March 1, 2011

Two Approaches to GSE Reform

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This paper offers two alternatives to reforming Freddie Mac and Fannie Mae, the government-sponsored enterprises (GSEs). One approach, the “devil you know” strategy, would restore the status quo ante, meaning that Freddie Mac and Fannie Mae would be returned to the investing public as private corporations with government backing, able to purchase loans for securities and able to hold securities in portfolio, subject to limits on loan amounts and subject to safety-and-soundness regulation. The other approach, the “Jimmy Stewart banker” strategy, would get the government out of the mortgage-guarantee business and let the mortgage market evolve in a decentralized way. In this system, mortgage lending would return to local banks, which would retain the loans that they originate.