Evaluating the implicit guarantee to fannie mae and freddie mac using contingent claims

Abstract

This paper uses contingent claims analysis to evaluate the implicit government guarantee to Fannie Mae and Freddie Mac prior to their placement into conservatorship. The main findings of the paper indicate that the expected value of the guarantee was in line with the size of capital injections under the Treasury Preferred Stock Purchase Agreement and that the market expected the government to cover nearly all expected losses on senior debt. However, simulations reveal that the eventual total cost to recapitalize the GSEs may be significantly higher than provided for under the original terms of the conservatorship.

Citation

Gapen, M.T. (2009), "Evaluating the implicit guarantee to fannie mae and freddie mac using contingent claims", Choi, J.J. and Papaioannou, M.G. (Ed.) Credit, Currency, or Derivatives: Instruments of Global Financial Stability Or crisis? (International Finance Review, Vol. 10), Emerald Group Publishing Limited, Leeds, pp. 329-352. https://doi.org/10.1108/S1569-3767(2009)0000010014