Guarantee Fees—An Art, Not a Science

Abstract

This article examines the potential impact of increasing the guarantee fees that Fannie Mae and Freddie Mac (the government-sponsored enterprises [GSEs]) charge lenders. The authors argue that guarantee fees are very assumption driven. They then identify the three most important assumptions made in determining the fees. They conclude that transparency regarding these assumptions is critical and that, under any reasonable set of assumptions, the fees should not be increased for the least risky loans. The authors also argue that guarantee fees should be set high enough to cover expected losses under a stress scenario plus expenses. Beyond that, the GSEs’ mission should be taken into account in determining the required return on capital.