The GSEs' special advantage arises because, despite the explicit statement on the prospectus to GSE debentures that they are not backed by the full faith and credit of the U.S. government, most investors have apparently concluded that during a crisis the federal government will prevent the GSEs from defaulting on their debt. An implicit guarantee is thus created not by the Congress but by the willingness of investors to accept a lower rate of interest on GSE debt than they would otherwise require in the absence of federal sponsorship.
Because Fannie and Freddie can borrow at a subsidized rate, they have been able to pay higher prices to originators for their mortgages than can potential competitors and to gradually but inexorably take over the market for conforming mortgages.2 This process has provided Fannie and Freddie with a powerful vehicle and incentive for achieving extremely rapid growth of their balance sheets. The resultant scale gives Fannie and Freddie additional advantages that potential private-sector competitors cannot overcome. Importantly, the scale itself has reinforced investors' perceptions that, in the event of a crisis involving Fannie and Freddie, policymakers would have little alternative than to have the taxpayers explicitly stand behind the GSE debt. This view is widespread in the marketplace despite the privatization of Fannie and Freddie and their control by private shareholders, because these institutions continue to have government missions, a line of credit with the Treasury, and other government benefits, which confer upon them a special status in the eyes of many investors.Greenspan himself seemed unaware of the extent to which the FMs had weakened their own lending standards in response to the GSE Act of 1992, as he continually references, in his testimony, 'conforming mortgages' without recognizing that they were very different beasts in 2004 than they had been prior to congressional intervention in the early to mid 1990s.
That said, it seems very odd that this hardly secret testimony of Chairman Greenspan was missed by the Seattle Times's Jon Talton in his recent piece purporting to explain How shadow banking blew up the economy.