Signe

Fannie and Freddie Up Risk-Based Pricing

The author doesn't appear to understand Fannie and Freddie's business. Paying out claims on defaulted mortgages over time is not an option -no one purchasing Fannie mbs or Freddie PCs expects to wait 30 years to get a return of principal. If either GSE stopped paying the full amount of unpaid principal and interest upon a mortgage default, the market for GSE-guaranteed mortgage-backed securiites would disappear as quickly as the private market did. Those securities are priced based upon certain prepayment speeds -none of which assume that borrowers will keep the same mortgage (or house, for that matter)for thirty years. Investors expect to receive any principal and interest due at the time of default in one lumpsum so that the impact on the securities is that of a prepayment. Creating mortgage-backed securities with potential 30 year tails would definitely increase the GSE's capital, because there would be no demand for their guarantees.