speeches · March 9, 2003

Speech

William Poole · President

Housing in the Macroeconomy OfficeofFederalHousingEnterpriseOversightSymposium RonaldReaganBuildingandInternationalTradeCenter Washington,D.C. March10,2003 PublishedintheFederalReserveBankofSt.LouisReview,May/June2003,85(3),pp.1-8 Iam very pleased to be here today to par- stabilityandeverypolicymakerwithaninterest ticipate in this symposium sponsored by inhousingandhousingfinance. the Office of Federal Housing Enterprise Beforeproceeding,Iwanttoemphasizethat Oversight. The topics are important, and theviewsIexpressherearemineanddonot the list of speakers impressive. necessarilyreflectofficialpositionsoftheFederal Mypurposeistoprovideanoverviewof ReserveSystem.Ithankmycolleaguesatthe FederalReserveBankofSt.Louis—especially longer-runtrendsinhousingandhousingfinance. RobertH.Rasche,seniorvicepresidentand TheUnitedStatesiswellhoused,andthehousing directorofResearch,andWilliamR.Emmons, financesystemhasbeenworkingefficientlyin economist—fortheirassistanceandcomments, recentyears.Inthefirsttwosectionsofmy butIretainfullresponsibilityforerrors. remarks,I’lldiscusssomeofthehistoryand reportsomemeasuresshowinghowthehousing stockhaschangedovertimeandhowthehousing SOME FACTS ABOUT HOUSING financesystemhasdeveloped.Ouraimmustbe tosustainandextendthisprogress. Housing,particularlyowner-occupiedhous- Thethirdsectionofmyremarksreflectsmy ing,haslongbeenapublicpolicyissueinthe long-standinginterestinissuesoffinancialsta- UnitedStates.Overtheyears,thesediscussions bilitystemmingfrommystudyofmonetaryeco- developedintwodifferentdirections:onefocus- ingontheavailabilityofhousingforlower-income nomicsandfinancialhistory.Giventheenormous families,whichIwillnotaddresshere,andthe importanceofhousingandhousingfinancetothe otheronthedevelopmentofhousingingeneral U.S.economy,Ithinkwedoneedtocarefully andtheefficiencyofmortgagemarkets. examinethepotentialforfinancialinstabilityand Thediscussionofpoliciestowardhousing considerstepsthatcouldreducetherisk.Inthis andmortgagemarketsdatesbacktoatleast1918.1 context,IespeciallywanttocommendOFHEO DuringtheGreatDepression,theNationalHousing foritsrecentreportentitled,“SystemicRisk: Actof1934createdtheFederalHousingAdminis- FannieMae,FreddieMacandtheRoleofOFHEO.” tration(FHA)withthemandatetoinsureprivate Thisreportdisplaysanimpressivedepthofschol- residentialmortgages.IntheaftermathofWorld arshipinreviewingalargebodyofprofessional WarII,theServiceman’sReadjustmentActof1944 literatureonthesubject.Itdeservescarefulstudy createdtheVeteransAdministration(VA)home- byeveryeconomistinterestedinissuesoffinancial loanguaranteeprogram.2Mortgagesinsured(or 1 HarryS.Schwartz,“TheRoleofGovernment-SponsoredIntermediaries,”HousingandMonetaryPolicy,FederalReserveBankofBoston, ConferenceSeries4,1970,p.68. 2 GeorgeF.Break,“FederalLoanInsuranceforHousing,”HousingandMonetaryPolicy,FederalCreditAgencies,CommissiononMoneyand Credit.EnglewoodCliffs,NJ:Prentice-Hall,Inc.1963,p.2. 1 ECONOMICFLUCTUATIONS guaranteed)bythegovernmentgainedconsider- teedloans.6Atthesametime,theFederalHome ablemarketsharethroughoutthe1940sand1950s, LoanMortgageCorporation—FreddieMac—was reachingapeakshareof44.3percentof1-4family createdtopromotethedevelopmentofasecond- homemortgagesin1956.Sincethen,theshareof arymarketinconventionalmortgages. government-insuredmortgageshasdeclined Anotherimportantdevelopmentinthe1930s steadily;bytheendof2000theshareamounted wasthecreationin1932oftheFederalHome toonly13.8percent.3 LoanBankSystem(FHLB),whichwaschartered TheoriginalFederalNationalMortgage toprovideliquiditytothriftinstitutions.In1934 Association—FannieMae,asitcametobeunoffi- theFederalSavingsandLoanInsuranceCorpora- ciallyandaffectionatelycalled—wasorganizedin tion(FSLIC)wasestablishedtoprovideinsurance February1938toincreasethevolumeofresiden- onsharesofdepositorsinthriftinstitutions.7 tialconstructionanddevelopasecondarymarket Withtheseinstitutionsinplace,thoughnot ingovernment-insuredor-guaranteedmortgages.4 necessarilybecauseoftheircreation,thenetstock Toachievethefirstobjective,fromitsinception ofrealresidentialassetspercapitabegantogrow FannieMaepurchasedmortgagesandissuedits afterWorldWarII.(SeeFigure1.)Thestockhad owndebt.Initially,FannieMaewasfunded beentrendlessbetween$12,500and$13,000 throughthesaleofpreferredstocktotheTreasury. 1996dollarsfromthemid-1920suntilafterWorld AccordingtoJackM.Guttentag,writingin1963, WarII.8From1948to1970thenetrealpercapita governmentsupportwasregardedastransitory stockofresidentialstructuresgrewata1.9per- sinceitwas“hopedthateventuallytheTreasury’s centannualrate.From1971to2001thenetstock investmentcanberetiredwiththeproceedsof grewatasomewhatloweraverageannualrateof commonstockalongwithretainedearnings,and thefunctiontransferredtoprivateownership.”5 1.5percent.Bytheendof2001,thenetpercapita Thisobjectivewaspartiallyachievedin1968 stockofrealresidentialstructureshadgrownto whentheoriginalFederalNationalMortgage $32,7001996dollars. Corporationwassplitintotwoparts:Government Asthestockofresidentialstructureswasgrow- NationalMortgageAssociation,orGinnieMae, ing,thequalityofthehousingstockwasimprov- whichremainedagovernmentagency,anda ing.Accordingtothe1950Census,35.5percent successorFannieMae(officially,stilltheFederal ofhouseslackedcompleteplumbingfacilities. NationalMortgageAssociation)thatwasspunoff By2000thefractionofhouseswithoutcomplete asaprivatecorporationunderafederalgovern- plumbinghadfallento0.6percent.Inthe1960 mentcharter.In1970GinnieMaestartedguaran- Census—thefirstcensusthatincludedaquestion teeingmortgage-backedpass-throughsecurities ontelephones—21.5percentofhouseshadno representingsharesinpoolsofFHA/VAguaran- telephone.By2000only2.4percentofhouses 3 Source:1939-59:EconomicReportofthePresident,February1970,TableC-58;1960-2000:EconomicReportofthePresident,February 2002,TableB-75. 4 JackM.Guttentag,“TheFederalNationalMortgageAssociation,”HousingandMonetaryPolicy,FederalCreditAgencies,Commissionon MoneyandCredit,EnglewoodCliffs,NJ:Prentice-Hall,Inc.1963,p.69. 5 JackM.Guttentag,“TheFederalNationalMortgageAssociation,”HousingandMonetaryPolicy,FederalCreditAgencies,Commissionon MoneyandCredit.EnglewoodCliffs,NJ:Prentice-Hall,Inc.1963,p.73. 6 P.H.Hendershott,“TheMarketforHomeMortgageCredit”,inR.A.Gilbert,ed.,TheChangingMarketinFinancialServices,proceedingsofthe 15thAnnualEconomicPolicyConferenceoftheFederalReserveBankofSt.Louis.NorwellMA:KluwerAcademicPublishers,1992,p.100. 7 ErnestBloch,“TheFederalHomeLoanBankSystem,”HousingandMonetaryPolicy,FederalCreditAgencies,CommissiononMoneyand Credit.EnglewoodCliffs,NJ:Prentice-Hall,Inc.1963,p.168-72. 8 BureauofEconomicAnalysis,U.S.DepartmentofCommerce,Chain-TypeQuantityIndexesforNetStockofFixedAssetsandConsumer DurableGoods.End-of-yearquantityindexesareavailablefrom1925-2001.Thequantityindexesofnetstocksofrealresidentialandnon- residentialassetsareconvertedintonetstocksvaluedin1996dollars. 2 HousingintheMacroeconomy Figure 1 U.S. Per Capita Real Net Residential Structures U.S. Per Capita Real Net Residential Structures Thousandsof1996Dollars 35 30 25 20 15 10 5 0 1925 1928 1931 1934 1937 1940 1943 1946 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 lackedatelephone.Inthe1970Census4.4percent importanceofthesesourceshasvariedconsider- ofhouseswererecordedaslackingcomplete ablyovertheyearssinceWorldWarII.Theshare kitchenfacilities.By2000,only1.3percentof of1-4familymortgageloansheldbycommercial houseswererecordedaswithoutcompletekitchen banksincreasedintheimmediateaftermathof facilities.Duringthisperiodthemediansizeof WorldWarIItoapeakof19.4percentin1948;it housesalsoincreased—from4.6roomsin1950 thentrendeddownto13.4percentin1961at to5.3roomsin2000.9 whichpointthetrendreversedandtheshare Asthequantityandqualityoftheresidential trendedupagain,reachingalmost24percentin housingstockincreased,homeownershipalso 2000.(SeeFigure2.)Lifeinsurancecompanies becamemorewidespread.Inthe1950Census wereasignificantplayerintheresidentialmort- thehomeownershipratewasreportedat55per- gagemarketimmediatelyafterWorldWarII,but cent—bythe2000Censusithadincreasedto theirshareoflendingpeakedin1951at23.5per- 67.5percent. centandhastrendeddowneversince.By2000, theshareoflifeinsurancecompanieswasonly 3.4percent,sotheseinstitutionshaveceasedto beasignificantfactorintheresidentialmortgage SOME FACTS ABOUT HOUSING market.Theshareof“allother,”whichincludes FINANCE lendingbyindividualsandprivatemortgagepools Growthofthehousingstockcouldnothave decreasedfrom34.1percentattheendofWorld occurredwithoutarobustsystemofmortgage WarIIto12.3percentin1977,afterwhichit finance.Thereareseveraldistinctsourcesof startedtrendingupandreached21.4percentby mortgagefinanceintheUnitedStates.10The 2000. 9 Roomsexcludebathrooms. 10Source:1939-59:EconomicReportofthePresident,February1970,TableC-59;1960to2000:EconomicReportofthePresident,February 2002,TableB-76. 3 ECONOMICFLUCTUATIONS Figure 2 1-4 Family Mortgage Lending 1-4FamilyMortgage Lending Shareof1-4Family Mortgages Held (Percent) 40.0 Commercial Banks 35.0 LifeInsuranceCompanies 30.0 AllOther 25.0 20.0 15.0 10.0 5.0 0.0 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 Figure 3 1-4 Family Mortgage Lending 1-4FamilyMortgage Lending Shareof1-4Family Mortgages Held (Percent) 50.0 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 Savings Institutions 5.0 U.S.Agencies 0.0 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 4 HousingintheMacroeconomy Figure 4 Home Mortgage Debt as Share of Total Nonfinancial Debt HomeMortgageDebtasShareofTotal NonfinancialDebt Share of Mortgage Debt (Percent) 30.0 25.0 20.0 15.0 10.0 5.0 0.0 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 Thetworemainingtypesofinstitutionsthat Asthepresenceofsavingsinstitutionsinthe atdifferenttimeshavebeenthemostsignificant residentialmortgagemarketreceded,thefinanc- playersintheresidentialmortgagelendingmarket ingvoidwasfilledbyU.S.governmentagencies. aresavingsinstitutions(includingsavingsand In1967,immediatelybeforetheHousingActof loanassociationsandmutualsavingsbanks)and 1968andreorganizationoftheestablished U.S.agenciesincludingGinnieMae,FannieMae, FannieMaeintoGinnieMaeandthenewFannie FreddieMac,andmortgagepass-throughsecuri- Mae,theshareoftheresidentialhousingmortgage tiesguaranteedbyfederalagenciesorgovernment marketforgovernmentagencieswas5.5percent. sponsoredenterprises(GSEs).Theshareofsavings By1990,theseinstitutionscapturedathirdof institutionsinresidentialmortgagelendinggrew theresidentialmortgagemarket,eitherthrough rapidlyafterWorldWarII,reaching46percent mortgagespurchasedfortheirownportfoliosor in1965.(SeeFigure3.)Theseinstitutionsmain- throughguaranteedmortgage-backedsecurities. tainedtheirmarketshareuntil1978,butthen Recentdataindicatethattheirmarketshareis lostsharedramatically. 42.5percentasoftheendofthethirdquarterof Thedeclineofthesavingsinstitutionswasa 2002.Clearly,theefficiencyandstabilityofthese consequenceofrisingnominalinterestratescom- governmentagencieshasbecomeacriticalfactor binedwithdurationmismatch,whichtogether inthefinancingofresidentialconstruction. generatedthesavingsandloancrisisofthe1980s. By1990,whentheS&Lcrisiswasfinallyresolved, theshareintheresidentialmortgagemarketof FINANCIAL STABILITY theseinstitutionshadshrunkto21.1percent,less thanhalfofthepeakmarketsharetwenty-five AsFigure4shows,residentialmortgagedebt yearsearlier.Inthesubsequentdecadethemarket hasgrownenormouslyasafractionoftotalnon- shareheldbytheseinstitutionsshrunkbyhalf financialdebtintheUnitedStates.Startingat again,toonly10.4percentattheendof2000. slightlymorethan5percentattheendofWorld 5 ECONOMICFLUCTUATIONS WarII,thesharegrewsteadilyuntilitexceeded aretodaywellawareoftheneedforcarefulrisk 20percentintheearly1960s.Fromthenuntil management. themid-1980s,thesharefluctuatedintheneigh- TheOFHEOreportmakesanextremely borhoodof20percentorabitmore.Inthepast importantpointaboutnonquantifiablerisks: 15yearstheshareagaingrewsteadilyuntilit Afurtherobstacletoquantifyingsystemicrisk reached30percentattheendof2001.11Given istheinherentdifficultyinusingquantitative thecurrentmagnitudeofmortgagedebtoutstand- techniquestoanalyzecatastrophiceventssuch ingrelativetototalcreditmarketdebt,anyserious aswarsandfinancialcrises.Sucheventsare instabilityinthefinancingoftheresidentialcap- rare,ofteninvolvesignificantdeparturesfrom italstockhasthepotentialforsignificanteffects recenthistoricalexperienceandcandevelop notonlyonthehousingindustrybutalsoonthe fromapotentiallyinfinitesetofconditions. entireeconomy. Analystsgenerallydonotmodel,simulate,or predictthecourseandconsequencesofuncon- TheannualreportsofFannieMaeandFreddie ditionalfinancialcrises,makingitdifficultto Mac,andtherecentOFHEOreportonSystemic obtainapreciseestimateofthelikelihoodof Risk,providemuchusefulinformationonrisk aspecificlevelofeconomiclossesresulting management.Itisinsightfultodividethissub- frompotentialfinancialcrises.Asaresult, jectintotwoparts.Oneconcernsmanagementof governmentofficialswhoseektoplanforsuch credit,interest-rate,andoperationalrisksthat eventscannotrelyontheusualquantitative canbemodeledwiththeassistanceoffinancial techniquestoevaluatealternativestrategies theoryandevidencefromthebehavioroffinancial foraddressingthem.(p.87) markets.Risksthatcanbestudiedandmodeled InapreviousspeechIsuggestedthatperiods canbetermed“quantifiablerisks.”Nonquanti- ofgreatmarketinstabilityarisewhenthreecondi- fiablerisksdeserveseparateattention. tionsaremet.First,somethinghappensthathas Therearecertainlycasesinwhichfirms,and widespreadsignificance—islargeenoughtomat- sometimesregulators,makemistakesindealing tertolotsofpeople.Second,thetriggeringevent withquantifiablerisks.Overtheyears,many isasurprise.Ordinarily,eventslonganticipated financialinstitutionshavefailedbecauseofsuch arenottroublesomebecausecorrectiveaction mistakes.Savingsandloanassociationfailures, occursbeforeproblemsarise.Third,substantial whichultimatelyledtothefailureoftheFederal uncertaintycloudsresolutionoftheproblem.It SavingsandLoanInsuranceCorporation(FSLIC), isespeciallydifficultforinvestorstoknowwhat weremostlyofthistype.Startinginthelate1960s, todowhenthegovernment’sresponsetoan economistswarnedforyearsthattheextreme unfoldingsituationishighlyuncertain.12 maturitymismatchfromS&Lbalancesheetswith Giventheextensivediscussionofquantifiable long-term,fixed-ratemortgagesfinancedthrough risks,Iwanttoconcentrateonthenonquantifiable short-termliabilitiesputtheindustryatgreatrisk. risks.Ithelpstomakethisissueconcretebylisting Asthoseriskswererealized,manyfirmsfailed someexamples.Thefailureornearfailureof andtheS&Lindustrydeclinedtoashadowofits Penn-Central,Continental-Illinois,Long-Term formerself.Thecosttotaxpayerstomakegood CapitalManagement,Enron,andWorldCommay ontheinsuranceguaranteeofferedbyFSLICwas nothavebeencompletesurprisestoknowledge- intheneighborhoodof$150billion.Asaconse- ableinsiders,buttheshockswerecertainly“news” quenceofthisexperience,managersoffirms, tomarketparticipants,regulators,andthegeneral regulators,andthoseactiveinfinancialmarkets public.Noonepredictedthetimingofthestock 11BoardofGovernorsoftheFederalReserveSystem,FlowofFundsAccounts,TableL.2,CreditMarketDebtOwedbyNonfinancialSectors. 12“FinancialStability”presentedbeforeTheCouncilofStateGovernmentsSouthernLegislativeConferenceAnnualMeeting,NewOrleans, Louisiana,Aug.4,2002:<www.stlouisfed.org/news/speeches.html>. 6 HousingintheMacroeconomy marketcrashof1987orthepeakoftheequity suchinstitutionbuilding.Agoodexampleisthe marketsinthespringof2000.Itiswellknown marketperceptionthatpublicpolicyhasestab- thateventhegreatYaleeconomistIrvingFisher lisheda“toobigtofail”doctrine.Thisperception wascaughtcompletelyoffguardbythecrashof grewovertimeandbecamemoreentrenchedas 1929.Surpriselegaldecisionsbroughtbankruptcy aresultoftheContinental-Illinoissituation.The to52firmsinvolvedwithasbestos,toDow- netresultisthatmarketparticipantsexpectthat, Corning,andtoTexaco.Finally,whileexpertsin underill-definedconditions,regulatorsand/or terrorismmayhaveunderstoodtherisksofattacks governmentagencieswillinfactinsurestatutorily onU.S.soil,theirinformationwasnotsufficient uninsuredpositionsinvolvinglargefinancial topreventtheSeptember11attacks;certainlyno institutions.Isthedoctrinereally“toobigtofail” oneelsehadanybasisforpredictingtheattacks. or“toobigtoliquidatequickly?”Howbigdoesa Allofthesecases,withthepossibleexceptionof financialinstitutionhavetobe,anddoesithaveto Continental-Illinois,reflectednonquantifiable beadepositoryinstitution,tobe“toobigtofail?” risks. Inthisrespect,thereistremendousambiguity Thepointhereisnottofaulttheforecasting aboutthestatusoftheGSEs.Themarketprices recordofanypersonoranyagency.Rather,itis theGSEs’debtasiftherewereafederalguarantee, toillustratethatmajorunforeseeneventsthatcan orahighprobabilityofaguarantee,standing bringaboutacollapseinconfidenceordisruption behindtheirentireoutstandingobligations.Yet, tothenormalfunctionoffinancialmarketswith- thereisnoexplicitguaranteeinthelaw.Actual outanywarningcananddooccurwithsomefre- experiencehasleftthemarketswithallofthese quency.ThehistoryoftheUnitedStates,aswell importantquestionsandambiguities. asothercountries,isrepletewithsuchexamples. Nooneshouldunderestimatethepotential Alittle-discussedbutcriticallyimportant importanceoftheambiguityoverthefinancial dimensionofsystemicriskistheuncertainty statusoftheGSEs.Would“toobigtofail”be abouthowthegovernmentandregulatorswill extendedtoGSEsinacrisis,andifsohowwould respondtoamajorunforeseenevent.13Beforethe itbeeffectedintheabsenceofafederalinsurance 1987stockmarketcrashtherewasconsiderable agencywithanunlimitedlineofcredit?How overconfidencethatabreakinequitypricessuch quicklycouldsucharescuebeimplemented? asoccurredin1929wasnotpossiblegivenmod- ItisnotsufficientforanysingleGSEtoargue erninstitutions.Asaresult,intheinitialhoursof thatitsownfinancialconditionissound.Ifone the1987crash,thepublicdidnotknowexactly GSEcomesunderacloud,othersmayalso.That howtheFedwouldreacttoasystemicliquidity hasbeenourexperiencewithfinancialfirmsagain crisis.ThewaytheFedhandledthatsituationis, andagain.Itistheprocesseconomistscall“con- inmyjudgment,oneofthehigh-watermarksin tagion,”wherebyuninvolvedorinnocentfirms thehistoryofourcentralbank.Notonlywasa areaffectedbecausethemarkethasdifficulty generalizedliquiditycrisisaverted,butalsocon- distinguishingsolidfirmsfromthoseatrisk. siderableinstitutionalcredibilitywascreated. InthecaseoftheGSEs,theenormousscale Therepercussionsinfinancialmarketson9/11 oftheirliabilitiescouldcreateamassiveproblem mighthavebeenmuchworsehadtheFednot inthecreditmarkets.IfthemarketvalueofGSE demonstratedin1987thatitcouldandwould debtweretofallsharply,becauseofambiguity reactimmediatelytomajormarketdisruptions. aboutthefinancialsoundnessofGSEsandabout Therearehistoricalcaseswherethereactions thewillingnessofthefederalgovernmenttoback- bygovernmentagenciesandregulatorstounpre- stopthedebt,whatwouldhappen?Idonotknow, dictedcrises,inmyjudgment,didnotresultin andneitherdoesanyoneelse. 13Idiscussedthisissueatsomelengthin“Expectations,”FederalReserveBankofSt.LouisReview,March/April2001,83(2),pp.1-10. 7 ECONOMICFLUCTUATIONS Letmethrowoutfordebatetwostepsthe large,veryquickly.Itisimportanttounderstand federalgovernmentmighttaketoresolvethe what“veryquickly”means.Becauseofthescale ambiguitythatIseeasafundamentalrisktothe oftheshort-termobligationsoftheGSEs,theGSEs continuingstabilityofourfinancialsystem.First, arerollingovermanybillionsofdollarsofobliga- variousaspectsoffederalsponsorshipthatthe tionseachweek.Forthisreason,amarketcrisis marketreadsasprovidinganimpliedguaranteeof couldbecomeacuteinamatterofdays,oreven GSEdebtshouldbewithdrawn.14TheSecretary hours. oftheTreasuryhastheauthoritytobuyGSEobli- CapitalonthebooksofFannieMaeand gations;inthecaseofFannieMaeandFreddie FreddieMaciswellbelowthelevelsrequiredof Mac,theauthorityisuptoamaximumof$2.25 regulateddepositoryinstitutions.Letmequotea billionforeachfirm.TheGSEscouldeasilyreplace paragraphfromthe2001AnnualReportofFannie thispotentialsourceofemergencyfinancialsup- Mae,thelargestsingleGSE.During2001,Fannie portwithcreditlinesatcommercialbanks,follow- Maeissued$5billionofsubordinateddebtthat ingthewidespreadpracticeamongissuersof receivedaratingofAAfromStandard&Poor’s commercialpaper.Inanyevent,theamount andAa2fromMoody’sInvestorsService. availableatthediscretionoftheSecretaryofthe FannieMae’ssubordinateddebtservesasa Treasuryisfartoosmalltodealwithacrisisin supplementtoFannieMae’sequitycapital, theGSEdebtmarket.EliminatingtheTreasury’s althoughitisnotacomponentofcorecapital. authoritytolendtotheGSEswouldprovideasig- Itprovidesarisk-absorbinglayertosupple- nalthatthegovernmentisseriouswhenitsays mentcorecapitalforthebenefitofseniordebt thatthereisnogovernmentguaranteeofGSEdebt. holdersandservesasaconsistentandearly Second,overatransitionalperiodofseveral marketsignalofcreditriskforinvestors.By years,theGSEsshouldaddtotheamountofcapi- theendof2003,FannieMaeintendstoissue taltheyhold.Capitaliscriticalbecausewhenthere sufficientsubordinateddebttobringthesum isacrisisinthesecuritiesmarkets,financially oftotalcapitalandoutstandingsubordinated strongfirmscanstandthepressurewithoutlast- debttoatleast4percentofon-balancesheet ingdamage.Capitalprovidesacushionagainst assets,afterprovidingadequatecapitaltosup- mistakesandunforeseeablecircumstances.With portoff-balancesheetMBS.Totalcapitaland adequatecapital,afirmcanalmostalwaysraise outstandingsubordinateddebtrepresented emergencyloanstocoveritsliquidityproblems. 3.4percentofon-balancesheetassetsat Theimportanceofadequatecapitalbecameclear December31,2001.(pp.44-5) topolicymakersastheS&Lproblemsaccumulated inthelate1980s.Tighteningofcapitalstandards ThecapitalsituationatFreddieMacisabout forinsureddepositoryinstitutionsandtheadmin- thesameastheoneatFannieMae.Thecapital istrationofthoserequirementswasakeypartof adequacystandardsapplyingtothesetwoGSEs thereformsputinplaceatthattime. wereestablishedbytheFederalHousingEnter- CapitalisespeciallyimportantfortheGSEs prisesFinancialSafetyandSoundnessActof becausetheirshort-termobligationsarelarge. 1992.Thecorecapitalrequirementis2.5percent FannieMaeandFreddieMachavedebtobliga- ofon-balancesheetassetsand0.45percentof tionsduewithinoneyearofabout45percentof outstandingmortgage-backedsecuritiesandother theirdebtliabilities.Anyprobleminthecapital off-balancesheetobligations.Theoff-balance marketsaffectingthesefirmscouldbecomevery sheetobligationshaveacapitalrequirement 14FarmerMac,anotherGSE,wasmuchinthenewsintherecentpast.AnarticleintheNewYorkTimesnotedthatoneoftheadvantagesconferred bygovernmentsponsorshipis“theabilitytoborrowalmostascheaplyasthegovernmentdoesbecauseofaperceptionofgovernmentbacking thatemanatesfromasinglesectioninitscharter.ThatprovisionallowstheTreasury,incertaincircumstances,toprovideupto$1.5billion inloanstoFarmerMactosupporttheguaranteesthecompanyextendsonfarmloans”(9June2002,p.8,column1). 8 HousingintheMacroeconomy becausetheyareguaranteedbyFannieand policy.Foronething,theseeventsarenotsorare Freddie. astheymightseem.Foranother,thecostsofa Intheprivatesector,governmentsecurities rareeventthathasmajorconsequencestothe dealerscarrycapitalintheneighborhoodof5 economycaneasilyoutweighalongstreamof percent,andotherfinancialfirmsconsiderably benefitsthatareordersofmagnitudesmaller. more.Forexample,FDIC-insuredcommercial banksholdequitycapitalandsubordinateddebt ofabitunder11percentoftotalassets. SUMMING UP TheissuewithFannieMaeandFreddieMac TheUnitedStateshasenjoyedmanyyears isnotprimarilyoneofdisclosure.Theirannual ofarisingstockofresidentialcapital.Moreover, reportsdisclosequitewellthehighdegreeofcom- dwellingshaveincreasedinaveragesizeand plexityoftheiroperations,andthesmallamount quality.Thenation’shousingfinancesystemhas ofcapitaltheycarryabovewhatisrequiredbylaw. beeneffectiveinmakingthisgrowthpossible. Myquestionsarethese:Giventhecomplexityof Thehousingfinancesystemhistoricallyhas theiroperations,isthecapitalstandardinthelaw beenhighlydiversified.Asagroup,theshareof adequate?Whyisthestandardsofarbelowthat savingsinstitutionsinresidentialmortgagelend- requiredoffederallyregulatedbanks?Whatwill ingreached46percentin1965,buthundredsof happentothehousingmarketifFannieand institutionswereinvolved.Thediversification Freddiebecomeunstable? oflendingbydifferenttypesofinstitutionsand ReportsissuedbyFannieMaeandFreddie numerousfirmswithinaclassofinstitutionshas Mac,andtherecentOFHEOreportonSystemic beenanimportantelementofstability,because Risk,indicatethatthetwofirmsemploystate-of- thefailureofoneorevenmanyfirmshasnot the-artriskmanagement.Nevertheless,mysense shakenthesystem.Competingfirmshavebeen isthatthefirmsarevulnerabletononquantifiable abletoenterthemarkettofillanyvoidsleftby risks,becausetheircapitalpositionsaresolow. failingfirms. Inmyjudgment,theonlywayforfinancial Today,thehousingfinancesystemisheavily institutionstoensurestabilityintheeventofnon- concentrated.Justthreefirms—FannieMae, quantifiableshocksisforthemtomaintainasub- FreddieMac,andGinnieMae—accountforover stantialextracapitalcushionabovethatdeemed 40percentoftheresidentialmortgagemarket. necessarybyanalysisofquantifiablerisks.One GinnieMaeisbackedbythefullfaithandcredit wayofthinkingabouttheappropriatesizeofthat oftheU.S.government.FannieMaeandFreddie cushionmightbetodecidethatafirmshouldbe Macarenotsobackedandholdcapitalfarbelow abletomeetitsmaturingobligationswithoutbor- thatrequiredofregulatedbankinginstitutions. rowingforacertainperiodoftime.Thelengthof Shouldeitherfirmberockedbyamistakeorby theperiodwoulddependonanassessmentofhow anunforecastableshock,intheabsenceofrobust longitwouldtaketoresolvewhateverproblem contingencyarrangements,theresultcouldbea mightarise.Underthiscriterion,thecapitalcush- crisisinU.S.financialmarketsthatwouldinflict ionwouldhavetobeinvestedinhighlyliquid, considerabledamageonthehousingindustry short-termassetsnotsubjecttodepreciationdue andtheU.S.economy. tointerestratechangesorcreditrisks,sothat maturingobligationscouldbemetforatimewith- outresorttoissuingnewobligations. Dismissingtherisksofnonquantifiableevents onthegroundsthattheyaretooimprobableto worryaboutisnotawiseapproachtopublic 9

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William Poole (2003, March 9). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20030310_poole

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@misc{wtfs_speech_20030310_poole,
  author = {William Poole},
  title = {Speech},
  year = {2003},
  month = {Mar},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20030310_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}