- Government-Sponsored Enterprises and Resource Allocation:Some Implications for Urban Economies
About half of the money that finances housing in the United States comes from three government-related "agencies": two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, and a government-owned enterprise, Ginnie Mae. These agencies buy mortgages and securitize them by selling either "pass-through" securities or debt backed by mortgages in the bond markets.1 This paper analyzes these three agencies—primarily Fannie and Freddie—including their role in the mortgage market and their effects on resource allocation and urban economies. It does not touch on some of the more popular recent aspects of Fannie Mae and Freddie Mac, in particular safety and soundness, accounting, and privatization. These are interesting, albeit not always well researched, topics that are beyond the scope of this paper. With one exception, the paper does not offer policy recommendations.
The analysis focuses on the way GSEs affect resource allocation and urban economies through their effects on the structure of the mortgage market—in particular, on the division of labor in the market between banks, which act primarily as portfolio lenders, and the GSEs, which act primarily as securitizers. [End Page 151] Most of the discussion in the paper focuses on the effects of GSEs on mortgage rates and market liquidity. However, there are also "mission" requirements that come out of their charters and legislation that imposes portfolio restrictions on the GSEs, which induce them to lend in central cities and to targeted groups. These are discussed as well. A problem with evaluating these requirements is that the nature of the portfolio restrictions, coupled with similar rules for banks, makes it extremely difficult to sort out the marginal impact of the GSE regulations on targeted lending. A proposal to make their impact easier to understand is discussed below.
Both banks and the GSEs exist simultaneously in the mortgage market, and an accurate description of the structure of the market can be summarized as one of dueling charters.2 That is, there are two major charters in the industry: one charter is for depositories or "banks" (traditionally thrifts, but now mostly commercial banks), which use the deposit market as their primary way of attracting funds; the other charter is for the GSEs, which use the bond markets. The charters have similarities, particularly in the form of ownership (both are privately owned) and subsidies (mainly in the form of implicit and explicit guarantees). They also have differences—for instance, in regulation and market structure (there are thousands of banks and only two GSEs in the mortgage business). Yet both are viable. The ratio of GSE purchases to mortgage originations increased sharply in the 1980s; since then, it has fluctuated over time, and it has been declining lately. The older distinction between primary markets (banks) and secondary markets (Fannie Mae and Freddie Mac) is no longer very important. Now there are simply different ways of getting money from the financial markets to the mortgage market (for example, via a bank through deposit markets or via a GSE through bond markets). In effect, there are two sorts of GSEs: explicit (Fannie and Freddie) and implicit (banks).
A central question in any analysis of financial structure is whether the type of funding and the type of institution doing the funding should matter. One of the basic tools of financial economics—the Modigliani-Miller irrelevance theorem—suggests that in competitive markets the nature of the institutions supplying funds does not matter.3 That is the point of departure. Of course, there are subsidies in the market. GSEs get theirs primarily in the form of implicit guarantees, allowing them to take on risk without fully paying for it; subsidies can invalidate the Modigliani-Miller theorem. But that is not enough to explain the rise of securitization and the determinants of market [End Page 152] share relative to banks because banks also receive subsidies from deposit insurance, and it is not at all clear that (at the margin) banks get smaller subsidies than GSEs do.4 An alternative candidate for theorem violation is asymmetric information coupled with restrictions on where subsidies can be used (banks have historically...