Reference no: EM133198888

Assignment:

1. Intervention into the Mortgage Market

a. Explain how banks use deposits to create lending spreads or spread the yield curve.

b. Explain the difference between Fannie Mae's debentures and its MBSs.

c. Describe how Fannie Mae would spread the yield curve before Congress gave it the authority to securitize mortgages in 1989.

d. True/False/Explain: "A mortgage securitizer (e.g., Fannie Mae after 1989, Freddie Mac) provides insurance just like any insurance company."

e. Prior to 1938, interstate banking regulations restricted the movement of deposits. Banks in states with large concentrations of deposits could not use them to fund mortgages in states with fewer deposits, thus limiting the ability of the banking system to spread the yield curve. When Fannie Mae was initially created (and before 1989), what assets did banks purchase to hold in their portfolios and fund with their deposits? As a result of these purchases, explain whether the new equilibrium in the national mortgage market became more efficient.

f. After Fannie was allowed to securitize mortgages in 1989, what assets did banks purchase to hold in their portfolios and fund with their deposits? As a result of these purchases, explain whether the new equilibrium in the national mortgage market became more efficient.

g. If the creation of Fannie Mae increased efficiency in the mortgage market, then explain the initial market failure that was corrected. Alternatively, if the creation of Fannie Mae reduced mortgage market efficiency, then explain the problematic economic incentive(s) introduced. For either scenario you choose, comment on the benefits or costs to BOTH lenders and borrowers.

2. Uniform Mortgage-Backed Securities (UMBSs)

a. True/False/Explain: "The risk(s) to a bank's lending portfolio is the same regardless if it holds numerous FHA mortgages or UMBSs."

b. True/False/Explain: "Prior to FHFA's single security initiative, the pricing differential between Fannie Mae' and Freddie Mac's MBS arguably represented a violation of the law of one price."

c. Explain the KEY requirement that the GSE's primary regulator, FHFA, imposed to prevent a material misalignment when implementing the single security initiative.

d. How do buyers and sellers of UMBS benefit when the underlying mortgages are fungible and the law of one price holds? Explain.

e. In response to COVID-19, the Federal Reserve lowered its federal funds to zero percent on March 15, 2020, followed by a drop in mortgage rates. The price (present value) of any bond, including UMBSs, normally increases after a fall in interest rates (and vice versa).

However, what specific type of mortgage risk offsets that normal relationship, thus causing the present value of UMBSs to move in the opposite predicted direction? Explain.

f. If existing owners (e.g., banks) must sell/liquidate their UMBSs for cash, would they further raise or further lower the prices (present value) to prospective private sector buyers in the OTC markets? (Hint: Assume banks are also seeing above-normal rates of deposit withdrawals.)

g. Suppose the Federal Reserve agrees to purchase UMBSs from banks at their initial preCOVID-19 prices-prior to March 15, 2020. Comment on whether the intervention is justified in response to a market failure. Support your answer either by explaining the market failure that is being addressed by the Federal Reserve OR why the UMBS pricing was still efficient after the March 15, 2020 rate cut. You can answer either way, but use sound economic logic.

h. How do the GSEs' credit risk transfer (CRT) securities differ from their UMBSs? Explain.

i. True/False/Explain: "During a recession, the investors holding CRTs are worse off relative to the investors holding UMBSs." (When answering 2i, assume there is NO intervention by the Federal Reserve.).