A recent paper from the Philadelphia Fed finds that Fannie and Freddie reduced their underwriting standards during a critical six month period in 2007 to protect the value of their existing mortgage portfolios. Their incentive to do this was tied to their concentrated positions in certain regional markets. Because of their positions in these markets, the GSEs believed that they could, in fact, effectively put a floor under house prices until they recovered. This proved a mistake, but as the authors of the paper note, it raises questions about whether the GSEs today – or privatized GSEs in the future – would duplicate this strategy during a house-price fall due to their concentrated exposures and what would happen if they did given how badly all this worked the first time.
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