The Interest Rate Risk of Fannie Mae and Freddie Mac

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