Title

Shifting Losses: The Impact of Fannie's and Freddie's Conservatorships on Commercial Banks

Document Type

Working Paper

Publication Date

4-19-2012

SSRN Discipline

Econometric Modeling: Financial Markets eJournals; LSN Subject Matter eJournals; Econometrics: Applied Econometric Modeling eJournals; ERN Subject Matter eJournals; Financial Economics Network; Management Research Network; Economics Research Network; Legal Scholarship Network; Banking & Financial Institutions eJournals; Econometric Modeling: Financial Economics eJournals; FEN Subject Matter eJournals; Administrative Law eJournals; Econometrics eJournals

Abstract

In fall 2008 the Federal Housing Finance Agency FHFA placed mortgage giants Fannie Mae and Freddie Mac in conservatorship As conservator the FHFA has control over the operations of both companies but it faces conflicting mandates On the one hand the FHFA is tasked with stabilizing the secondary mortgage market and providing access to mortgage credit Achieving this task encourages Fannie and Freddie to absorb some mortgagerelated losses On the other hand the FHFA is tasked with returning Fannie and Freddie to financial health For Fannie and Freddie to return to financial health they must minimize their losses perhaps by passing those losses along to commercial banks This Article examines how the FHFA as conservator resolves its conflicting mandates The Article examines the FHFA's key lossshifting decisions and the impact of those decisions on commercial banks In particular it inspects 1 the FHFA's decision to allow Fannie and Freddie to continue their activity in the secondary mortgage market 2 the FHFA's decision to allow the Department of the Treasury to recapitalize Fannie and Freddie in a way that resulted in large losses for holders of Fannie and Freddie stock and 3 the FHFA's decision to enforce Fannie's and Freddie's rights against sellers of mortgages and privatelabel mortgagebacked securities The Article concludes that as a result of its conflicting mandates the FHFA has allowed Fannie and Freddie to absorb losses "” particularly when those losses would otherwise have been transferred to the large systemically important banks In other instances the FHFA has shifted Fannie and Freddie losses to small community banks Such loss transfer practices have the potential to cause undue consolidation in the banking industry and exacerbate the problem of financial institutions that are too big to fail While such loss transfer practices may be consistent with the FHFA's conflicting mandates they are troubling because the FHFA's decisions are often made behind closed doors with little opportunity for the public to determine whether the FHFA is striking the right balance between its market stabilization and loss prevention goals This Article urges the FHFA to adopt disclosure practices that will allow the public to evaluate the Enterprises' lossshifting policies

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