As the Federal Reserve begins looking for ways to reduce its $1.1 trillion of agency MBS holdings, a group of private sector policy analysts are advancing a proposal that would finance the transfer of agency MBS back to the GSEs. 

The move, the Shadow Financial Regulatory Committee argues, would allow Fannie Mae and Freddie Mac to manage and liquidate the assets.

"It would place housing debt on the books of Fannie and Freddie where it belongs and remove the Fed from financing U.S. housing policy," according to the group which laid out its ideas at a meeting sponsored by the American Enterprise Institute.

Under the proposal, the Treasury Department would issue Treasury debt to Fannie and Freddie and the GSEs would swap the debt for the MBS. As MBS are sold or the mortgages run off, the GSEs would pay Treasury back.

Financial consultant Bert Ely said Fannie and Freddie might do a better job of managing the MBS than the Fed-if the GSEs do not overspend on hedging interest rates and prepayment risk. The Treasury note should be structured as a pass-through, he said, "so they don't feel compelled to go out and waste money on Wall Street on hedging."

Fed staff estimates the agency MBS portfolio will have a run-off rate of $200 billion a year, according to the Shadow Regulators. Credit Suisse mortgage analysts view the annual run-off rate as too high. They estimate the Fed experienced close to $50 billion in runoff in 2009 mostly due to prepayments. "This year we estimate $100 billion in run-off," said Mahesh Swaminathan, a mortgage strategist at Credit Suisse.

During 2009, the Fed was buying agency MBS on a weekly basis, eventually accumulating $1.1 trillion in MBS. The Fed stopped its buying spree in March.

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