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Byline: Dwight Jaffee (1) Keywords: Fannie Mae; Freddie Mac; government sponsored enterprises; interest rate risk; mortgage market. Abstract: This paper evaluates the interest rate risk of Fannie Mae and Freddie Mac (F&amp F) and develops related public policy proposals. F&amp F merit special attention due to (1) their potentially very large interest rate risk, and (2) their status as U.S. government sponsored enterprises. The analysis focuses on the dynamic hedging strategy and extensive use of interest rate derivatives employed by F&amp F to control their interest rate risk. While dynamic hedging is highly cost effective for F&amp F, it creates imperfect hedges and thus could impose significant costs on U.S. taxpayers in a potential future F&amp F bailout. The policy discussion includes proposals to modify the F&amp F interest rate disclosures and the OFHEO stress test, and to create rate interest risk standards for F&amp F. Author Affiliation: (1) University of California, USA Article History: Registration Date: 05/10/2004

Byline: Richard Roll (1) Keywords: Financial intermediation; borrowing costs. Abstract: Mortgage investing is the domain of financial intermediaries, such as Fannie Mae and Freddie Mac, who possess specialized knowledge and experienced analytic teams. Capital is channeled to homeowner/borrowers at lower cost through such entities. As the demand for mortgage borrowing outstrips aggregate domestic saving (which is currently negative) foreign sources of capital should become even more significant. Foreign capital can be channeled efficiently into the U.S. mortgage market by Fannie and Freddie. Their debt has the highest credit standing and their risk management ability has been demonstrated by their enormous 'retained portfolios' of mortgages. Author Affiliation: (1) University of California, USA Article History: Registration Date: 05/10/2004

Byline: Lawrence J. White (1) Keywords: Housing finance; mortgages; Fannie Mae; Freddie Mac; government sponsored enterprises. Abstract: Fannie Mae and Freddie Mac are unique and controversial participants in the housing finance system of the United States. Because of these enterprises' federal government charters, the financial markets believe that the government would not allow Fannie and Freddie to fail to honor their debt obligations, and they are thereby able to borrow more cheaply in credit markets in turn, they lower interest rates for residential mortgages. If the financial markets are right, however, Freddie and Fannie also create a contingent liability for the government. Though there are positive externalities from home ownership, the Fannie/Freddie route is far too broad and unfocused to address those externalities effectively. Privatization, accompanied by targeted federal assistance for potential first-time low- and moderate-income home buyers, would be a superior policy direction. Author Affiliation: (1) New York University, USA Article History: Registration Date: 05/10/2004