Secondary Mortgage Markets, GSEs, and the Changing Cyclicality of Mortgage Flows

In recessions, depository institutions accounted for most declines in mortgage flows. Recently, they partially offset their withdrawals from primary markets with accumulations of mortgage-backed securities. Increases in direct flows into agency and private pools also countered the declining flows elsewhere. As the less-procyclical secondary mortgage markets grew and matured, they increasingly stabilized mortgage flows. During periods of international financial crises or of domestic economic stress, GSEs may be particularly well suited to facilitating mortgage flows. So long as there are such crises and stresses, GSEs may be particularly effective in stabilizing mortgage markets and moderating business cycles. Congress chartered the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae) as housing-related, government-sponsored enterprises (GSEs). The missions of Fannie Mae and Freddie Mac are to: (1) promote the flow of capital to residential mortgage markets and (2) stabilize residential mortgage markets by facilitating “a continuous supply of mortgage credit for U.S. homebuyers in all economic environments” (Federal Home Loan Mortgage Corporation 2000). Numerous studies have concluded that Freddie Mac and Fannie Mae raised homeownership rates by promoting the flow of capital to (residential) mortgage markets. By providing guarantees of the timely payment of principal and interest on mortgages, Freddie Mac and Fannie Mae have contributed mightily to the development of secondary markets in mortgages (McCarthy and Peach 2002). Secondary mortgage markets, in turn, have increased the efficiency and liquidity of primary mortgage markets and the integration of U.S. mortgage markets into world capital markets (Devaney and Pickerill 1990, Federal Reserve Bank of Minneapolis 2001, Goebel and Ma 1993, Rudolph and Griffith 1997). Apart from the reductions in mortgage interest rates generally that may be attributed to the maturation of secondary markets, interest rates on conforming mortgages averaged a bit more than 25 basis points lower than those on jumbo mortgages before the 1990s, and a bit less than 25 basis points lower since the middle of the 1990s (Hendershott and Shilling 1989, Congressional Budget Office 2001). The total lowering of mortgage interest rates attributable to GSEs benefited homeowners substantially. By increasing the aggregate, longer-term supply of mortgage credit, and thereby lowering mortgage interest rates and raising homeownership rates, GSEs can be said to have achieved the first part of their missions. Less attention has been devoted to the second aspect of the GSEs’ public missions. The volumes of assets and trading associated with secondary mortgage markets and the GSEs, anecdotal evidence, and introspection support the hypothesis that large, active secondary mortgage markets have altered the procyclicality of residential mortgage flows and construction. Nonetheless, in spite of the widely held view that the mortgage markets now operate fundamentally differently, little systematic evidence exists that secondary mortgage markets have altered mortgage flows during recessions. In contrast to the studies about GSEs that predominantly focus on the average effects of GSEs on mortgage rates, here we focus on fluctuations in mortgage flows at depository institutions and at other private sector suppliers of funds, as well as at GSEs. In particular, we quantify how much these total mortgage flows changed during national economic recessions. We calculate how much the flows of mortgage funds that were provided by depository institutions, pensions, insurance companies, and other suppliers of mortgage funds changed during recessions. We calculate how much GSEs intermediated mortgage flows during recessions, how their intermediation compared with others’, and how it shifted through time. Of special interest to us was how much, or even whether, GSEs offset others’ declines in mortgage intermediation and thereby stabilized the aggregate supply of mortgage credit during recessions. By stabilizing mortgage flows, Freddie and Fannie could dampen fluctuations in real activity, both in the housing sector and in the macroeconomy. For that reason, which stands quite apart from their continuing value to the longer-term operation and development of secondary mortgage markets, the housing GSEs may contribute to the broader aims of public