, the implicit subsides to the gses are incurred wholly at the discretion of the gses. because fannie and freddie can borrow at a subsidized rate, they have been able to pay banks, thrifts, mortgage companies, and other home mortgage originators slightly higher prices for mortgages than their potential competitors have paid. this edge has enabled fannie and freddie to gain gradually but inexorably an ever - larger share of the home mortgage market. investors have provided fannie and freddie with a powerful vehicle for pursuing profits through the rapid growth of their balance sheets, and the resultant scale has given them an advantage that their potential private - sector competitors cannot meet. but the higher prices that these two gses pay for mortgages are only a small part of their subsidy, as evidenced by their persistent and well - above - market returns on equity capital. their annual return on equity, often exceeding 25 percent, is far in excess of the average approximately 15 percent annual under securitization, mortgages are bundled into pools and then turned into securities that can be easily bought and sold along side other debt securities. mortgage securitization continues to perform this important function, and such securitization techniques now have been applied extensively by the private sector to many other types of financial instruments. for example, the government provides the gses with a line of credit from the department of the treasury, fiscal agency services through the federal reserve, exemptions from securities registration requirements, exemptions from bank regulations on security holdings, and tax exemptions. the boards of directors of fannie and freddie are allowed to invest in almost anything as long as there is some link, direct or indirect, to their mission of supporting conforming mortgage markets. as demonstrated by recent innovations in the home equity lending and asset - backed securities markets, much of the $ 9 trillion in household credit can potentially be secured by real estate and thus may be available to the gses as investments. moreover, the gses have been allowed to invest in many forms of non - mortgage debt, such as corporate bonds and commercial paper, to the degree the gses'can argue such investments support the gses'liquidity goals and thus indirectly support mortgage markets. returns achievable by other large financial competitors holding substantially similar assets. virtually none of the gse excess return reflects higher yields on assets ; it is almost wholly attributable to subsidized borrowing costs. the ability of the

##s are financed largely by the issuance of gse debt, which, in turn, is held by investors. if mortgage - backed securities were sold into the market or allowed to self - amortize - and accordingly gse debt was redeemed - the transaction from the point of view of the supply and demand for high - quality credit is essentially a wash. in the simplest outcome, the holders of gse debt would be seen as exchanging their debt instruments for the mortgage - backed securities previously held on gse balance sheets. 8 as for homebuyers, whether gse mortgage purchases are held in gse portfolios or securitized and sold to investors appears to have no noticeable effect on mortgage rates. limitations on portfolio holdings could be imposed gradually over several years and then adjusted upward or downward depending on the growth of the single - family mortgage market. very short - term treasury holdings needed for liquidity and other assets employed for business operations could be exempt from these limitations. such a restriction would provide the gses with ample liquidity and would focus the gses almost exclusively on the purchase and securitization of mortgages, including mortgages for affordable housing. in other words, this restriction frees the gses of the difficulties of hedging large - scale interest rate risk. i should note that, even with such portfolio limits, fannie and freddie would likely remain among the most formidable of financial institutions in our country. * * * as i concluded last year, the gses need a regulator with authority on a par with banking regulators, with a free hand to set appropriate capital standards, and with a clear and credible process sanctioned by the congress for placing a gse in receivership, where the conditions under which debt holders take losses are made clear. however, if legislation takes only these actions and does not limit gse portfolios, we run the risk of solidifying investors'perceptions that the gses are instruments of the government and that their debt is equivalent to government debt. the gses will have increased facility to continue to grow faster than the overall home - mortgage market ; indeed since their portfolios are not constrained, by law, to exclusively home mortgages, gses can grow virtually without limit. without restrictions on the size of gse balance sheets, we put at risk our ability to preserve safe and sound financial markets in the united states, a key ingredient of support for homeownership. if gse debt holders do not want to hold