Debate over Fannie, Freddie takes place in the extremes

Supporters of Fannie Mae and Freddie Mac say that cutting their massive mortgage portfolios would doom the housing market. Critics say those same portfolios create the risk of an LTCM-style meltdown that would doom financial markets.

They could both be wrong: The housing market continued to thrive last year even as the costs of rising interest rates outpaced the benefits Fannie and Freddie offered to homebuyers. And those rising rates didn't pull the bottom peg out of their seemingly Jenga-like portfolios.

Fannie and Freddie, the U.S. government-sponsored entities (GSEs) that buy and hold mortgages in an effort to keep borrowing costs low and make home-buying more affordable, had a portfolio of about $1.4 trillion in mortgage debt at the end of January, the latest data available, about a fifth of all U.S. mortgage-debt outstanding.

The GSEs' critics, including the Bush administration and former Federal Reserve Chairman Alan Greenspan, say they get the heebie jeebies seeing all that interest-rate risk lumped on the balance sheets of just two companies. They have argued for cutting it or limiting it, arguments that gathered steam after both companies had trouble accounting for the complicated hedging strategies they use to offset that risk.

Supporters argue that GSEs' portfolios make borrowing costs cheaper. Banks, hedge funds and other entities probably wouldn't want to hold some of the riskier debt in the GSEs' portfolios without charging higher rates for it. And those same entities would have to pay higher rates for their own borrowing than the GSEs do -- costs that would be passed on to consumers.

Few people on either side doubt Fannie and Freddie's impact on the housing market and interest rates. The question is: How much difference do they make? The answer: Maybe not all that much.

A 2001 Fed study decided that the GSEs lowered mortgage rates by between 0.18 and 0.23 percentage point -- in other words, a fixed-rate 6.5%, 30-year mortgage would possibly be as high as 6.73% in a world without GSEs.

Several other studies have come up with similar results. A 2004 paper by Brent Ambrose of the University of Kentucky, Michael LaCour-Little of Washington University in St. Louis and Anthony Sanders of Ohio State University found that GSEs gave homeowners just a 0.24-point advantage. Lawrence White, a Cato Institute adjunct scholar and economics professor at New York University's Stern School of Business, figures the benefit is about 0.25 point.

•	Debate over Fannie, Freddie takes place in the extremes Trading shots Wall Street Journal, Friday, March 3, 2006 Byline: Mark Gongloff