Staff Reports
Defragmenting Markets: Evidence from Agency MBS
Number 965
May 2021

JEL classification: G12, G18, G21, E58

Authors: Haoyang Liu, Zhaogang Song, and James Vickery

Agency mortgage-backed securities (MBS) issued by Fannie Mae and Freddie Mac have historically traded in separate forward markets. We study the consequences of this fragmentation, showing that market liquidity endogenously concentrated in Fannie Mae MBS, leading to higher issuance and trading volume, lower transaction costs, higher security prices, and a lower primary market cost of capital for Fannie Mae. We then analyze a change in market design—the Single Security Initiative—which consolidated Fannie Mae and Freddie Mac MBS trading into a single market in June 2019. We find that consolidation increased the liquidity and prices of Freddie Mac MBS without measurably reducing liquidity for Fannie Mae; this was in part achieved by aligning characteristics of the underlying MBS pools issued by the two agencies. Prices partially converged prior to the consolidation event, in anticipation of future liquidity. Consolidation increased Freddie Mac’s fee income by enabling it to remove discounts that previously compensated loan sellers for lower liquidity.

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AUTHOR DISCLOSURE STATEMENT(S)
Haoyang Liu
The author (Haoyang Liu) declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Zhaogang Song
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.

James Vickery
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.
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