Mac. Although these firms stopped growing when the irregularities were disclosed, I will emphasize that once they get their houses in good order they will likely resume rapid growth because of the special advantages they enjoy in the marketplace from their ties to the federal government. I remain hopeful that Congress will eventually pass meaningful GSE reform legislation. Private sector financial firms ought to have an intense interest in reform legislation. Still, given that there seems to be so little appreciation of the importance of the GSE issue, where do they--and we--go from here?

Before proceeding, I want to emphasize that the views I express here are mine and do not necessarily reflect official positions of the Federal Reserve System. I thank my colleagues at the Federal Reserve Bank of St. Louis for their comments--especially Bill Emmons, senior economist, who provided special assistance. …