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GSE Funding Advantages and Mortgagor Benefits: Answers from Asset Pricing

By Søren Willemann

Abstract

We take an asset pricing approach to model the funding advantage of Government Sponsored Enterprises (GSEs) such as Fannie Mae and Freddie Mac. In order to replicate some stylized facts, we extend a referenced model to incorporate defaultability of mortgage agencies. The model implies that the direct effect from having a government guarantee results in a funding advantage of 21 bp. This indicates that the funding advantage of 40 bps estimated in the literature may be a bad proxy for the dollar value of the liability to the government. For a GSE, which explicitly takes a guarantee into account, the funding advantage is passed through to mortgagors. If not, as much as 75% of the funding advantage is retained by the GSE. We relate this to empirical findings in the earlier literature. Finally, we discuss and illustrate how a government guarantee in itself can induce a stabilized mortgage market.Government sponsored enterprises; Mortgage backed bonds; Credit risk

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