Fisher Center for Real Estate and Urban Economics

This paper evaluates a current policy proposal to limit the size of the retained mortgage portfolios held by Fannie Mae and Freddie Mac (hereafter F&F). The proposal is a response to the growing concerns that the interest rate risks contained in the F&F portfolios create a serious threat to the US financial system. The analysis begins with a review of data on how F&F operate and on the role they play within the US mortgage market. Special attention is paid to the manner in which the firms hedge their interest rate risk. Key questions regarding the policy proposal include (1) what fund sources will replace F&F as mortgage investors, how will the interest rate risk be covered after it is removed from the F&F portfolios, and (3) what is the likely impact of the change on US mortgage interest rates. The conclusion is to endorse legislation that will limit the F&F retained mortgage portfolios.