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 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 bps. 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 the 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.
By Søren Willemann.