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The Journal of Real Estate Finance and Economics

Erschienen in:

30.11.2018

Fannie Mae and Freddie Mac: Risk-Taking and the Option to Change Strategy

verfasst von: Jason Thomas, Robert Van Order

Erschienen in: The Journal of Real Estate Finance and Economics | Ausgabe 3/2020

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Abstract

We analyze causes of the surge in defaults experienced by Fannie Mae and Freddie Mac during the Great Recession. Our data are consistent with the following: The two faced a trade-off between subsidized risk-taking (due to a guarantee implied by their charters) and franchise value (due to the scarcity of their charters). Around 2005 there was a change in the relative benefits of the two due to increased competition from “private label” securities. Along with declines in house prices, the increase in defaults is best explained by exercising an option to change strategy, before regulators fully caught on, toward newer, riskier loan types, after the decline in franchise value.

Vorheriger Artikel Mortgage Pricing Implications of Prepayment: Separating Pecuniary and Non-pecuniary Prepayment

Nächster Artikel The Wealth Effects of REIT Property Acquisitions and Dispositions: the Creditors’ Perspective

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Capital requirements were essentially the maximum of capital needed to pass a stress test and a separate minimum capital ratio. On the GSE stress tests and their performance see Frame et al. (2015b). They came to results similar to ours of a shift in the default function.

There were also contract provisions that allowed GSE to put mortgages back to sellers for contract violations.

For the remaining 10% there was some sort of risk-sharing (required by charter). Contracts with sellers often required buybacks when contract terms had been violated.

Note again that differences are even larger than depicted in the table because these raw data do not adjust for later vintage loans having less time to default. We make an adjustment for this in our estimation in the next section.

Negative amortizing loans were not the issue as much as other factors. They defaulted at a 39% lower rate than the overall book of business. Loans with no-or-negative amortization features are more likely to be underwater because they have a higher residual unpaid principal balance, but this effect is negligible given the timeframe involved.

PSA or Public Securities Administration is a simple benchmark that is often used for quoting yields on mortgages based on a simple model of prepayments.

This is the parameter estimate exponentiated, i.e. e^1.36 = 3.9.

This is the parameter estimate exponentiated minus one, i.e. e^-0.75 = 0.47–1 = −0.53.

Deng et al. (2000) find a similar result.

This is the parameter estimate exponentiated minus one, i.e. e^-0.78 = 0.45–1 = −0.54.

In unreported regressions, the results in this section are replicated using a logit model instead of the proportional hazards and a “probability of underwater” variable in place of Market LTV.

We conjecture that the very high coefficients for the first two years come from the very low probability of loans form this vintage had negative equity, and that the Gaussian distribution underestimates tail events. There are still effects for LTV at 80 and at 90, suggesting as before that these loans have something to hide.

The very high coefficients for probability of negative equity for 2001 and 2002 probably reflects shortcomings in the negative equity measure.. That is our measure makes that number very small, but there were still defaults, so high coefficients are needed to fit those two years.

They have loan level data and know exposure year as well as origination year and simultaneously estimate prepayment

In an earlier version of this paper we performed Granger Causality tests, which confirm what is clear from looking at the timing.

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Titel: Fannie Mae and Freddie Mac: Risk-Taking and the Option to Change Strategy
verfasst von: Jason Thomas
Robert Van Order
Publikationsdatum: 30.11.2018
Verlag: Springer US
Erschienen in: The Journal of Real Estate Finance and Economics / Ausgabe 3/2020
Print ISSN: 0895-5638
Elektronische ISSN: 1573-045X
DOI: https://doi.org/10.1007/s11146-018-9679-7

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