Week 3.1

Week 3.
1. The case study discusses mainly the risks associated with Government Sponsored Entities
like Fannie and Freddie. What are the upsides, if any, associated with their existence?
Why were they created in the first place?
According to Dehan, (2022), GSEs were created by Congress to help stabilize certain
markets and sectors of the American economy (agriculture and real estate, for example).
GSEs do not loan money; rather, they guarantee certain loan products geared toward low-
to middle-income borrowers. By guaranteeing they’ll buy loans from financial
institutions, banks are able to give credit to consumers who otherwise would not qualify.
They also help banks free up capital to turn around and write more mortgage loans.
2. If you had the power as a policymaker, what course of action would you recommend and
why? Options might include: Phase-out; Significantly enhanced regulation; Minor
enhanced regulation; Status-quo. Elaborate briefly on your reasoning.
If I had the power a policymaker, I would recommend to stablish a more rigorous system
that provides steps to build a single housing GSE regulator, establishing standards to
measure (with data) GSE mission compliance, and provide reasonable transparency of
financial and performance activities, and adopt compensation arrangements
that focus on long-term and short-term results.
3. Where does the discussion about Fannie and Freddie currently stand? Do some research
and cite the position taken by economic commentators, academics and/or policymakers.
Because of a lack of clear measures, it is difficult for Congress, accountability

organizations, and the public to determine whether the benefits provided by the GSEs'
activities are in the public interest and outweigh their financial risks. Evidence and data
indicate that the housing GSEs have made, in some cases, progress in benefiting
homebuyers. It is generally agreed that Fannie Mae and Freddie Mac's activities have
lowered mortgage interest rates, although there is debate over the degree of these benefits
(govinfo.gov, 2004).
Accounting and financial reporting problems related to earnings disclosed by Freddie
Mac in 2004, raised several concerns about the company's management and board of
directors as well as the effectiveness of regulatory oversight that is designed to protect
taxpayers from the risks associated with the GSEs. Recently reported investment losses at
the FHLBanks have also served to raise public concerns regarding the well-being of
GSEs. These events prompted Congress to consider the need for meaningful reforms to
help
strengthen the oversight of GSEs.
References
https://www.quickenloans.com/learn/government-sponsored-enterprise
https://www.govinfo.gov/content/pkg/CHRG-110hhrg35407/html/CHRG-110hhrg35407.htm
1. Define shadow banking and provide one example of the same.
The Financial Stability Board (2012) describes shadow banking as “credit intermediation
involving entities and activities (fully or partially) outside the regular banking system”. This is a
useful benchmark, but has two weaknesses:
 First, it may cover entities that are not commonly thought of as shadow banking, such as
leasing and finance companies, credit-oriented hedge funds, corporate tax vehicles, etc.
 Second, it describes shadow banking activities as operating primarily outside banks. But
in practice, many shadow banking activities, for instance, liquidity puts to securitization
structured investment vehicles, collateral operations of dealer banks, repos, and so on,
operate within banks, especially systemic ones (Pozsar and Singh 2011, Cetorelli and
Peristiani 2012)
2. How significant was the shadow banking phenomenon in contributing to the financial crisis.
What role did money-market mutual funds play?
Shadow banking posed risks to the financial crisis because they were unable to meet their
financial obligations, and other financial market participants depending on payments
from these shadow banking became also unable to meet their financial responsibilities.
For example, because of some of these shadow banking became insolvent, financial
institutions holding their enterprise's obligations were put into a situation where they
could no longer rely on those securities as a ready source of liquidity declining the
economic activity thus contributing to the existing financial crises decline (govinfo.gov,
2004).
3. Where do you stand on the tradeoff between innovation and regulation? Innovations like shadow
banking can have benefits for users/investors but also increase financial stability risk. Cite an
example from personal experience (or readings) to make your point.
Shadow banking perform a useful function in the financial system and are not inherently risky or harmful.
They improve efficiency in the delivery of financial services, increase the supply of credit to the
economy, facilitate greater diversification of risk, enhance innovation and competition, and reallocate
risks away from the federal safety net. Like traditional banking, they need to be regulated in proportion to
the risks they pose. To a large extent, they already are regulated and some—in particular money market
funds—are more highly regulated than traditional banks (Fein, 2013).
The shadow banking system have been the primary sponsors, issuers, and guarantors of mortgage-backed
securities and asset-backed commercial paper for years. Without their support, many people (especially
low and mid income) could have not afforded to buy a house or even have a reliable mean of
transportation.
Reference
https://voxeu.org/article/what-shadow-banking
https://www.govinfo.gov/content/pkg/CHRG-110hhrg35407/html/CHRG-110hhrg35407.htm
https://www.sec.gov/comments/s7-04-09/s70409-95.pdf

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Week 3.

Because of a lack of clear measures, it is difficult for Congress, accountability

1. Define shadow banking and provide one example of the same.

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