Congressman Richard Baker, R-La., chairman of the House Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises, is releasing a report today by the Congressional Budget Office updating its 1996 study that attempted to quantify the advantages that Freddie Mac and Fannie Mae get from their congressional charters and the benefits to consumers.
The CBO concludes now, as in 1996, that Freddie Mac and Fannie Mae come out way ahead of homeowners.
Unfortunately, it missed the boat in 1996 and has done so again in 2001. Its analysis is fundamentally flawed, and any policy change made on the basis of the latest report could carry a big price tag for the American public.
Freddie Mac and Fannie Mae are government-sponsored enterprises that play a crucial role in the secondary market for residential mortgages. Operating under essentially identical congressional charters, they get lower borrowing costs than they would have in the absence of federal sponsorship, and they use this funding advantage to reduce the cost of mortgage credit and provide other perks to homeowners.
In anticipation of the CBOs update, Freddie Mac asked us to evaluate the original 1996 study. Our review uncovered things that lead CBO to overstate the GSEs funding advantage and understate the consumer upside. These errors resulted from several technical mistakes and also from a myopic approach that assumed that Freddie Mac and Fannie Mae are mere conduits for federal subsidy.
Thus, the CBO methodology missed the full import of Freddie Mac and Fannie Maes effects lowering rates throughout the mortgage market and providing liquidity, and thus stability, over a wide range of financial market conditions.
Freddie Mac also asked us to provide our own estimates. With respect to their effects on mortgage interest rates alone, we concluded that Freddie Mac and Fannie Mae save consumers $8.4 billion to $23.5 billion a year. (We did not attempt to quantify advantages associated with increased liquidity and the social goal of expanded homeownership opportunities for low-income and minority families.)
On the other hand, we estimate that the yearly funding advantage to Freddie Mac and Fannie Mae ranges from $2.3 billion to $7 billion. Thus, under the current institutional arrangement, even the lowest estimate of consumer benefit exceeds the highest estimate of GSE funding advantage.
The CBO report released today includes many errors, some that were in the earlier study and some new ones.
Our criticisms fall in three major areas. First, the CBO makes erroneous assumptions that inflate the alleged subsidies to the GSEs and deflate benefits to consumers.
For example, though Freddie Mac and Fannie Mae have recently been rated AA-minus on a stand-alone basis, the CBO bases its estimates of the GSEs funding advantage on securities issued by a group of banks, most of which have ratings of single-A. The resulting differential, 47 basis points, is above the range of estimates produced by numerous other researchers and also above the estimate the CBO would have obtained had it based its analysis on comparably rated securities. At the same time, the office uses an artificially low estimate of the GSEs effect on homeowners mortgage interest expense.
Second, the latest report adopts a new accounting methodology that further inflates the CBOs estimate of the funding advantage.
The 1996 study measured benefits to consumers and GSEs as annual flows. Todays update records benefits in the year the loan is made, measured by the capitalized value of the flow of benefits over time.
While this methodology has its place as in budgeting credit guarantees of the federal government this is not the same kettle of fish. The typical consumer does not consider a loan secured last year on favorable terms as having exhausted its advantages; rather, it is a source of monthly savings.
The new methodology also produces anomalous fluctuations in measured benefits and requires simplifying assumptions that introduce more problems into the analysis than the methodology purportedly solves.
Third, the model the CBO uses to address the benefits issue is totally inappropriate. In CBOs world, the federal government hands over to Freddie Mac and Fannie Mae certain benefits that the two companies then distribute to intended beneficiaries consumers of mortgages minus a service charge.
This formulation is narrow and unrealistic, for it ignores, among other things, activities of Freddie Mac and Fannie Mae in making the mortgage market more cost-effective. The correct way to analyze the GSEs role is to include the whole panoply of effects of their institutional arrangement.
The CBOs use of a myopic flow-through model causes it to miss some of the most dynamic aspects of the mortgage market while undercounting benefits that consumers all across America realize every day.
Mr. Pearce, an economist specializing in housing finance and labor markets, is vice president of Welch Consulting in College Station, Tex. Mr. Miller, who was a director of the Office of Management and Budget from 1985 to 1988, is a director of LECG Economics-Finance in Washington. Their evaluation of the congressional Budget Office's 1996 report and their response to the new report can be found at www.freddiemac.com.