The GSEs’ Special Status

This post is mostly for reference so I can link to it in further posts. Below is a section from a Congressional Budget Office report issued May 2003 when the Bush administration was trying to allow the SEC to regulate Freddie Mac, Fannie May and the Federal Home Loan Banks (collectively, the government sponsored enterprises or GSEs). It nicely summarizes the special status of the GSEs and explains how the market reacted to their special status. (Scroll down to the section, The Benefits of GSE Status.)

Current law treats the GSEs as instrumentalities of the federal government, rather than as fully private entities. As a consequence, they are afforded exemptions from many taxes, fees, and regulations; and for many purposes, their securities are treated as government securities.

For Fannie Mae and Freddie Mac, GSE status starts with their federal statutory charter, which exempts them from state and local income taxes (but not federal taxes or local property taxes) and enables them to use the Federal Reserve as their fiscal agent. In addition, the U.S. Treasury is authorized to lend $2.25 billion to each enterprise either through purchases of its securities or through direct lending. Like Treasury debt, debt issued by the GSEs is eligible for use by banks as collateral for both public deposits (for example, the Treasury’s deposits)(4) and loans from Federal Reserve banks, for unlimited investment by federally chartered and insured banks and thrifts, and for purchase by the Federal Reserve in its open-market operations.(5) Finally, Fannie Mae and Freddie Mac–along with the Federal Home Loan Banks and the Farm Credit System (but not the Federal Agricultural Mortgage Corporation, which is known as “Farmer Mac”)–are exempt by law from the registration and disclosure requirements that the Securities and Exchange Commission (SEC) imposes on nearly all other large privately owned issuers of publicly traded securities.(6) Fannie Mae and Freddie Mac are also the only issuers of publicly traded stock that are exempt.
If Fannie Mae and Freddie Mac were federal, rather than government-sponsored, agencies, those provisions would be unremarkable. But the enterprises are privately owned entities that have a possibility of insolvency. Although Fannie Mae is financially strong now, it experienced a series of losses in the early 1980s that could have caused the failure of a purely private firm.(7) The statutory provision for the U.S. Treasury to lend to the GSEs in time of financial distress acknowledges the risk of failure. Indeed, the Office of Federal Housing Enterprise Oversight (OFHEO), the safety and soundness regulator of Fannie Mae and Freddie Mac, was established to control GSEs’ risks.
The GSEs receive two distinct but related benefits from their sponsored status.(8) First, regulatory and tax exemptions reduce their operating costs. Second, and far more important, their treatment in federal law is interpreted by investors as implying that the credit risk of GSE debt and MBSs is comparable to that of U.S. Treasury debt, which is regarded as the least risky debt in the financial markets.(9) As a consequence, GSEs’ debt issues are traded in the market for federal agencies’ obligations, where interest rates are somewhat higher than those on Treasury debt but below those on the highest-quality private securities.

So it’s easy to see how the GSEs distorted the market by hiding the risk of residential real estate lending. There is no way that a private entity could get its securities rated as equal to U.S. Treasury bonds. Neither could a private entity change the laws to allow other institutions to use its securities as legal collateral. 

In creating the GSEs, the government created a chimeric monster with the backing and authority of a government agency combined with the profit seeking of a private company. Such a combination was inevitably going to lead to trouble. 

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