Fannie Mae and Freddie Mac
Analysis of Options for Revising the Housing Enterprises' Long-term Structures Gao ID: GAO-09-782 September 10, 2009Congress established Fannie Mae and Freddie Mac (the enterprises) with two key housing missions: (1) provide stability in the secondary market for residential mortgages (also in periods of economic stress) and (2) serve the mortgage credit needs of targeted groups such as low-income borrowers. To accomplish these goals, the enterprises issued debt and stock, purchased mortgages from lenders with the proceeds, and retained them in portfolio or pooled them into mortgage-backed securities (MBS) sold to investors. On September 6, 2008, the Federal Housing Finance Agency (FHFA) placed the enterprises into conservatorship out of concern that their deteriorating financial condition ($5.4 trillion in outstanding obligations) would destabilize the financial system. With estimates that the conservatorship will cost taxpayers nearly $400 billion, GAO initiated this report under the Comptroller General's authority to help inform the forthcoming congressional debate on the enterprises' future structures. It discusses the enterprises' performance in meeting mission requirements, identifies and analyzes options to revise their structures, and discusses key transition issues. GAO reviewed studies and data, and interviewed housing finance experts and officials from the enterprises, FHFA, Departments of the Treasury (Treasury) and Housing and Urban Development (HUD), the Federal Reserve, lenders, and community groups.
The enterprises have a mixed record in meeting their housing mission objectives, and both capital and risk management deficiencies have compromised their safety and soundness as follows: (1) The enterprises' secondary market activities are credited with helping create a liquid national mortgage market, lowering mortgage rates somewhat, and standardizing mortgage underwriting processes. However, their capacity to support housing finance during periods of economic stress has not been established, and they only have been able to do so during the current recession with substantial financial assistance from Treasury and the Federal Reserve. (2)There is limited evidence that a program established in 1992 that required the enterprises to meet annual goals for purchasing mortgages serving targeted groups materially benefited such groups. (3) The enterprises' structures (for-profit corporations with government sponsorship) undermined market discipline and provided them with incentives to engage in potentially profitable business practices that were risky and not necessarily supportive of their public missions. For example, the enterprises' retained mortgage portfolios are complex to manage and expose them to losses resulting from changes in interest rates. Further, the enterprises' substantial investments in assets collateralized by subprime and other questionable mortgages in recent years generated losses that likely precipitated the conservatorship. It will be necessary for Congress to reevaluate the roles, structures, and performance of the enterprises, and to consider options to facilitate mortgage finance while mitigating safety and soundness and systemic risk concerns. These options generally fall along a continuum with some overlap in key areas: (1)Reconstitute the enterprises as for-profit corporations with government sponsorship but place additional restrictions on them. While restoring the enterprises to their previous status, this option would add controls to minimize risk. As examples, it would eliminate or reduce mortgage portfolios, establish executive compensation limits, or convert the enterprises from shareholder-owned corporations to associations owned by lenders. (2) Establish the enterprises as government corporations or agencies. Under this option, the enterprises would focus on purchasing qualifying mortgages and issuing MBS but eliminate their mortgage portfolios. The Federal Housing Administration (FHA), which insures mortgages for low-income and first-time borrowers, could assume additional responsibilities for promoting homeownership for targeted groups. (3) Privatize or terminate them. This option would abolish the enterprises in their current form and disperse mortgage lending and risk management throughout the private sector. Some proposals involve the establishment of a federal mortgage insurer to help protect mortgage lenders against catastrophic mortgage losses. During the conservatorship, the federal government has tasked the enterprises to implement a variety of programs designed to help respond to the current housing crisis, such as helping borrowers forestall foreclosures. While these efforts may be necessary to help mitigate the effects of the housing crisis, they also might significantly affect the costs of the conservatorship and transition to a new structure. For example, investors might be unwilling to invest capital in reconstituted enterprises unless Treasury assumed responsibility for losses incurred during their conservatorship. Finally, any transition to a new structure would need to consider the enterprises' still-dominant position in housing finance and be implemented carefully (perhaps in phases) to ensure its success.
GAO-09-782, Fannie Mae and Freddie Mac: Analysis of Options for Revising the Housing Enterprises' Long-term Structures
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Report to Congressional Committees:
United States Government Accountability Office:
GAO:
September 2009:
Fannie Mae and Freddie Mac:
Analysis of Options for Revising the Housing Enterprises' Long-term
Structures:
GAO-09-782:
GAO Highlights:
Highlights of GAO-09-782, a report to congressional committees.
Why GAO Did This Study:
Congress established Fannie Mae and Freddie Mac (the enterprises) with
two key housing missions: (1) provide stability in the secondary market
for residential mortgages (also in periods of economic stress) and (2)
serve the mortgage credit needs of targeted groups such as low-income
borrowers. To accomplish these goals, the enterprises issued debt and
stock, purchased mortgages from lenders with the proceeds, and retained
them in portfolio or pooled them into mortgage-backed securities (MBS)
sold to investors. On September 6, 2008, the Federal Housing Finance
Agency (FHFA) placed the enterprises into conservatorship out of
concern that their deteriorating financial condition ($5.4 trillion in
outstanding obligations) would destabilize the financial system. With
estimates that the conservatorship will cost taxpayers nearly $400
billion, GAO initiated this report under the Comptroller General‘s
authority to help inform the forthcoming congressional debate on the
enterprises‘ future structures. It discusses the enterprises‘
performance in meeting mission requirements, identifies and analyzes
options to revise their structures, and discusses key transition
issues.
GAO reviewed studies and data, and interviewed housing finance experts
and officials from the enterprises, FHFA, Departments of the Treasury
(Treasury) and Housing and Urban Development (HUD), the Federal
Reserve, lenders, and community groups.
What GAO Found:
The enterprises have a mixed record in meeting their housing mission
objectives, and both capital and risk management deficiencies have
compromised their safety and soundness as follows:
* The enterprises‘ secondary market activities are credited with
helping create a liquid national mortgage market, lowering mortgage
rates somewhat, and standardizing mortgage underwriting processes.
However, their capacity to support housing finance during periods of
economic stress has not been established, and they only have been able
to do so during the current recession with substantial financial
assistance from Treasury and the Federal Reserve.
* There is limited evidence that a program established in 1992 that
required the enterprises to meet annual goals for purchasing mortgages
serving targeted groups materially benefited such groups.
* The enterprises‘ structures (for-profit corporations with government
sponsorship) undermined market discipline and provided them with
incentives to engage in potentially profitable business practices that
were risky and not necessarily supportive of their public missions. For
example, the enterprises‘ retained mortgage portfolios are complex to
manage and expose them to losses resulting from changes in interest
rates. Further, the enterprises‘ substantial investments in assets
collateralized by subprime and other questionable mortgages in recent
years generated losses that likely precipitated the conservatorship.
It will be necessary for Congress to reevaluate the roles, structures,
and performance of the enterprises, and to consider options to
facilitate mortgage finance while mitigating safety and soundness and
systemic risk concerns. These options generally fall along a continuum
with some overlap in key areas:
* Reconstitute the enterprises as for-profit corporations with
government sponsorship but place additional restrictions on them. While
restoring the enterprises to their previous status, this option would
add controls to minimize risk. As examples, it would eliminate or
reduce mortgage portfolios, establish executive compensation limits, or
convert the enterprises from shareholder-owned corporations to
associations owned by lenders.
* Establish the enterprises as government corporations or agencies.
Under this option, the enterprises would focus on purchasing qualifying
mortgages and issuing MBS but eliminate their mortgage portfolios. The
Federal Housing Administration (FHA), which insures mortgages for low-
income and first-time borrowers, could assume additional
responsibilities for promoting homeownership for targeted groups.
* Privatize or terminate them. This option would abolish the
enterprises in their current form and disperse mortgage lending and
risk management throughout the private sector. Some proposals involve
the establishment of a federal mortgage insurer to help protect
mortgage lenders against catastrophic mortgage losses.
GAO provides a framework for identifying trade-offs associated with the
options and identifies potential regulatory and oversight structures,
principles, and actions that could help ensure their effective
implementation (see table).
Table: Summary of Implications of the Options to Revise the
Enterprises‘ Structures:
Ability to provide liquidity and support to mortgage markets:
Reestablish as government-sponsored enterprises (GSE):
Reconstituting the enterprises as GSEs may provide liquidity and other
benefits to mortgage finance during normal economic times. However, as
for-profit entities, their capacity to support housing finance during
stressful economic periods is open to question.
Establish government corporation or agency: A government entity, with
access to Treasury-issued debt, may be positioned to provide mortgage
liquidity during normal and stressful economic periods. But, without a
portfolio to hold mortgages, its capacity to do the latter also may be
limited. Treasury or the Federal Reserve may need to step in and
purchase mortgage assets under such circumstances.
Privatize or terminate: If other financial institutions assumed key
enterprise activities such as mortgage purchases and MBS issuance,
liquid mortgage markets could be reestablished in normal economic
times. But, private mortgage lending has collapsed in the current
recession. A federal mortgage insurer could help ensure that private
lenders provide mortgage funding in stressful economic periods.
Support housing opportunities for targeted groups:
Reestablish as government-sponsored enterprises (GSE): For-profit
status and elimination of mortgage portfolios could limit enterprises‘
capacity to fulfill this objective. But, permitting smaller mortgage
portfolios, expanding FHA programs, or providing direct financial
assistance to targeted borrowers could be alternatives.
Establish government corporation or agency: Might be expected to
perform this function as a public entity. But, may face challenges
implementing a program to purchase mortgages for such groups if they
cannot hold these mortgages in portfolio. FHA insurance programs could
be expanded as an alternative.
Privatize or terminate: Would eliminate traditional basis (government
sponsorship) for previous programs that required enterprises to serve
mortgage credit needs of targeted groups. But, a federal mortgage
insurer could be required to establish such programs due to its
government sponsorship.
Potential safety and soundness concerns:
Reestablish as government-sponsored enterprises (GSE): Although
additional regulations could minimize risks, safety and soundness
concerns may remain as this option would preserve the enterprises‘
previous status as for-profit corporations with government sponsorship.
Establish government corporation or agency: May mitigate risk due to
lack of profit motive and the elimination of existing mortgage
portfolios. However, managing the enterprises‘ ongoing MBS business
still would be complex and risky, and a government entity may lack the
staffing and technology to do so effectively.
Privatize or terminate: In one scenario, risks would decrease as
mortgage lending would be dispersed among many institutions. But, large
institutions that assumed functions such as MBS issuance may be viewed
as too big to fail, which could increase risks. A federal mortgage
insurer also may not charge premiums that reflect its risks.
Key elements for potential regulatory and oversight structure:
Reestablish as government-sponsored enterprises (GSE): Reduce or
perhaps eliminate the enterprises‘ mortgage portfolios, increase
capital standards and impose regulations, such as executive
compensation limits, and establish new ownership structures, as
appropriate. Require financial disclosures to help ensure transparency
and provide congressional oversight of the enterprises‘ and FHFA‘s
performance.
Establish government corporation or agency: Provide entity with
flexibility to hire staff and obtain necessary technology. Establish
risk-sharing arrangements with the private sector, appropriate
disclosures of risks and liabilities in the federal budget to help
ensure transparency, and robust congressional oversight of operations.
Privatize or terminate: Fragmented U.S. financial regulatory structure
would need to be revised, as GAO has identified in previous reports, to
help oversee risks of large institutions that may assume enterprise
functions or acquire their assets. Oversight structure for a federal
mortgage insurer also would need to be established.
Source: GAO analysis of structural reform options.
[End of table]
During the conservatorship, the federal government has tasked the
enterprises to implement a variety of programs designed to help respond
to the current housing crisis, such as helping borrowers forestall
foreclosures. While these efforts may be necessary to help mitigate the
effects of the housing crisis, they also might significantly affect the
costs of the conservatorship and transition to a new structure. For
example, investors might be unwilling to invest capital in
reconstituted enterprises unless Treasury assumed responsibility for
losses incurred during their conservatorship. Finally, any transition
to a new structure would need to consider the enterprises‘ still-
dominant position in housing finance and be implemented carefully
(perhaps in phases) to ensure its success.
In written comments, FHFA stated that the report is timely and does a
good job summarizing the dominant proposals for restructuring the
enterprises and some of their strengths and weaknesses. FHFA also
offered key questions and principles for guiding initial decisions that
will have to be made about the future of the mortgage market.
View [hyperlink, http://www.gao.gov/products/GAO-09-782] or key
components. For more information, contact William B. Shear at (202) 512-
8678 or shearw@gao.gov.
[End of section]
Contents:
Letter:
Background:
The Enterprises Had a Mixed Record on Achieving Housing Mission
Objectives, and Risk-Management Deficiencies Compromised Their Safety
and Soundness:
Options to Revise the Enterprises' Structures Aim to Help Ensure
Housing Mission Achievement, While Mitigating Safety and Soundness
Risks:
A Framework for Identifying and Analyzing the Trade-offs Associated
with Options to Revise the Enterprises' Structures, and Oversight
Structures That Might Help Ensure Their Effective Implementation:
Federal Efforts to Support Housing Markets during the Conservatorships
and Certain Terms of Treasury Agreements Could Increase the Costs and
Challenges Associated with the Transition to New Enterprise Structures:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Comments from the Federal Housing Finance Agency:
Appendix III: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Federal Initiatives Designed to Facilitate the Availability of
Home Mortgage Credit and Housing Opportunities:
Table 2: Time Line of Significant Events in Federal Housing Finance
System:
Table 3: Enterprise Compliance with Low-and Moderate-Income Numeric
Mortgage Purchase Goals, 2002-2008:
Table 4: Summary of Options to Revise the Enterprises' Structures:
Table 5: Trade-offs Associated with Enterprise Reform Options as They
Relate to Long-Established Enterprise Objectives and Potential
Oversight Structures:
Figures:
Figure 1: Enterprises and Private-Label MBS Issuances, 2004-2008:
Figure 2: Growth in Enterprises' Retained Mortgage Portfolios, 1990-
2008:
Figure 3: Total Private-Label Mortgage Backed Securities as Percentage
of the Enterprises Retained Mortgage Portfolios, 1998-2007:
Abbreviations:
CBO: Congressional Budget Office:
CDBG: Community Development Block Grant:
CRS: Congressional Research Service:
FHA: Federal Housing Administration:
FHFA: Federal Housing Finance Agency:
FHFB: Federal Housing Finance Board:
FHL Bank System: Federal Home Loan Bank System:
Ginnie Mae: Government National Mortgage Association:
GSE: government-sponsored enterprise:
HAMP: Home Affordable Modification Plan:
HARP: Home Affordable Refinance Program:
HERA: Housing and Economic Recovery Act of 2008:
HUD: Department of Housing and Urban Development:
LIHTC: Low-Income Housing Tax Credit:
MBS: mortgage-backed securities:
OCC: Office of the Comptroller of the Currency:
OFHEO: Office of Federal Housing Enterprise Oversight:
OTS: Office of Thrift Supervision:
PC" participation certificate:
PIH: HUD's Office of Public and Indian Housing:
SIFMA" Securities Industry and Financial Markets Association:
USDA/RD" Department of Agriculture's Rural Development Housing and
Community Facilities Programs:
VA" Department of Veterans Affairs:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
September 10, 2009:
Congressional Committees:
On September 6, 2008, the Federal Housing Finance Agency (FHFA) placed
Fannie Mae and Freddie Mac into conservatorship out of concern that the
deteriorating financial condition of the two government-sponsored
enterprises (GSE or enterprise) threatened the stability of financial
markets.[Footnote 1] According to FHFA's former Director, James B.
Lockhart III, at the time the conservatorships were established, Fannie
Mae and Freddie Mac had worldwide debt and other financial obligations
totaling $5.4 trillion, and their default on those obligations would
have significantly disrupted the U.S. financial system.[Footnote 2] The
Department of the Treasury (Treasury) has agreed to provide substantial
financial support to the enterprises so that they can continue to
support mortgage finance during the current financial crisis.[Footnote
3] As of June 30, 2009, Treasury had provided about $85 billion in
funds to support the enterprises. The Congressional Budget Office (CBO)
has estimated that the total cost of the conservatorships to taxpayers
will be $389 billion.[Footnote 4] The Board of Governors of the Federal
Reserve System (Federal Reserve) also has committed to a variety of
activities, including purchasing substantial amounts of the
enterprises' debt and securities, to support housing finance, housing
markets, and the financial markets more generally.[Footnote 5] While
the conservatorships can remain in place indefinitely as efforts are
undertaken to stabilize the enterprises and restore confidence in
financial markets, FHFA has said that the conservatorships were not
intended to be permanent. Over the longer term, Congress and the
Executive Branch will face difficult decisions on how to restructure
the enterprises and promote housing opportunities while limiting risks
to taxpayers and the stability of financial markets.
Congress originally established Fannie Mae and Freddie Mac as
government entities in 1968 and 1989, respectively, chartering them as
for-profit, shareholder-owned corporations.[Footnote 6] They share a
primary mission that has been to stabilize and assist the U.S.
secondary mortgage market and facilitate the flow of mortgage credit.
To accomplish this goal, the enterprises issued debt and stock and used
the proceeds to purchase conventional mortgages that met their
underwriting standards, known as conforming mortgages, from primary
mortgage lenders such as banks or thrifts.[Footnote 7] In turn, banks
and thrifts used the proceeds to originate additional mortgages. The
enterprises held some of the mortgages that they purchased in their
portfolios. However, most of the mortgages were packaged into mortgage-
backed securities (MBS), which were sold to investors in the secondary
mortgage market.[Footnote 8] In exchange for a fee (the guarantee fee)
the enterprises guaranteed the timely payment of interest and principal
on MBS that they issued. The charter requirements for providing
assistance to the secondary mortgage markets specify that those markets
are to include mortgages on residences for low-and moderate-income
families. In 1992, Congress instituted authority for requiring the
enterprises to meet numeric goals set by the Department of Housing and
Urban Development (HUD) on a yearly basis for the purchase of single-
and multifamily conventional mortgages that serve targeted groups.
[Footnote 9]
While the enterprises operated profitably for many years, their
structures long have been in question. For example, critics questioned
the extent to which private for-profit corporations could be expected
to serve a federally mandated housing mission. Furthermore, critics
stated that the federal government's sponsorship conveyed certain
financial and other advantages to the enterprises that encouraged them
to engage in riskier activities than otherwise would be the case.
[Footnote 10] In particular, despite the federal government explicitly
not guaranteeing the enterprises' debt and MBS or including them in the
federal budget, there was an assumption in financial markets of an
"implied" federal guarantee, which enabled the enterprises to borrow at
lower rates than other for-profit corporations.[Footnote 11] Critics
argued that this implicit government guarantee and access to less
costly credit created a moral hazard. That is, it encouraged the
enterprises to assume greater risks and hold less capital than would
have been the case in the absence of such a guarantee.
According to former Treasury Secretary Henry M. Paulson, Jr., the FHFA
conservatorships provide an opportunity for Congress to reconsider the
nature and structure of the enterprises and make revisions to better
ensure their safety and soundness as they participate in efforts to
stabilize the mortgage markets. Researchers and research institutes,
financial commenters and market participants, and others have made a
variety of proposals about the future structure of Fannie Mae and
Freddie Mac, both before and after the establishment of the FHFA
conservatorships. Some proposals call for converting the enterprises
into government entities while others advocate privatization or
termination. While there is no consensus on what the next steps should
be, whatever actions Congress takes will have profound impacts on the
structure of the U.S. housing finance system.
We initiated this review under the Comptroller General's authority to
provide Congress with information on the roles, benefits, and risks
associated with the enterprises' activities in housing finance over the
years and to help inform the forthcoming deliberation on their future
structure. Specifically, this report (1) discusses how the enterprises'
roles, structures, and activities have changed over time and their
performance in achieving key housing mission objectives; (2) identifies
various options for revising the enterprises' eventual structure; (3)
analyzes these options in terms of their potential capacity to achieve
key housing mission and safety and soundness objectives; and (4)
discusses how the federal government's management of the
conservatorships and response to the housing crisis could affect any
transition.
To meet our objectives, we reviewed reports, studies, and data on the
enterprises and their regulation, including our reports, as well as
proposals to revise their structures. We also met with researchers who
wrote relevant reports or were knowledgeable on enterprise-related
issues and with representatives from FHFA, Treasury, the Federal
Reserve, HUD, the Government National Mortgage Association (Ginnie
Mae), CBO, the enterprises, banking and mortgage organizations, the
National Association of Home Builders, and community groups. Through
such research and interviews, we sought to identify (1) key housing
mission, safety and soundness, and other objectives that have been
associated with the enterprises over the years; (2) options to reform
the enterprises' structures and how they would affect these objectives;
and (3) principles associated with effective regulatory oversight
structures. While it is not possible to conclusively determine the
potential implications of the various proposals, we grounded our
analysis of likely outcomes on previous research and evaluations. We
also sought to include, where appropriate, assessments of how recent
developments in financial markets, particularly actions by federal
agencies to provide financial support to troubled banks and other
institutions, could affect the operations of the various options. We
recognize that a variety of factors could change over time, such as the
condition of credit markets and the financial performance of the
enterprises while in conservatorship, which could affect our analysis
of the options. A more detailed analysis of our objectives, scope, and
methodology is included in appendix I.
We conducted this performance audit from October 2008 to September
2009, in accordance with generally accepted government auditing
standards. Those standards require that we plan and perform the audit
to obtain sufficient, appropriate evidence to provide a reasonable
basis for our findings and conclusions based on our audit objectives.
We believe that the evidence obtained provides a reasonable basis for
our findings and conclusions based on our audit objectives.
Background:
The enterprises constitute one component of a range of federal
initiatives that, since the 1930s, have facilitated the availability of
mortgage credit and housing opportunities (see table 1). While these
initiatives may involve differing missions, structures, and activities,
they generally rely on federal support and subsidies to achieve their
objectives. In some cases, these initiatives--such as the Federal Home
Loan Bank System (FHLBank System), the enterprises' general mortgage
support activities, federal tax deductions for mortgage interest, and
exemptions for capital gains--apply broadly and are designed generally
to facilitate mortgage lending and homeownership. In other cases, the
initiatives have been designed to facilitate home ownership and housing
opportunities for targeted populations and groups. For example,
programs administered by the Federal Housing Administration (FHA),
Department of Veterans Affairs (VA), Department of Agriculture's Rural
Development Housing and Community Facilities Programs (USDA/RD), and
HUD's Office of Public and Indian Housing (PIH) are designed to
facilitate homeownership and housing opportunities for moderate-and low-
income persons, as well as first-time buyers, veterans, residents of
rural areas, and Native Americans, respectively. In some cases, these
federal housing initiatives also target similar populations and
borrowers. For example, through their general business activities and
affordable housing goal requirements, the enterprises, like FHA,
provide mortgage credit to low-income borrowers and other targeted
groups.
Table 1: Federal Initiatives Designed to Facilitate the Availability of
Home Mortgage Credit and Housing Opportunities:
Entities that operate in the primary mortgage market:
FHLBank System; (GSE):
Purpose: Established in 1932 by Congress as a GSE to support mortgage
lending and related community investment. The 12 FHLBanks borrow funds
in debt markets and provide their members low-cost, long- and short-
term advances (loans), which members use to fund mortgage loans and
maintain liquidity for their operations. Advances are primarily
collateralized by residential mortgage loans and government and agency
securities. Advances are priced at a small spread over comparable
Treasury obligations.
FHA; (government agency in HUD):
Purpose: Congress created FHA under the National Housing Act of 1934 to
expand opportunities for homeownership. FHA provides mortgage insurance
on loans made by private lenders. Located in HUD since 1965, FHA's
loans generally are for low-income, first-time homebuyers and
minorities. FHA is legislatively constrained by the dollar amount of
loans it can insure.
VA (federal agency):
Purpose: VA guarantees housing loans for veterans and their families.
VA does not impose a maximum loan amount that may be guaranteed.
However, for certain high-cost counties, county "limits" must be used
to calculate VA's maximum guarantee amount. Unlike FHA, VA guarantees
only a portion of the loan.
USDA/RD Housing and Community Facilities Programs--Loan Guarantee
Program:
Purpose: USDA/RD guarantees loans for moderate-income individuals or
households to purchase homes in rural areas.
Entities that operate in the secondary mortgage market:
Fannie Mae and Freddie Mac (GSEs):
Purpose: The GSEs guarantee investors in their securities that they
will receive their expected principal and interest payments. Fannie Mae
and Freddie Mac have similar federal charters. The loans they purchase
are required to be under the legislative conforming limit (currently at
$417,000, except for high-cost areas that have a limit of $729,750).
They also are required to meet affordable housing goals for both single-
and multifamily housing.
Ginnie Mae (government corporation in HUD):
Purpose: It guarantees securities backed by pools of FHA-, VA-,
USDA/RD-, and PIH-insured or guaranteed mortgages. Specifically, Ginnie
Mae guarantees that investors in MBS issued by lenders will receive
timely principal and interest payments. Ginnie Mae guaranteed MBS have
the full faith and credit of the federal government.
Direct outlays:
HUD programs, such as HOME, Community Development Block Grant (CDBG),
Section 8 rental assistance, and HOPE VI assistance:
Purpose: HOME and CDBG provide grants to state or local governments
with a flexible funding source to meet their diverse affordable housing
needs. Section 8 subsidizes rents for low-income residents and HOPE VI
is used to rebuild or rehabilitate public housing.
USDA/RD Housing and Community Facilities Programs:
Purpose: USDA/RD makes direct, low-interest loans with no down payments
to help low-and moderate-income individuals or households purchase
homes and also operates a rental assistance program.
Tax subsidies:
Mortgage interest tax deduction:
Purpose: Available to homeowners of all income levels, it allows
homeowners who itemize deductions on their income tax returns to deduct
the interest they pay on their mortgages.
Treatment of capital gains:
Purpose: Individual taxpayers are exempted from paying a capital gains
tax on the first $250,000 of capital gains ($500,000 for joint filers)
from the sale of their principal residence. A principal residence is
defined as a property that was owned and used as a primary residence
for a total of at least 2 years during the 5-year period that ended on
the date of the sale.
Mortgage revenue bonds:
Purpose: State or local agencies issue tax-exempt bonds, the proceeds
of which are used to provide below market interest rate mortgages to
first-time homebuyers who earn no more than the area median income.
Most of the costs of the bonds are borne by the federal government in
the form of lost tax revenue.
Low-Income Housing Tax Credit (LIHTC):
Purpose: Created by the Tax Reform Act of 1986, LIHTC has become the
primary vehicle for production of affordable rental housing in the
country. States are authorized to allocate federal tax credits as an
incentive to the private sector to develop rental housing for low-
income households. Project investors can claim the tax credit award
annually on their tax returns for 10 years.
Source: GAO.
[End of table]
Establishment and Management of the FHFA Conservatorships:
During 2007 and the first half of 2008, Fannie Mae's and Freddie Mac's
financial conditions deteriorated significantly, which FHFA officials
said prompted the agency to establish the conservatorships. As later
described in this report, the enterprises incurred substantial credit
losses on their retained portfolios and their guarantees on MBS. These
credit losses resulted from pervasive declines in housing prices, as
well as specific enterprise actions such as their guarantees on MBS
collateralized by questionable mortgages (mortgages with limited or no
documentation of borrowers' incomes), and investments in private-label
MBS collateralized by subprime mortgages. In July 2008, Fannie Mae's
and Freddie Mac's financial condition deteriorated, which prompted
congressional and Executive Branch efforts to stabilize the enterprises
and minimize associated risks to the financial system. In particular,
Congress passed and the President signed the Housing and Economic
Recovery Act of 2008 (HERA) which, among other things, established
FHFA. HERA sets forth FHFA's regulatory responsibilities and
supervisory powers, which include expanded authority to place the
enterprises in conservatorship or receivership, and provides Treasury
with certain authorities to provide financial support to the
enterprises, which are discussed below. While Treasury and other
federal regulatory officials stated in July 2008 that the
conservatorship or other major measures likely would not be necessary,
the enterprises' financial conditions continued to deteriorate.
According to FHFA and Treasury officials, their ongoing financial
analysis of Fannie Mae and Freddie Mac in August and early September
2008, as well as continued investor concerns about the financial
condition of each enterprise, resulted in FHFA's imposition of the
conservatorships on September 6, 2008, to help ensure the enterprises'
viability, fulfill their housing missions, and stabilize financial
markets.
As conservator of the enterprises, FHFA has replaced their Chief
Executive Officers, appointed new members of the boards of directors,
assumed responsibility for overseeing key business decisions, and
ceased the enterprises' lobbying activities. While FHFA oversees key
enterprise business decisions, agency officials said that they expect
enterprise managers to continue to run day-to-day business activities.
FHFA officials also said that the agency's staff continues to oversee
the enterprises' safety and soundness and housing mission achievement.
For example, FHFA officials said that agency examiners are located on-
site at each enterprise to assess their ongoing financial performance
and risk management.
Since FHFA became conservator, the enterprises have been tasked by the
federal government to help respond to the current housing and financial
crisis. For example, in November 2008, the enterprises suspended the
initiation of foreclosure proceedings on mortgages that they held in
their portfolios or on which they had guaranteed principal and interest
payments for MBS investors, and this initiative subsequently was
extended through March 31, 2009. Furthermore, under the
administration's Homeowner Affordability and Stability Plan, which was
announced on February 18, 2009, the enterprises are tasked to (1)
provide access to low-cost refinancing for loans they own or guarantee
to help homeowners avoid foreclosures and reduce monthly payments and
(2) initiate a loan modification plan for at-risk homeowners that will
lower their housing costs through a combination of interest rate
reductions, maturity extensions, and principal forbearance or
forgiveness.
Treasury Has Been Providing Financial Support to the Enterprises during
Their Conservatorships:
As authorized by HERA, the Secretary of the Treasury entered into
agreements with Fannie Mae and Freddie Mac on September 7, 2008, to
provide substantial financial support to the enterprises and thereby
minimize potential systemic financial risks associated with their
deteriorating financial condition.[Footnote 12] Specifically, Treasury
has entered into agreements and announced the following initiatives:
* Enhance the enterprises' financial solvency by purchasing their
senior preferred stock and making funding available on a quarterly
basis, to be recovered by redemption of the stock or by other means.
[Footnote 13] While the initial funding commitment for each enterprise
was capped at $100 billion, Treasury increased the cap to $200 billion
per enterprise in February 2009 to maintain confidence in the
enterprises. As of June 30, 2009, Treasury had purchased approximately
$50.7 billion in Freddie Mac preferred stock and $34.2 billion in
Fannie Mae preferred stock under the agreements. As part of the
preferred stock purchase agreement, Treasury has received warrants to
buy up to 79.9 percent of each enterprise's common stock for $0.00001
per share. The warrants are exercisable at any time and should the
enterprises' financial conditions improve sufficiently, the warrants
would help the government recover some of its investments in the
enterprises. However, according to CBO, it is unlikely that the federal
government will recover much of its massive financial investments in
the enterprises.[Footnote 14] Treasury also is to receive dividends on
the enterprises' senior preferred stock at 10 percent per year and,
beginning March 31, 2010, quarterly commitment fees from the
enterprises.
* Purchase MBS until December 31, 2009, when the purchase authority
expires. From September 2008 through July 2009, Treasury purchased
$171.8 billion in the enterprises' MBS. While Treasury's authority
under HERA to make such MBS purchases expires at the end of 2009, it
may continue to hold previously purchased MBS in its portfolio beyond
that date.
* Establish a temporary secured credit lending facility that allows the
enterprises, as well as the FHLBank System, to borrow funds in the
event they face difficulties issuing debt in financial markets. Under
this Treasury program, the enterprises are to collateralize any
borrowings with their MBS and the FHLBanks are to collateralize such
borrowings with mortgage assets. To date, neither the enterprises nor
any FHLBanks have used this borrowing authority, and Treasury's
authority for this program expires at the end of 2009.
The Federal Reserve's Steps to Improve Conditions in the Mortgage
Markets:
The Federal Reserve also has agreed to acquire substantial amounts of
debt and MBS of the enterprises and other entities in order to reduce
the cost and increase the availability of credit for the purchase of
homes, and to foster improved conditions in financial markets. In
November 2008, the Federal Reserve announced it would purchase up to
$100 billion of debt issued by Fannie Mae, Freddie Mac, and the FHLBank
System, and up to $500 billion in MBS guaranteed by Fannie Mae, Freddie
Mac, and Ginnie Mae. On March 18, 2009, the Federal Reserve announced
that during the current year it would purchase an additional $100
billion of the enterprises' debt up to a total of $200 billion and an
additional $750 billion of enterprise MBS up to a total of $1.25
trillion. As of August 19, 2009, the Federal Reserve had purchased
$111.8 billion in federal agency housing debt securities and $609.5
billion in guaranteed MBS.[Footnote 15]
The Enterprises Had a Mixed Record on Achieving Housing Mission
Objectives, and Risk-Management Deficiencies Compromised Their Safety
and Soundness:
To help inform the forthcoming congressional consideration of the
enterprises' future purposes and structures, this section discusses key
aspects of their histories and performance in achieving key housing
mission and safety and soundness objectives. Specifically, in this
section, we discuss (1) the enterprises' changing roles, structures,
and activities over the years; (2) their performance in supporting
mortgage finance consistent with charter obligations; (3) the extent to
which the numeric housing goals may have materially benefited
homeownership opportunities for targeted groups; and (4) the effect of
the enterprises' risk-management practices on their safety and
soundness.
Enterprises' Roles, Structures, Activities, and Regulatory Oversight
Underwent Important Changes since the 1930s:
As discussed below, the enterprises underwent important structural
changes over the decades and accrued diverse missions and activities
relating to the public and for-profit aspects of their structures and
functions. Table 2 provides a time line that summarizes the key events
in the federal housing finance system related to the enterprises over
the past 77 years.
Table 2: Time Line of Significant Events in Federal Housing Finance
System:
1930s: Government stabilized the flow of funds into housing, promoted
stability by providing liquidity in housing finance through the
secondary market, and standardized longer term, fixed-rate mortgages:
1932: FHLBank System was created.
1934: FHA was created; FHA was given authority to authorize the
establishment of privately held national mortgage associations for the
purchase and sale of mortgages.
1938: FHA, within its authority, established a national mortgage
association, which became Fannie Mae, within FHA for the purpose of the
purchase and sale of FHA-insured mortages.
1940s: In the postwar period, housing demand grew rapidly:
1946: Fannie Mae's predecessor began buying and selling loans
guaranteed by VA.
1948: FHA given authority specifically to charter the Federal National
Mortgage Association (Fannie Mae) which received statutory authority to
buy and sell loans guaranteed by VA.
1950s: Fannie Mae's purchases of FHA-insured and VA-guaranteed
mortgages increased substantially:
1954: Fannie Mae was chartered specifically to provide liquidity in the
mortgage market, and support the mortgage market when there was a
threat to the stability of the economy.
1954: The Housing Act reorganized Fannie Mae as a mixed-ownership
corporation with eligible shareholders being the federal government and
lenders that sold mortgages to Fannie Mae.
1960s: Federal housing agencies were restructured:
1965: FHA became part of HUD, within its Office of Housing.
1968: Fannie Mae was divided in two: Fannie Mae continued in the
secondary market sector as a private, shareholder-owned entity with a
federal charter overseen by HUD, while the newly created Ginnie Mae
guaranteed FHA and VA mortgages from within HUD.
1970s: Freddie Mac was created and Fannie Mae moved into the
conventional mortgage market:
1970: Federal Home Loan Mortgage Corporation (Freddie Mac) was created
to develop a secondary market for conventional mortgage loans.
1970: Ginnie Mae first issued securities, backed by FHA and VA loans.
1971: Freddie Mac introduced the first conventional mortgage security,
the mortgage participation certificate (PC).
1972: Fannie Mae bought its first conventional mortgages--those not
backed by FHA or VA.
1980s: Fannie Mae faced challenges with interest-rate risk and Freddie
Mac became publicly traded:
Early 1980s: Fannie Mae held mortgage assets in portfolio and
experienced financial trouble because of high, short-term interest
rates; the federal government provided financial support.
1981: Fannie Mae first issued MBS.
1989: Freddie Mac became a publicly traded, shareholder-owned
corporation.
1989: FHLBank oversight transferred to the Federal Housing Finance
Board (FHFB) from the Federal Home Loan Bank Board.
1990s: Unprecedented growth:
1992: Federal Housing Enterprises Safety and Soundness Act was enacted
and established the Office of Federal Housing Enterprise Oversight
(OFHEO) as an independent agency within HUD to monitor the safety and
soundness of the enterprises.
1992: Numeric housing goals were established.
Mid 1990s: Rapid growth in enterprise mortgage portfolios begins.
2000s: Housing bubble bursts and the enterprises undertake activities
that led to their conservatorships:
Early 2000s: Fannie Mae and Freddie Mac started buying Alt-A and
subprime mortgage securities.
2003: Freddie Mac found by OFHEO to have used improper accounting
methods.
2004: Fannie Mae found by OFHEO to have used improper accounting
methods.
2008: HERA created FHFA to oversee Fannie Mae, Freddie Mac, and the
FHLBank System, abolished OFHEO and FHFB as regulatory agencies, and
transferred HUD's mission authority (including numeric housing goals)
to FHFA.
2008: FHFA placed Fannie Mae and Freddie into conservatorship on
September 6, 2008.
Source: GAO.
[End of table]
Created in the 1930s, Fannie Mae Initially Provided Additional
Liquidity to the Mortgage Market by Buying and Holding FHA Mortgages:
Prior to the 1930s, the federal government did not play a direct role
in supporting housing finance. Typically lenders--mainly savings and
loans (thrifts), but also banks--originated short-term mortgages (from
3 to 10 years). Since thrifts and banks primarily served local markets,
regional differences in the demand for and supply of mortgage credit
resulted in regional disparities in mortgage interest rates and credit
availability. During the Great Depression, thousands of thrifts and
banks failed due to their credit losses, and housing finance generally
became unavailable.
In response, the federal government established institutions and
initiatives to revive the housing finance market. In 1932, Congress
established the FHLBank System--the first housing GSE--to provide short-
term loans (called advances) to member savings and loans institutions
that would use them to fund home mortgages.[Footnote 16] Additionally,
Congress established FHA in 1934 in part to promote and insure long-
term housing mortgages (up to 20 years) that called for borrowers to
pay off the principal and interest of loans over a specified number of
years.[Footnote 17] Fannie Mae was established by FHA under authority
provided in 1938 as a government-held association to buy and hold
mortgages insured by FHA, thereby providing additional liquidity to the
mortgage market.[Footnote 18] During the 1940s, Congress authorized
Fannie Mae to purchase VA-guaranteed mortgages to facilitate the
efforts of veterans to purchase homes.[Footnote 19]
The Housing Act of 1954 instituted Fannie Mae as a mixed-ownership
corporation and specified in its federal charter the entity's role and
requirements that subsequently served as some of the enterprises' key
housing mission objectives.[Footnote 20] Among its provisions, the act
required Fannie Mae to (1) provide liquidity for mortgage investments
to improve the availability of capital for home mortgage financing and
(2) support the mortgage market when there was a threat to the
stability of the economy. The 1954 act also provided Fannie Mae with
certain financial benefits thought necessary to carry out its
objectives, such as exemptions from all local taxes except property
taxes. Lenders that sold mortgages to Fannie Mae were required to
purchase stock in it, but the federal government remained the
enterprise's majority owner.
Throughout the late 1950s and 1960s, Fannie Mae's purchases of FHA-
insured and VA-guaranteed mortgages increased substantially. During
this period, limits on interest rates that banks and thrifts could
offer for deposits and restrictions on their ability to branch across
state lines contributed to liquidity constraints and continuing
regional disparities in mortgage interest rates. By operating across
the nation, Fannie Mae could help alleviate such scarcities and
disparities.
Congress Established Fannie Mae and Freddie Mac as For-profit
Corporations in 1968 and 1970, Respectively, to Carry Out Housing
Missions:
In 1968, the Housing and Urban Development Act (the 1968 act)
reorganized Fannie Mae as a for-profit, shareholder-owned company with
government sponsorship and established Ginnie Mae as an independent
government corporation in HUD.[Footnote 21] Ginnie Mae's primary
function was to guarantee the timely payment of principal and interest
from pools of FHA-, USDA/RD-, and PIH-insured and VA-guaranteed
mortgages. Ginnie Mae has the full faith and credit backing of the
federal government. Although now a for-profit, shareholder-owned
company, Fannie Mae continued its activities, which were mainly
purchasing FHA and VA mortgages. According to some financial analysts,
Congress largely reorganized Fannie Mae as a private company for
budgetary purposes (that is, to remove its financial obligations from
the federal budget). The 1968 act also gave the HUD Secretary general
regulatory authority over Fannie Mae, as well as authority to require
that a reasonable portion of its mortgage purchases serve low-and
moderate-income families. The Secretary subsequently established
numeric housing goals for Fannie Mae that essentially required that at
least 30 percent of its purchases serve low-and moderate-income
families, and at least 30 percent serve families living in central
cities. However, HUD was not given authority to collect data that would
be necessary to determine compliance with the goals.
In the Emergency Home Finance Act of 1970, Congress chartered Freddie
Mac as a housing GSE to help mitigate business challenges facing the
thrift industry.[Footnote 22] Increasing interest rates had undermined
thrifts' capacity to finance long-term mortgages held in their
portfolios.[Footnote 23] Freddie Mac was to purchase long-term
mortgages from thrifts and thereby help stabilize the industry and
enhance its capacity to fund additional mortgages. As a result, Freddie
Mac was the first enterprise to develop products to facilitate
securitization of mortgage loans. Freddie Mac was first owned by the
Federal Home Loan Bank Board, which regulated the thrift industry.
Freddie Mac did not become a shareholder-owned company like Fannie Mae
until it was reorganized in 1989. While subject to HUD's general
regulatory oversight under the 1989 legislation, Freddie Mac initially
was not subject to the same mortgage purchase goals as Fannie Mae.
Although both Freddie Mac and Fannie Mae were to provide a secondary
market for conventional mortgages, they pursued markedly different
business strategies in the 1970s and 1980s. Freddie Mac focused its
business activities on purchasing conforming, conventional mortgages
from thrifts and issuing MBS rather than holding mortgages in its
portfolio. According to a Freddie Mac official, this business strategy
was intended to help the thrift industry manage interest-rate risk by
passing such risk to the MBS investors. In contrast, Fannie Mae
followed its traditional business strategy by purchasing mortgages and
holding them in its portfolio. During the early 1980s, Fannie Mae
experienced substantial losses, as did the thrift industry, due to
sharply rising interest rates while Freddie Mac's financial performance
generally was unaffected. During this period, the federal government
provided certain financial benefits to Fannie Mae, such as regulatory
forbearance and tax benefits, to help it recover. After Freddie Mac was
turned into a for-profit, shareholder-owned corporation in 1989, it
began to hold more mortgages in its retained portfolio, similar to
Fannie Mae.[Footnote 24]
Congress Revised Enterprise Regulation in 1992 to Better Ensure Safety
and Soundness and Help Manage the Potential Conflict between Their
Profit Motives and Housing Missions:
By 1992, Congress concluded that the enterprises posed potential safety
and soundness risks, and regulations that had been in place since 1968
were inadequate to manage such risks. Over the years, the enterprises
had become large and complex organizations, and Fannie Mae's financial
difficulties in the early 1980s indicated that they posed risks to
taxpayers and financial stability. Furthermore, HUD had not fulfilled
its statutory responsibility to monitor the enterprises' financial
operations and risks. For example, HUD did not routinely examine the
enterprises' financial activities or promulgate regulations necessary
to help ensure their safe and sound operations. There was also a
concern that the enterprises were not adequately serving the mortgage
credit needs of low-and moderate-income borrowers and other targeted
groups due to their potentially higher default risks. In a 1996 report,
we noted that, in 1992, there was a perception that the enterprises'
distribution of conventional, conforming loan funding to low-and
moderate-income borrowers was lagging behind the primary mortgage
market, and a Federal Reserve study was consistent with this
perception.[Footnote 25] Moreover, HUD did not enforce the housing
goals--which at that time applied only to Fannie Mae--or collect the
data necessary to do so.
In enacting the Federal Housing Enterprises Safety and Soundness Act of
1992 (the 1992 Act), Congress fundamentally revised regulation of the
enterprises and took steps to clarify Fannie Mae's and Freddie Mac's
roles within the housing finance system and better define their public
housing mission responsibilities. For example, the 1992 Act reiterated
the enterprises' long-standing obligations to support mortgage finance
through secondary market activities, including during stressful
economic periods, and clarified and expanded the enterprises' charter
obligations to facilitate the flow of mortgage credit serving targeted
groups. Moreover, the 1992 Act set forth oversight authority and
mechanisms to better manage potential conflicts between the
enterprises' profit motivations and housing missions.
* First, it established OFHEO as an independent agency in HUD
responsible for the enterprises' safety and soundness. Among other
things, OFHEO was given supervisory authority to establish and monitor
compliance with minimum and risk-based capital standards and conduct
routine safety and soundness examinations. In so doing, Congress
established a safety and soundness regulatory framework that resembled
the supervisory framework for insured depository institutions such as
banks and thrifts, although OFHEO's authority was less extensive.
* Second, the 1992 Act expanded the enterprises' previous housing
mission responsibilities by requiring them to meet specific annual
goals for the purchase of mortgages serving targeted groups.
Specifically, it directed the HUD Secretary to promulgate regulations
setting annual housing goals for both Fannie Mae and Freddie Mac for
the purchase of mortgages serving low-and moderate-income families;
special affordable housing for families (i.e., low-income families in
low-income areas, and very low-income families); and housing located in
central city, rural, and other underserved areas. The 1992 Act also
provided HUD with the authority to collect data necessary to monitor
the enterprises' compliance with the goals and to enforce such
compliance. It should be noted that the enterprises' affordable housing
goals required them to compete with other federal initiatives to
support housing, particularly FHA's mortgage insurance programs that
also primarily serve low-and moderate-income borrowers and first-time
homeowners. This issue is discussed in more detail later in this
report.
* Third, the 1992 Act set forth HUD's regulatory authority over the
enterprises and specified procedures that HUD must follow when
reviewing and approving new mortgage program proposals by the
enterprises. That is, it directed the HUD Secretary to approve any new
program that an enterprise proposed, unless the Secretary determined
that the program violated the enterprise's charter or would not be in
the public interest. Additionally, the 1992 Act required the HUD
Secretary, for a specified transition period, to reject a new program
proposal if the Director of OFHEO determined that the proposal would
risk a significant financial deterioration of the enterprise.
Despite Improvements, Limitations in Oversight Continued to Affect The
Enterprises' Safety and Soundness and Mission Compliance:
While the 1992 Act enhanced the enterprises' regulatory structure in
several important respects, it still had important limitations in its
capacity to ensure the enterprises' safety and soundness and housing
mission compliance. First, federal oversight of the enterprises and the
FHLBank System was divided among OFHEO, HUD, and FHFB--which was the
safety and soundness and housing mission regulator for the FHLBank
System. However, OFHEO and FHFB were small agencies that lacked the
resources necessary to monitor large and complex financial
organizations from the standpoint of safety and soundness, as well as
mission goals. Furthermore, as compared with federal bank regulators,
both OFHEO and FHFB lacked key authorities--such as authority to take
enforcement actions based on declining capital levels and unsound
financial practices--that were available to federal bank regulators.
[Footnote 26]
Enterprise regulation also had limited capacity to address potential
conflicts between the enterprises' profit motivations and their
federally mandated housing missions. In particular, we noted that, due
to the financial benefits derived from their federal charters and their
dominant position within the mortgage finance system, the enterprises
had financial incentives to engage in potentially profitable activities
that were not fully consistent with their charter obligations and
restrictions.[Footnote 27] For example, Freddie Mac, during the mid-
1990s, had invested in nonmortgage assets, such as long-term corporate
bonds, that potentially allowed the enterprise to earn higher returns
based on the enterprises' funding advantage.[Footnote 28] Freddie Mac
argued that its investments in nonmortgage assets were permissible and
necessary to help manage the liquidity of its investment portfolio.
Although HUD had general regulatory and new mortgage program
authorities, it was not clear if HUD was well-positioned to assess such
arguments or the extent to which the enterprises may have been straying
from their charter obligations and restrictions. At that time, HUD
officials said that they lacked staff with the expertise necessary to
oversee large and complex financial institutions and determine if the
enterprises' activities were consistent with their charters and housing
finance missions.
By retaining the enterprises' off-budget status as GSEs, the 1992 Act
permitted a continuation of the lack of transparency about the
enterprises' risks and potential costs to taxpayers. Under the Federal
Credit Reform Act of 1990, the potential costs associated with many
direct federal loan and loan guarantee programs have to be disclosed in
the federal budget.[Footnote 29] Congress and the Executive Branch can
use such disclosures to assess the potential costs and future risks of
such programs and take steps on a timely basis to potentially mitigate
such costs and risks (for example, tightening eligibility criteria).
Despite the implied federal guarantee of their obligations, the
government's exposure in connection with the enterprises is not
disclosed in the federal budget because GSE activities were excluded
from the federal budget totals.[Footnote 30] The 1992 Act did not
change the status of the enterprises as off-budget entities. However,
it should be noted that such financial disclosures could have involved
an offsetting risk. Such treatment might have increased the perception
that, despite the enterprises' statements to the contrary, the federal
government would provide financial support to them in an emergency,
which may have further reduced market discipline and enterprise actions
to mitigate risks.
Congress substantially revised the enterprises' regulatory structure
with the passage of HERA in 2008. In HERA, Congress abolished OFHEO and
FHFB and established FHFA as the regulator of the enterprises and the
FHLBank System. HERA charges FHFA with responsibility for housing GSE
safety and soundness. In this regard, HERA augments the safety and
soundness responsibilities and authorities administered by the
predecessor agencies. Additionally, HERA transferred responsibility for
the enterprises' mission oversight, including their satisfaction of
numeric goals for purchases of mortgages to low-and moderate-income
borrowers and the review and approval of enterprise new mortgage
programs, from HUD to FHFA. FHFA's supervisory authority over safety
and soundness matters includes specific authority to place the housing
GSEs into conservatorship or receivership based on grounds set forth in
HERA. Since placing Fannie Mae and Freddie Mac into conservatorship in
September 2008, FHFA has appointed new Chief Executive Officers and
boards of directors at each enterprise and stands in lieu of
shareholders in matters of corporate governance. In contrast, FHFA's
role with respect to the FHLBank System has remained solely that of an
independent regulator.
The Enterprises' Performance in Achieving Key Housing Finance Support
Objectives Has Been Mixed:
It is generally accepted that the enterprises have been successful in
enhancing liquidity in the mortgage finance system as directed in their
charters. We have reported that the enterprises established a viable
secondary mortgage market for conventional loans that enabled capital
to flow to areas with the greatest demand for mortgage credit.[Footnote
31] This free flow of capital tended to equalize interest rates across
regions for mortgages with similar risk characteristics. However, the
removal of restrictions on the ability of banks and thrifts to pay
market rates for deposits and to operate across state lines also have
contributed to mortgage liquidity and the establishment of an
integrated national mortgage finance system.
The enterprises' activities also have been credited with achieving
other benefits consistent with their charter obligations to support
mortgage finance, which include the following:
* Lowering mortgage interest rates on qualifying mortgages below what
they otherwise would be. GAO and others have stated that the
advantageous borrowing rates that the enterprises derived from the
implied federal guarantee on their financial obligations were passed on
to borrowers to some degree, although estimates vary.[Footnote 32]
However, we also have noted that these benefits were not entirely
passed along to homebuyers. Rather, the enterprises' shareholders and
senior management also benefited for many years from the relatively
higher profits that the companies achieved due to cost savings
associated with the implied guarantee.
* Establishing standard underwriting practices and forms for
conventional mortgages. Due to the enterprises' large purchases of
conventional mortgages each year, their underwriting guidelines and
forms became the industry standard. GAO and others have found that
standardization facilitated the efficiency of the mortgage underwriting
process and resulted in cost savings for lenders and borrowers. The
enterprises' efforts to standardize mortgage underwriting likely also
helped develop the MBS market, as consistent standards are viewed as
critical for helping investors evaluate risks.
However, the extent to which the enterprises have been able to support
a stable and liquid secondary mortgage market during periods of
economic stress, which are key charter and statutory obligations, is
not clear. In 1996, we attempted to determine the extent to which the
enterprises' activities would support mortgage finance during stressful
economic periods by analyzing Fannie Mae's mortgage activities in some
states, including oil producing states such as Texas and Louisiana,
beginning in the 1980s.[Footnote 33] Specifically, we analyzed state-
level data on Fannie Mae's market shares and housing price indexes for
the years 1980-1994. We did not find sufficient evidence that Fannie
Mae provided an economic cushion to mortgage markets in those states
during the period analyzed.
During the current financial crisis, the enterprises have provided
critical support to mortgage finance, but only with the benefit of
substantial financial assistance provided by Treasury and the Federal
Reserve during the conservatorships. As shown in figure 1, the
enterprises and Ginnie Mae accounted for nearly 60 percent of MBS
issuances in 2006, while private-label issuances, such as MBS
collateralized by pools of subprime and jumbo mortgages, accounted for
nearly 40 percent. By the end of 2008, the enterprises and Ginnie Mae
accounted for about 97 percent of MBS issuances, while private-label
issuances stood at about 3 percent due to the collapse of many subprime
lenders and the associated reduction in nonconforming mortgage
origination and precipitous downturn in securitization markets.
According to FHFA's former Director, one of the reasons that the agency
established the conservatorships in September 2008 is that the
financial challenges the enterprises were facing as independent
entities compromised their capacity to support mortgage finance. For
example, the enterprises' mortgage purchases slowed in 2008, and they
planned to raise certain fees to help offset their losses. While the
enterprises are now a critical component of the federal government's
response to the housing crisis, such support would not be possible
without Treasury's financial support and the Federal Reserve's plans to
purchase almost $1.45 trillion of their MBS and debt obligations as
well as those of other entities.[Footnote 34]
Figure 1: Enterprises and Private-Label MBS Issuances, 2004-2008:
[Refer to PDF for image: stacked vertical bar graph]
Year: 2004;
GSEs and Ginnie Mae: 1,375.2 million (72.1%);
Private label: 532.7 million (27.9%).
Year: 2005;
GSEs and Ginnie Mae: 1,321 million (59.5%);
Private label: 901.2 million (40.5%).
Year: 2006;
GSEs and Ginnie Mae: 1,214.7 million (57%);
Private label: 917.4 million (43%).
Year: 2007;
GSEs and Ginnie Mae: 1,372.2 million (63.9%);
Private label: 773.9 million (36.1%).
Year: 2008;
GSEs and Ginnie Mae: 1.299.2 million (97%);
Private label: 40.5 million (3%).
Source: GAO analysis of data from Securities Industry and Financial
Markets Association.
[End of figure]
Evidence to Support Effectiveness of Enterprises' Program to Increase
Purchases of Mortgages Serving Targeted Groups Is Limited:
While the enterprises' numeric housing goal mortgage purchase program
has been in place for more than 10 years, its effectiveness in
supporting homeownership opportunities for targeted groups and areas is
not clear. Pursuant to the 1992 Act, HUD established interim goals for
1993 and 1994, which were extended through 1995, and final goals for
the period from 1996 through 1999. In 1998, we found these were
conservative goals, which placed a high priority on maintaining the
enterprises' financial soundness.[Footnote 35] For example, according
to research conducted by HUD and OFHEO, the additional mortgage
purchases required under the goals were modest and would not materially
affect the enterprises' financial condition. HUD also established
housing goals in 2000 (covering 2001-2004) and in 2004 (covering 2005-
2008). According to a speech by the FHA Commissioner in 2005, the 2004
goals established significantly higher requirements than the 2000
goals.
According to HUD data, the enterprises generally have met the numeric
housing goals since the beginning of the program. For example, table 3
shows that Fannie Mae and Freddie Mac met the low-and moderate-income
housing goals in place from 2002 through 2007. However, the enterprises
failed to meet this goal in 2008, and, according to HUD, did not meet
certain subgoals in 2007.
Table 3: Enterprise Compliance with Low-and Moderate-Income Numeric
Mortgage Purchase Goals, 2002-2008:
Goal:
Percentage of low-and moderate-income purchases: 2002: 50.0;
Percentage of low-and moderate-income purchases: 2003: 50.0;
Percentage of low-and moderate-income purchases: 2004: 50.0;
Percentage of low-and moderate-income purchases: 2005: 52.0;
Percentage of low-and moderate-income purchases: 2006: 53.0;
Percentage of low-and moderate-income purchases: 2007: 55.0;
Percentage of low-and moderate-income purchases: 2008: 56.0.
Fannie Mae performance:
Percentage of low-and moderate-income purchases: 2002: 51.8;
Percentage of low-and moderate-income purchases: 2003: 52.3;
Percentage of low-and moderate-income purchases: 2004: 53.4;
Percentage of low-and moderate-income purchases: 2005: 55.1;
Percentage of low-and moderate-income purchases: 2006: 56.9;
Percentage of low-and moderate-income purchases: 2007: 55.5;
Percentage of low-and moderate-income purchases: 2008: 53.6.
Freddie Mac performance:
Percentage of low-and moderate-income purchases: 2002: 50.3;
Percentage of low-and moderate-income purchases: 2003: 51.2;
Percentage of low-and moderate-income purchases: 2004: 51.6;
Percentage of low-and moderate-income purchases: 2005: 54.0;
Percentage of low-and moderate-income purchases: 2006: 55.9;
Percentage of low-and moderate-income purchases: 2007: 56.1;
Percentage of low-and moderate-income purchases: 2008: 51.5.
Source: GAO.
Note: Under the goals, in 2002 for example, half of each enterprise's
total mortgage purchases were to serve borrowers who qualified as being
low-and moderate-income under HUD's definition. (See GAO/GGD-98-173).
[End of table]
Although the enterprises generally satisfied the numeric purchase goals
through 2007, HUD and independent researchers have had difficulty
identifying tangible benefits for targeted groups associated with the
enterprises' purchase program. In setting higher housing goals
beginning in 2005, HUD stated that the intent was to encourage the
enterprises to facilitate greater financing and homeownership
opportunities for the groups targeted by the goals. HUD concluded that,
although the enterprises had complied with previous goals, they
continued to serve less of the affordable housing market than was
served by conventional conforming primary market lenders during those
years. Furthermore, recent research indicates that, although the
enterprises have enhanced their product offerings to meet the housing
goals, the effects of the housing goals on affordability and
opportunities for target groups have been limited. For example, a 2003
study that modeled the impacts of the housing goals found that the
enterprises likely increased credit in specified areas in only 1 of the
5 years included in the model.[Footnote 36] A 2006 study concluded that
the enterprises' purchases of mortgages in certain targeted low-and
moderate-income areas (census tracts in California during the 1990s
with depressed housing markets) generally did not increase
homeownership rates as compared with other low-and moderate-income
areas that were not specifically targeted by the numeric housing goals.
The research found only one low-income target area (in San Francisco)
that showed improvements in homeownership rates as a result of the
enterprises' activities.[Footnote 37]
Another study suggested that enterprise-FHA interactions in the same
areas may help explain why the program's benefits were limited.
[Footnote 38] While the enterprises' numeric mortgage purchase program
and FHA's mortgage insurance were intended to benefit similar targeted
groups, such as low-income and minority borrowers, the study suggested
that the programs may have offset each other. That is, as the
enterprises increased their mortgage purchases in areas with
concentrations of targeted groups, FHA activity declined in those
areas. According to the study, while the relatively lower costs of
conventional loans compared with FHA-insured loans provided benefits
for those households able to switch to a conventional loan, this cost
differential also permitted the enterprises to attract an increasing
share of the most creditworthy targeted borrowers in these areas, which
FHA had served before. In response to losing its more creditworthy
borrowers, FHA could have retained market share by reaching for
borrowers that represented greater credit risks and either (1) accepted
the riskier portfolio wholesale or (2) increased premiums to insure
itself against expected losses. However, the study concluded that FHA
applied stricter underwriting standards and reduced its loan volume.
Therefore, the overall impact of the two programs on promoting
homeownership opportunities in these areas was limited. After 2002,
both the enterprises' and FHA's market share declined in areas with
concentrations of low-income and minority groups as subprime lending
grew in size, which may have limited the impact of both the
enterprises' housing goal program and FHA's mortgage insurance
activities.[Footnote 39]
Earlier research sponsored by HUD in 2001 largely discounted the
alleged benefits for affordable multifamily finance resulting from the
enterprises' numeric mortgage goals.[Footnote 40] According to the
research, the enterprises generally did not play a leading role in
affordable multifamily mortgage finance because their underwriting
standards were considered conservative and fairly inflexible, compared
with other multifamily mortgage providers. In contrast, representatives
from mortgage finance, housing construction, and consumer groups we
contacted said that the benefits from the enterprises' purchases of
affordable multifamily mortgages pursuant to their goals have been
significant. The representatives said that the enterprises' involvement
and, in some cases, guarantees on the financing of affordable
multifamily projects, which may be complex and involve a variety of
government and private-sector entities, were crucial to their
successful completion. In addition, the representatives said that the
enterprises were the only source of funding for multifamily projects
because many other traditional providers, such as banks and insurance
companies, largely have withdrawn from the market during the current
financial crisis.
The Enterprises' Risk-management and Operational Practices Have Been
Deficient:
While housing finance may have derived some benefits from the
enterprises' activities over the years, GAO, federal regulators,
researchers, and others long have argued that the enterprises had
financial incentives to engage in risky business practices to
strengthen their profitability partly because of the financial benefits
derived from the implied federal guarantee on their financial
obligations. For example, during the late 1990s and early 2000s, we
raised concerns about the rapid growth of the enterprises' retained
mortgage portfolios, which reached about $1.6 trillion by 2005 (see
figure 2). Although increasing the size of their mortgage portfolios
may have been more profitable than issuing MBS, it also exposed the
enterprises to significant interest-rate risk. We reported that the
rapid increase in the enterprises' mortgage portfolios and the
associated interest-rate risk did not result in a corresponding benefit
to the achievement of their housing missions. For example, the rapid
growth in the enterprises' retained mortgage portfolios in the late
1990s, and in 2003 through 2004, occurred during periods of strong
economic growth when mortgage markets did not necessarily require the
enterprises to be robust portfolio lenders.
Figure 2: Growth in Enterprises' Retained Mortgage Portfolios, 1990-
2008:
[Refer to PDF for image: multiple line graph]
Year: 1990;
Total GSE retained portfolios: 199.1 trillion;
Fannie Mae retained portfolios: 167.5 trillion;
Freddie Mac retained portfolios: 31.6 trillion.
Year: 2000;
Total GSE retained portfolios: 1,190 trillion;
Fannie Mae retained portfolios: 728.1 trillion;
Freddie Mac retained portfolios: 461.9 trillion.
Year: 2001;
Total GSE retained portfolios: 1,415.9 trillion;
Fannie Mae retained portfolios: 826.4 trillion;
Freddie Mac retained portfolios: 589.5 trillion.
Year: 2002;
Total GSE retained portfolios: 1,622.1 trillion;
Fannie Mae retained portfolios: 943.7 trillion;
Freddie Mac retained portfolios: 678.4 trillion.
Year: 2003;
Total GSE retained portfolios: 1,779.2 trillion;
Fannie Mae retained portfolios: 1,035.5 trillion;
Freddie Mac retained portfolios: 743.7 trillion.
Year: 2004;
Total GSE retained portfolios: 1,740.2 trillion;
Fannie Mae retained portfolios: 1,012.7 trillion;
Freddie Mac retained portfolios: 727.5 trillion.
Year: 2005;
Total GSE retained portfolios: 1,533 trillion;
Fannie Mae retained portfolios: 781 trillion;
Freddie Mac retained portfolios: 752 trillion.
Year: 2006;
Total GSE retained portfolios: 1,464.8 trillion;
Fannie Mae retained portfolios: 746 trillion;
Freddie Mac retained portfolios: 718.9 trillion.
Year: 2007;
Total GSE retained portfolios: 1,433.6 trillion;
Fannie Mae retained portfolios: 723.6 trillion;
Freddie Mac retained portfolios: 710 trillion.
Source: OFHEO Report to Congress, April 15, 2008.
[End of figure]
In 2003 and 2004, OFHEO found that Freddie Mac and Fannie Mae
manipulated accounting rules so that their public financial statements
would show steadily increasing profits over many years and thereby
increase their attractiveness to potential investors. The
misapplication of accounting rules generally involved standards for
reporting on derivatives, which the enterprises used to help manage the
interest-rate risks associated with their large retained mortgage
portfolios. According to investigative reports, the enterprises also
may have manipulated their financial reports to show consistently
increasing profits to help ensure senior executives would receive
bonuses. OFHEO also found that the enterprises lacked key operational
capacities, such as information systems and personnel, necessary to
manage large mortgage portfolios and account for them correctly. The
enterprises were required to restate their financial statements and
adjust their earnings reports by billions of dollars.
While the enterprises were subject to increased OFHEO scrutiny because
of these accounting and operational deficiencies in 2004 and 2005, they
still embarked on aggressive strategies to purchase mortgages and
mortgage assets with questionable underwriting standards. For example,
they purchased a large volume of what are known as Alt-A mortgages,
which typically did not have documentation of borrowers' incomes and
had higher loan-to-value ratio or debt-to-income ratios. Furthermore,
as shown in figure 3, enterprise purchases of private-label MBS
increased rapidly as a percentage of retained mortgage portfolios from
2003 through 2006. By the end of 2007, the enterprises collectively
held more than $313 billion in private-label MBS, of which $94.8
billion was held by Fannie Mae and $218.9 billion held by Freddie Mac.
According to some commenters, the 2004 increase in housing goals
provided the enterprises with incentives to purchase mortgage assets,
such as Alt-A mortgages and private-label MBS collateralized by
subprime and Alt-A mortgages,that in large degree served targeted
groups. However, former FHFA Director Lockhart stated that the
enterprises' primary motivation in purchasing such assets was to
restore their share of the mortgage market, which declined
substantially from 2004 through 2007 as the "nontraditional" (for
example, subprime) mortgage market rapidly increased in size. FHFA
further stated that the enterprises viewed such mortgage assets as
offering attractive risk-adjusted returns.
Figure 3: Total Private-Label Mortgage Backed Securities as Percentage
of the Enterprises Retained Mortgage Portfolios, 1998-2007:
[Refer to PDF for image: multiple line graph]
Year: 1998;
Fannie Mae: 4.7%;
Freddie Mac: 6.6%.
Year: 1999;
Fannie Mae: 6.1%;
Freddie Mac: 9.6%.
Year: 2000;
Fannie Mae: 5.6%;
Freddie Mac: 9.3%.
Year: 2001;
Fannie Mae: 4.1%;
Freddie Mac: 8.4%.
Year: 2002;
Fannie Mae: 3.4%;
Freddie Mac: 12%.
Year: 2003;
Fannie Mae: 5.1%;
Freddie Mac: 16.2%.
Year: 2004;
Fannie Mae: 11.8%;
Freddie Mac: 25%.
Year: 2005;
Fannie Mae: 11.8%;
Freddie Mac: 32.6%.
Year: 2006;
Fannie Mae: 13.4%;
Freddie Mac: 32.1%.
Year: 2007;
Fannie Mae: 13.1%;
Freddie Mac: 30.8%.
Source: OFHEO Report to Congress, April 15, 2008.
[End of figure]
According to FHFA, while these questionable mortgage assets accounted
for less than 20 percent of the enterprises' total assets, they
represented a disproportionate share of credit-related losses in 2007
and 2008. For example, by the end of 2008, Fannie Mae held
approximately $295 billion in Alt-A loans, which accounted for about 10
percent of the total single-family mortgage book of business (mortgage
assets held in portfolio and mortgages that served as collateral for
MBS held by investors). Similarly, Alt-A mortgages accounted for nearly
half of Fannie Mae's $27.1 billion in credit losses of its single-
family guarantee book of business in 2008. At a June 2009 congressional
hearing, Lockhart said that 60 percent of the AAA-rated, private-label
MBS purchased by the enterprises have since been downgraded to below
investment grade.[Footnote 41] He also stated that investor concerns
about the extent of the enterprises' holdings of such assets and the
potential associated losses compromised their capacity to raise needed
capital and issue debt at acceptable rates.
Options to Revise the Enterprises' Structures Aim to Help Ensure
Housing Mission Achievement, While Mitigating Safety and Soundness
Risks:
The enterprises' mixed records in achieving their housing mission
objectives and the losses and weaknesses that resulted in the
conservatorships reinforce the need for Congress and the Executive
Branch to fundamentally reevaluate the enterprises' roles, structures,
and business activities in mortgage finance. Researchers and others
believe that there is a range of options available to better achieve
housing mission objectives (in some cases through other federal
entities such as FHA), help ensure safe and sound operations, and
minimize risks to financial stability. These options generally fall
along a continuum with some overlap among key features and advocate (1)
establishing a government corporation or agency, (2) reconstituting the
enterprises as for-profit GSEs in some form, or (3) privatizing or
terminating them (see table 4). This section discusses some of the key
principles associated with each option and provides details on how each
could be designed to support housing objectives.
Table 4: Summary of Options to Revise the Enterprises' Structures:
Potential structure: Government corporation or agency;
Proposed function: Focus on purchasing qualifying mortgages and issuing
MBS but eliminate mortgage portfolios, which are complex to manage and
can result in losses due to fluctuations in interest rates.
Responsibilities for promoting homeownership for targeted groups could
be transferred to the FHA, which insures mortgages for low-income and
first-time borrowers.
Potential structure: Reestablish for-profit enterprises with government
sponsorship;
Proposed function: Restore the enterprises to their preconservatorship
status but add controls to minimize risk. These controls might include
eliminating or reducing the enterprises' mortgage portfolios or
subjecting the enterprises to public utility-type regulation, which
involves business activity restrictions and profitability limits, and
establishing executive compensation limits. Convert enterprises from
publicly-traded, shareholder-owned corporations to cooperative
associations owned by mortgage lenders.
Potential structure: Privatization or termination;
Proposed function: Abolish the enterprises in their present form and
disperse mortgage lending and risk management throughout the private
sector. Some proposals involve the establishment of a federal mortgage
insurer to help protect mortgage lenders against catastrophic mortgage
losses.
Source: GAO.
[End of table]
Government Corporation or Agency:
Some proposals advocate that, after the FHFA conservatorships are
terminated, consideration should be given to establishing a government
corporation or agency to assume responsibility for key enterprise
business activities.[Footnote 42] Supporters of these proposals
maintain that the combination of the implied federal guarantee on the
enterprises' financial obligations, and their need to respond to
shareholder demands to maximize profitability, encouraged excessive
risk-taking and ultimately resulted in their failures. Accordingly,
they also believe that a government corporation or agency, which would
not be concerned about maximizing shareholder value, would be the best
way to ensure the availability of mortgage credit for primary lenders,
while minimizing the risks associated with a for-profit structure with
government sponsorship. Establishing a government corporation or agency
also would help ensure transparency in the federal government's efforts
through appropriate disclosures of risks and costs in the federal
budget.
Under one proposal, a government corporation would assume
responsibility for purchasing conventional mortgages from primary
lenders and issuing MBS.[Footnote 43] However, under this proposal, the
enterprises' retained mortgage portfolios would be eliminated over time
because of their interest-rate risk and associated safety and soundness
concerns. Taxpayer protections would come from sound underwriting
standards and risk-sharing arrangements with the private sector. The
government corporation also would be required to establish financial
and accountability requirements for lenders and institute consumer
protection standards for borrowers as appropriate.
While this proposal advocates the establishment of a government
corporation to replace Fannie Mae and Freddie Mac, it states that there
are risks associated with doing so. For example, a government
corporation might face challenges retaining capable staff or become
overly bureaucratic and unreceptive to market developments.
Accordingly, the proposal includes a provision that the government
corporation should be carefully reevaluated to ensure that it does not
"ossify" over time. The proposal also concludes that the new government
corporation either "sunset" (terminate) after 5 years if the market has
stabilized or be allowed to continue under a renewable charter that
would require periodic reviews.
Under a second proposal, a government corporation or agency also would
focus on issuing MBS rather than maintaining a retained mortgage
portfolio.[Footnote 44] Borrowers would be charged actuarially based
premiums to help offset the risks associated with the government
corporation's or agency's activities. For example, mortgages with a 10
percent or lower down payment would be subject to a higher premium than
mortgages with a 20 percent down payment. The government corporation or
agency also would focus its activities on middle-income borrowers, and
the mortgage credit needs of targeted groups would be served by an
expansion of FHA's mortgage insurance programs. The proposal suggests
that specific appropriations to FHA represent a more efficient means to
assist low-income borrowers than seeking to assist such borrowers
through the enterprises' activities. A third proposal advocates that
the government provide funding directly to targeted borrowers though
down-payment assistance rather than relying on the enterprises'
mortgage purchase program.[Footnote 45]
For purposes of comparison, we note that Ginnie Mae is an existing
government corporation that performs important functions in the
secondary markets for government guaranteed and insured mortgage loans.
Specifically, Ginnie Mae guarantees the timely payment of principal and
interest on MBS that are collateralized by pools of mortgages that are
insured or guaranteed by FHA, VA, PIH, and USDA/RD. However, Ginnie Mae
does not perform functions that are envisioned for a government
corporation or agency that might replace Fannie Mae and Freddie Mac. In
particular, Ginnie Mae does not issue MBS, as do Fannie Mae and Freddie
Mac. Moreover, Ginnie Mae is not responsible for monitoring the
underwriting or the credit risk associated with the mortgages that
collateralize the MBS pools but instead relies on FHA, VA, PIH, and
USDA/RD to do so.
Reconstituted GSEs:
While many of the enterprises' critics view the for-profit GSE
structure as precipitating the enterprises' financial crises that led
to conservatorship, market participants and commenters, trade groups
representing the banking and home construction industries, as well as
community and housing advocates we contacted, believe that the for-
profit GSE structure generally remains superior to the alternatives.
They assert that continuing the enterprises as for-profit GSEs would
help ensure that they would remain responsive to market developments,
continue to produce innovations in mortgage finance, and be less
bureaucratic than a government agency or corporation. But, they also
generally advocate additional regulations and ownership structures to
help offset the financial risks inherent in the for-profit GSE
structure.
While this option generally envisions that the enterprises would focus
on issuing MBS, as is the case with proposals to establish government
corporations or agencies, several proponents believe they should be
permitted to maintain a mortgage portfolio to meet certain key
responsibilities. For example, home construction, small bank, and
community and housing advocates noted that the enterprises may need to
maintain portfolios to support multifamily and rural housing finance.
Representatives from the home building industry said that the
enterprises generally have held the majority of their affordable
multifamily mortgage assets in their portfolios. Fannie Mae officials
also said that issuing MBS collateralized by multifamily mortgages can
be difficult compared with issuing MBS collateralized by single-family
properties for several reasons.[Footnote 46]
A variation of this option involves breaking up the enterprises into
multiple GSEs. For example, the Congressional Research Service (CRS)
has stated that the enterprises could be converted into 10 or so GSEs,
which could mitigate safety and soundness risks.[Footnote 47] That is,
rather than having the failure of two large GSEs threaten financial
stability, the failure of a smaller GSE likely would have a more
limited impact on the financial system. CRS also has stated that
creating multiple GSEs could enhance competition and benefit
homebuyers.
A potential regulatory action to limit the risks associated with
reconstituting the enterprises as GSEs would be to establish executive
compensation limits as deemed appropriate. As discussed previously,
OFHEO investigative reports in 2003 and 2004 concluded that the
enterprises manipulated their financial statements in part to help
ensure that senior executives would receive bonuses. In June 2009, FHFA
published proposed rules to implement sections of HERA that give FHFA
authority over executive compensation at the enterprises.[Footnote 48]
It has also been suggested that the enterprises be converted from
publicly traded companies into cooperatives owned by lenders similar to
the FHLBank structure. For example, one commenter suggested that, by
having lenders assume some of the risks associated with the
enterprises' activities, mortgage underwriting standards could be
enhanced. A mortgage lending group stated in a recent analysis of
options to revise the secondary mortgage markets that, under a
cooperative structure for enterprises, lenders would need to post as
collateral a portion of their loan-sale proceeds to cover some initial
level of potential losses.[Footnote 49] This collateral would be
refundable to the lenders as loans age and that rights to the
collateral could be sold to third parties. The trade group also noted
that while the cooperatives would determine pricing, credit standards,
and eligibility requirements, they still would need to be subject to
safety and soundness oversight by the federal government. However,
representatives from a trade group that represents smaller banks said
that it might be difficult to convince such banks to participate in a
cooperative. They said that many smaller banks suffered substantial
losses on the preferred stock they held in Fannie Mae and Freddie Mac
before their conservatorships and would be very reluctant to make such
investments in the future.
It also has been suggested that the reconstituted enterprises be
subject to public utility-type regulation.[Footnote 50] Traditionally,
such regulation has been used at the federal and state level to oversee
and control the financial performance of monopolies or near monopolies,
such as electric, telephone, and gas companies. To help prevent
disadvantages to ratepayers, federal and state governments
traditionally have imposed limits on such public utilities' rate of
return and required that their rate structures be fair and equitable.
It has been suggested that the enterprises' historically dominant
positions in the mortgage markets, and their cost advantages associated
with the implied guarantee, among other advantages, potentially make
them candidates for public utility-type regulation.
Former Treasury Secretary Paulson advocated keeping the enterprises as
corporations, because of the private sector's capacity to assess credit
risk compared with government entities, with substantial government
support but with a variety of controls on their activities. First,
Paulson suggested that the corporations purchase mortgages with a
credit guarantee backed by the federal government and not retain
mortgage portfolios. Second, Paulson recommended that the corporations
be subject to public utility-type regulation.[Footnote 51]
Specifically, he recommended that a public utility-type commission be
established with the authority to set appropriate targets for the
enterprises' rate of return and review and approve underwriting
decisions and new mortgage products. Paulson also recommended that the
enterprises pay a fee to help offset the value of their federal support
and thereby also provide incentives for depository institutions to fund
mortgages, either as competitors to a newly established government
structure or as a substitute for government funding.
Privatization or Termination:
Some analysts and financial commenters contend that privatizing,
significantly reducing, or eliminating the enterprises' presence in the
mortgage markets represents the best public policy option.[Footnote 52]
Advocates of this proposal believe that it would result in mortgage
decisions more closely aligned with market factors and reduce safety
and soundness risks. That is, sources of mortgage credit and risk would
not be concentrated in two large and complex organizations that might
take excessive risks because of the implied federal guarantee on their
financial obligations. Instead, mortgage credit and risk would be
diversified throughout the financial system. Federal Reserve Chairman
Ben S. Bernanke has suggested that privatized entities may be more
innovative and efficient than government entities, and operate with
less interference from political interests.[Footnote 53]
Proposals to privatize, minimize, or eliminate the enterprises'
presence in the mortgage markets may involve a transition period to
mitigate any potential market disruptions and facilitate the
development of a new mortgage finance system. For example, one proposal
would freeze the enterprises' mortgage purchase activities, which would
permit banks and other lenders to assume a greater role in the
financial system.[Footnote 54] Some researchers and financial
commenters also have suggested that private-sector entities, such as
consortiums or cooperatives of large banks, would have a financial
incentive to assume responsibility for key enterprise activities, such
as purchasing mortgages and issuing MBS.
Given the substantial financial assistance that Treasury and the
Federal Reserve have provided to the enterprises during their
conservatorships, it may be very difficult to credibly privatize them
as largely intact entities. That is, the financial markets likely would
continue to perceive that the federal government would provide
substantial financial support to the enterprises, if privatized as
largely intact entities, in a financial emergency. Consequently, such
privatized entities may continue to derive financial benefits, such as
lowered borrowing costs, resulting from the markets' perceptions. In
exploring various options for restructuring the enterprises, Bernanke
has noted that some privatization proposals involve breaking the
enterprises into smaller units to eliminate the perception of federal
guarantees.
Bernanke also has questioned whether fully privatized enterprises would
be able to issue MBS during highly stressful economic conditions. He
pointed out that, during the current financial crisis, private-sector
mortgage lending largely stopped functioning. Bernanke cited a study by
Federal Reserve economists that advocated the creation of an insurer,
similar to the Federal Deposit Insurance Corporation, to support
mortgage finance under the privatization proposal.[Footnote 55] The new
agency would offer premium-supported, government-backed insurance for
any form of bond financing used to provide funding to mortgage markets.
Bernanke and Paulson also have discussed using covered bonds as a
potential means to enhance private-sector mortgage finance in the
United States. According to Bernanke, covered bonds are debt
obligations issued by financial institutions and secured by a pool of
high-quality mortgages or other assets. Bernanke stated that covered
bonds are the primary source of mortgage funding for European banks,
with about $3 trillion outstanding. However, Bernanke concluded that
there are a number of challenges to implementing a viable covered bond
market in the United States. For example, as a source of financing, he
said covered bonds generally are not competitive with financing
provided by the FHLBanks or the enterprises, which have lower financing
costs due to their association with the federal government.
A Framework for Identifying and Analyzing the Trade-offs Associated
with Options to Revise the Enterprises' Structures, and Oversight
Structures That Might Help Ensure Their Effective Implementation:
Each of the options to revise the enterprises' structures involves
important trade-offs in terms of their capacity to achieve key housing
mission and safety and soundness objectives (see table 5). This section
examines the three options in terms of their ability to (1) provide
ongoing liquidity and support to mortgage markets, (2) support housing
opportunities for targeted groups, and (3) ensure safe and sound
operations. Furthermore, it identifies potential regulatory and
oversight structures that might help ensure that the implementation of
any of the options achieves their intended housing mission and safety
and soundness objectives.
Table 5: Trade-offs Associated with Enterprise Reform Options as They
Relate to Long-Established Enterprise Objectives and Potential
Oversight Structures:
Proposed Reform Option: Government corporation or agency;
Provide liquidity and support to mortgage markets including in bad
economic times: A government entity, with access to Treasury-issued
debt to fund its operations, may be in a better position to provide
liquidity to the mortgage market during normal economic periods and
when capital markets are impaired. However, because in some cases
investor demand for its MBS may be limited in times of financial stress
a government entity that does not have a retained portfolio may face
challenges supporting mortgage markets during such periods. Treasury or
the Federal Reserve may have to purchase mortgage assets under such
circumstances as has been the case during the current disruption in
mortgage credit markets;
Support housing opportunities for targeted groups: A government entity
most likely would be expected to pursue housing opportunity programs
for targeted groups due to its public status. However, if the
government entity does not have a retained mortgage portfolio, it may
face certain challenges in managing a housing goal program since some
types of affordable loans, like multifamily loans, often are held in
portfolio. As alternatives, fees could be assessed on the government
entity's activities to support housing opportunities for targeted
groups or FHA's mortgage insurance programs could be expanded;
Ensure safe and sound operations: This model may represent less risk
than traditionally has been the case with the enterprises' GSE
structure and because MBS issuance is less complicated and risky than
managing a retained mortgage portfolio. However, this business activity
still would be more complicated than Ginnie Mae's activities and could
result in substantial taxpayer losses if mismanaged. Furthermore, a
government corporation could face greater challenges than private-
sector entities in obtaining the human and technological resources
necessary to manage complex processes or lack the operational
flexibility to do so;
Possible elements of regulatory and oversight structure: Key elements
for consideration include: (1) certain operational flexibilities to
obtain appropriate staff and information technology to carry out
responsibilities, (2) risk-sharing agreements with private lenders or
mortgage insurers, (3) appropriate disclosures in the federal budget of
risks and liabilities to ensure financial transparency, and (4) robust
congressional oversight of operations.
Proposed Reform Option: Reconstituted GSEs;
Provide liquidity and support to mortgage markets including in bad
economic times: The enterprises as reconstituted GSEs may provide
liquidity and other benefits to mortgage finance during normal economic
times as they did for many years. However, their ability to provide
such support during stressful economic periods is questionable given
current experience. Furthermore, with significantly reduced or
eliminated retained mortgage portfolios, reconstituted GSEs' capacity
to provide support to mortgage markets during periods of economic
distress may also be limited;
Support housing opportunities for targeted groups: Reconstituted GSEs,
with their responsibility to maximize profits for their shareholders,
might find it difficult to support some public policy housing
initiatives. Moreover, without a retained mortgage portfolio, the
reconstituted GSEs may face challenges in implementing a numeric
housing goal purchase program. This challenge could be addressed by
permitting a reconstituted GSE to maintain a relatively small portfolio
or by supporting housing opportunities for targeted groups through
assessments on its activities;
Ensure safe and sound operations: The current financial crisis
highlights some of the problems with the traditional GSE structure,
including the incentive for the enterprises to increase leverage and
maximize the size of their portfolios, creating risks to financial
stability. Reconstituting the GSEs would combine private ownership with
an explicit government guarantee, reestablish and perhaps strengthen
these incentive problems, which again could lead to even greater moral
hazard and safety and soundness concerns, as well as potentially
increased systemic risks. Proposals to regulate GSEs like public
utilities could, in principle, constrain excessive risk-taking, but the
applicability of the public utility model of regulation to the
enterprises has not been established. Moreover, FHFA has not been
tested as an independent safety and soundness and housing mission
regulator as the agency generally has acted as a conservator since its
establishment in July 2008;
Possible elements of regulatory and oversight structure: Key elements
for consideration include: (1) reducing or perhaps eliminating retained
mortgage portfolios as deemed appropriate depending on prioritization
of numeric housing and safety and soundness objectives, (2)
establishing capital standards that are commensurate with relevant
risks, (3) developing additional regulations such as executive
compensation limits or perhaps including public utility regulation, (4)
requiring appropriate financial disclosures in the federal budget to
enhance transparency, and (5) ensuring strong congressional oversight
of the enterprises' and FHFA's performance.
Proposed Reform Option: Privatization or termination;
Provide liquidity and support to mortgage markets including in bad
economic times: Privatizing or terminating the enterprises would
eliminate many problems with the current GSE model, including the
conflict between public policy and private shareholders. If key
enterprise activities such as mortgage purchases and MBS issuances are
provided by other financial institutions, liquid mortgage markets could
be reestablished in normal economic times. There is significant reason
to question the capacity of private banks to support mortgage markets
in times of financial distress without government support, given the
failure or near failure of key financial institutions and the absence
of private-label securitization during the current financial crisis. A
federal mortgage insurer could help such lenders to provide liquidity
and other benefits in times of financial stress;
Support housing opportunities for targeted groups: Privatization or
termination would remove the traditional legislative basis, government
sponsorship, for the enterprises to implement programs to serve the
mortgage credit needs of targeted groups. However, the basis for such
programs may remain if a government insurer for mortgage debt is
established and the federal government guarantees its financial
obligations. Furthermore, programs might be justified by Congress on
the grounds that large lenders that assume responsibility for key
enterprise activities or purchase their assets are viewed as "too big
to fail" and/or benefit from implied federal guarantees on their
financial obligations;
Ensure safe and sound operations: The termination of the enterprises as
GSEs and reliance on private-sector firms would leave market discipline
and regulators of financial institutions with responsibility for
promoting safety and soundness. However, moral hazard concerns would
still remain if some mortgage lenders were deemed "too big to fail."
These concerns may be heightened because the current fragmented
financial regulatory system already faces challenges in overseeing such
organizations. Additionally, safety and soundness concerns may remain
if a federal entity is established to insure mortgage debt and does not
charge appropriate premiums to offset the risks that it incurs. FHA and
the FHLBank System may become more prominent if the enterprises were
privatized or terminated;
Possible elements of regulatory and oversight structure: The need for a
new financial regulatory system, due to concerns about the current
fragmented system, may be heightened to the extent that terminating or
privatizing the enterprises results in larger and more complex
financial institutions. In considering a new system, Congress should
consider establishing clear regulatory goals, a systemwide risk focus,
and the need to mitigate taxpayer risks. If a new federal mortgage
insurer is established, there should be an appropriate oversight
structure for such an entity. This structure might include appropriate
regulations and capital standards, the disclosure of risks and
liabilities in the federal budget, and congregational oversight.
Source: GAO analysis of structural reform options.
[End of table]
Potential Trade-offs Associated with Establishing a Government
Corporation or Agency:
With many of its activities funded directly through Treasury debt
issuances, a government corporation or agency (a government entity)
could help provide liquidity to mortgage markets during good economic
times through the purchase of large volumes of mortgages that meet
specified underwriting criteria and issue MBS collateralized by such
mortgages. In the process, a government entity also could help ensure
standardization in the mortgage underwriting process. Additionally, a
government entity might have a structural advantage over private
entities--such as reconstituted GSEs, banks, or other private lenders--
in providing liquidity to mortgage markets during periods of economic
stress. That is, a government entity may be able to continue to fund
its activities through government debt issuances. In contrast, for-
profit entities face potential conflicts in supporting mortgage finance
during stressful economic periods because they also must be concerned
about maintaining shareholder value, which may mean substantially
reducing their activities or withdrawing from markets entirely as has
occurred during the recent economic downturn. However, to the extent
that a retained mortgage portfolio may be necessary to help respond to
a financial crisis, a government entity without such a portfolio may
face challenges in supporting mortgage finance, particularly if
investor demand for its MBS were to become limited. Other federal
entities, such as Treasury and the Federal Reserve, may have to step in
to purchase and hold mortgage assets on their balance sheets (as has
been the case during the current financial crisis) if such a situation
existed.
The absence of a retained mortgage portfolio for a government entity
also could affect the traditional conventional, conforming mortgage
market. Over the past 10 years, the enterprises, as discussed earlier,
have maintained large mortgage portfolios. If this option is no longer
available, lenders may find it more challenging to find buyers for
these mortgages in the secondary market. It is not clear the extent to
which a government entity could maintain the same general level of
mortgage purchases as the enterprises if it were confined to assembling
all such mortgages into MBS.
Potential Capacity to Facilitate the Flow of Mortgage Credit to
Targeted Groups:
A government entity most likely would be expected to support
homeownership opportunities for targeted groups given its status as a
public organization. This option also would resolve any structural
conflicts that the enterprises faced over the years as for-profit,
publicly-traded, shareholder-owned corporations in supporting
homeownership opportunities for targeted groups. A government
corporation or agency would be a public entity without the
responsibility to maximize shareholder value. However, if a government
entity were not permitted to have a retained mortgage portfolio, as
some researchers have proposed, it likely would face challenges in
implementing a numeric mortgage purchase program similar to that of the
enterprises. As discussed previously, the enterprises tended to hold a
significant portion of multifamily mortgages that were purchased
pursuant to the numeric mortgage purchase programs in their retained
portfolios. That is because it may be difficult to convert multifamily
mortgage assets into MBS compared with single-family mortgages. There
might be several different ways to address this challenge. For example,
fees or assessments could be imposed on the activities of the
government entity, and such revenues could be used to directly support
the construction of affordable housing or provide down payment
assistance to targeted homebuyers. Under HERA, the enterprises were to
pay assessments to fund a Housing Trust Fund for the purposes of
providing grants to states to increase and preserve the supply of
rental housing and increase homeownership for extremely low-and very
low-income families, but FHFA has suspended this program due to the
enterprises' financial difficulties.[Footnote 56] Alternatively, FHA
could be expanded to assume responsibility for the enterprises' ongoing
efforts to support homeownership opportunities as one researcher has
suggested. However, as is discussed later, FHA's current operational
capacity to manage a large increase in its business may be limited,
which could increase taxpayer risks.
Potential Safety and Soundness Concerns:
In some respects, a government entity that focused its activities on
purchasing mortgages and issuing MBS might pose lower safety and
soundness risks than has been the case with the enterprises. For
example, a government entity would not be motivated by an implied
federal guarantee to engage in risky business practices to achieve
profitability targets and thereby maintain shareholder value as was the
case with the enterprises. Furthermore, if a government entity were not
to retain a mortgage portfolio, as has been proposed, then it would be
less complex and potentially less risky than the enterprises' current
structure. As already discussed, the enterprises' large retained
portfolios exposed them to significant interest-rate risk, and they
misapplied accounting rules that governed the hedging techniques
necessary to manage such risks.
Nevertheless, successfully managing a large conventional mortgage
purchase and MBS issuance business still may be a complex and
challenging activity for a government entity, and the failure to
adequately manage the associated risks could result in significant
losses that could be the direct responsibility of taxpayers. For
example, the enterprises' substantial losses in recent years have been
credit-related (due to mortgage defaults), including substantial losses
in their MBS guarantee business. This risk may be heightened if a
government entity were expected to continue purchasing mortgages and
issuing MBS during stressful economic periods when the potential for
losses may be greater than would otherwise be the case. As discussed
previously, Ginnie Mae provides only a limited model for the
establishment of such a government corporation or agency. Ginnie Mae
guarantees the timely payment of principal and interest on MBS
collateralized by mortgages, but federal agencies insure or guarantee
such mortgages and lenders issue the MBS. Furthermore, Ginnie Mae is
not responsible for establishing credit underwriting standards or
monitoring lenders' adherence to them; rather, these functions are
carried out by FHA, VA, PIH, and USDA/RD. In contrast, a government
entity that issued MBS collateralized by conforming mortgages as is the
case with the enterprises would be responsible for managing credit
risk, including setting appropriate guarantee fees to offset such risk.
[Footnote 57]
As described in our previous work on FHA, government entities may lack
the financial resources necessary to attract the highly skilled
employees needed to manage complex business activities or the
information technology necessary to help do so.[Footnote 58]
Furthermore, government entities sometimes are subject to laws and
regulations that may limit their capacity to respond to market
developments. In a range of recent reports, HUD's Office of Inspector
General expressed concerns about whether FHA had the staffing expertise
and information technology needed to manage the rapid increase in its
mortgage insurance business since 2008.[Footnote 59]
Oversight Structure That Could Help Ensure the Effective Implementation
of a Government Corporation or Agency:
To help ensure that a government entity could achieve its housing
mission objectives while operating in a safe and sound manner, an
appropriate oversight framework would need to be established. While
such a framework would need to clearly define the roles and objectives
of a government entity in the mortgage finance system, it would need to
afford the entity sufficient flexibility to acquire adequate resources
and manage its activities to fulfill its mission. The establishment of
risk-sharing arrangements with the private sector, such as requirements
that lenders that sell mortgages to the government entity retain some
exposure to potential credit losses or that private mortgage insurance
is obtained on such mortgages, could help mitigate the risk of
potential losses. Such a government entity could be expected to reflect
its risk and liabilities in the federal budget to help ensure financial
transparency of its operations. Finally, robust congressional oversight
of any such entity would be needed to help ensure that the entity was
fulfilling its objectives.
Potential Trade-offs Associated with Reestablishing the Enterprises as
For-profit GSEs:
When mortgage credit markets stabilize, the enterprises as
reconstituted GSEs might be expected to perform functions that they
have performed for many years, such as purchasing conventional
mortgages, issuing MBS, and perhaps managing a relatively small
retained mortgage portfolio under some proposals. Through such
activities, the enterprises might be expected to provide liquidity to
mortgage markets during good economic periods, as well as provide
standardization to the mortgage underwriting process and certain
technical and procedural innovations. However, as for-profit
corporations, significant concerns remain about how well the
reconstituted enterprises would be able to support financial markets
during stressful economic periods without substantial financial support
from Treasury or the Federal Reserve.
Moreover, the reconstituted GSEs, like government corporations or
agencies, might face challenges in their ability to support mortgage
finance if their mortgage portfolios were substantially downsized or
eliminated as envisioned under some proposals. For example, with
substantially downsized or eliminated mortgage portfolios, the
reconstituted GSEs might further limit their capacity to respond to
financial crisis, in which case, the likelihood that Treasury or the
Federal Reserve would need to respond by buying and holding mortgage
assets on their balance sheets would be increased. In addition,
substantially downsizing or eliminating the reconstituted GSEs mortgage
portfolios could limit lenders' ability to sell conventional,
conforming mortgages on the secondary market. Permitting the
enterprises as reconstituted GSEs to maintain mortgage portfolios,
albeit at lower levels than prior to their conservatorships, could help
address these potential concerns.
Potential Capacity to Facilitate the Flow of Mortgage Credit Serving
Targeted Groups:
Similarly, decisions about the size of the reconstituted GSEs' mortgage
portfolios would likely affect their capacity to support mortgage
purchase programs to facilitate the flow of mortgage credit to targeted
groups. If the reconstituted GSEs' mortgage portfolios were
substantially decreased or eliminated, then their ability to purchase
and hold multifamily mortgages that serve targeted groups might be
limited. On the other hand, permitting the reconstituted GSEs to
maintain a mortgage portfolio of an appropriate size could mitigate
this potential concern. Another consideration associated with
establishing the enterprises as for-profit GSEs is the potential
conflict with a requirement to facilitate the flow of mortgage credit
serving targeted groups. Alternatives to establishing a numeric
mortgage purchase program to support homeownership opportunities for
targeted groups could include assessing fees on the reconstituted GSEs
to directly fund such programs, expanding FHA's mortgage insurance
programs, or providing direct down-payment assistance to targeted
borrowers.[Footnote 60]
Potential Safety and Soundness Concerns:
Continuing the enterprises as GSEs could present significant safety and
soundness concerns as well as systemic risks to the financial system.
In particular, the potential that the enterprises would enjoy explicit
federal guarantees of their financial obligations, rather than the
implied guarantees of the past, might serve as incentives for them to
engage in risky business practices to meet profitability objectives.
Treasury guarantees on their financial obligations also might provide
the enterprises with significant advantages over potential competitors.
Furthermore, FHFA's capacity to monitor and control such potentially
risky business practices has not been tested. Since its establishment
in July 2008, FHFA has acted both as the enterprises' conservator and
safety and soundness and housing mission regulator. Under the
conservatorship, FHFA has significant control over the enterprises'
operations. For example, the FHFA Director has appointed the
enterprises' chief executive officers and boards of directors and can
remove them as well. But FHFA officials said that agency staff also
have been monitoring the enterprises' business risks. It remains to be
seen how effectively FHFA would carry out its oversight
responsibilities solely as an independent regulator if the enterprises
were reconstituted as for-profit GSEs.
While converting the enterprises into multiple GSEs could mitigate
safety and soundness and systemic risk concerns by minimizing
concentration risks, it also likely would involve trade-offs. For
example, multiple GSEs, due to their potentially small size, may not be
able to achieve economies of scale and generate certain efficiencies
for mortgage markets as has been the case with Fannie Mae and Freddie
Mac. As discussed earlier, the enterprises, through their secondary
mortgage market activities, have been credited with facilitating the
development of a liquid national mortgage market and establishing
standardized underwriting practices for mortgage lending.
Alternatively, converting the enterprises from their current structure
as publicly owned corporations into cooperatives owned by the lenders
that sell mortgages to them may offer certain advantages in terms of
their safety and soundness. For example, as the owners of the
enterprises, lenders may have financial incentives to ensure that the
mortgages that they sell to the enterprises are properly underwritten
so as to minimize potential losses that would affect the value of their
investments. As discussed previously, Freddie Mac, as a cooperative,
generally managed to avoid the financial problems that Fannie Mae,
which was a publicly owned corporation, faced during the early 1980s.
However, it should also be noted that the cooperative structure may
also have limitations. For example, some FHLBanks, which are members of
the cooperative FHLBank System, have faced losses recently due to their
investments in private-label mortgage assets.
While the public utility model of regulation has been proposed as a
means to help mitigate the risks associated with reestablishing the
enterprises as GSEs, this proposal involves complexities and trade-
offs. For example, it is not clear that the public utility model is an
appropriate regulatory structure because, unlike natural monopolies
such as electric utilities, the enterprises have faced significant
competition from other providers of mortgage credit over the years. For
example, as discussed previously, the enterprises' market share
declined substantially from 2004 through 2006 due to the rapid growth
of the private-label MBS market. Public utility-type regulation also
has been criticized as inefficient and many states have sought to
deregulate their electric and other markets. Furthermore, these
proposals may have offsetting effects on the GSEs' financial viability.
For example, former Treasury Secretary Paulson's proposal would subject
their credit decisions and rate of return to preapproval by a public
utility-type board, and impose fees on them to offset any benefits
derived from government sponsorship of their activities. It is not
clear if an entity subject to such business activity restrictions,
regulations, and fees, even with Treasury guarantees on its financial
obligations, would be able to raise sufficient capital from investors
or purchase mortgages on terms that mortgage lenders would find cost-
effective.
Potential Oversight Structure That Could Help Ensure the Effective
Implementation of Reconstituted GSEs:
A range of potential options exist for developing an appropriate
regulatory structure to help ensure that any reconstituted GSEs would
operate in a safe and sound manner while achieving housing mission
objectives. For example, if maintaining safety and soundness is viewed
as a priority over a numeric housing goal program, then eliminating
retained mortgage portfolios may be viewed as appropriate.
Alternatively, the retained mortgage portfolios could be substantially
smaller and restricted to certain types of assets to help ensure safety
and soundness while promoting housing mission achievement. Other steps
that may be deemed appropriate could include establishing capital
standards for the enterprises commensurate with their risk, additional
restrictions on their activities, executive compensation limits, public
utility regulation, appropriate financial disclosures of risks and
liabilities in the federal budget, and strong congressional oversight
of the enterprises' and FHFA's performance.
Potential Trade-offs Associated with Privatizing or Terminating the
Enterprises:
As with the preceding two sets of options, proposals that involve the
privatization or ultimate termination of the enterprises involve a
number of trade-offs. For example, if a consortium of large banks
assumed responsibility for key activities (such as mortgage purchases
and MBS issuances) of the enterprises, during good economic times it
might be able to provide liquidity to the mortgage finance system, help
ensure consistency through uniform underwriting standards, and
potentially promote innovation in mortgage finance. However, the
ability of private lenders to provide support to mortgage markets
during stressful economic periods is questionable. As discussed
previously, many private-sector lenders have failed or withdrawn from
mortgage markets during the current economic downturn. The
establishment of a federal mortgage debt insurer, as has been proposed,
may facilitate private lenders' capacity to support mortgage markets
during stressful periods.
Privatizing or terminating the enterprises also could affect the
structure of mortgage lending that has evolved over the years. For
example, lenders might be less willing to originate 30-year, fixed-rate
mortgages, due to the associated interest-rate risk of holding them in
portfolio, if any ensuing private-sector secondary market alternatives
(such as a consortium of private-sector lenders) were less willing to
purchase such mortgages than the enterprises had been. Additionally,
privatization or termination could result in a relative increase in
mortgage interest rates, because private-sector lenders might not have
the funding advantages that the enterprises derived from their federal
sponsorship over the years.[Footnote 61]
Potential Capacity to Facilitate the Flow of Mortgage Credit to
Targeted Groups:
This option also could eliminate the traditional legislative basis for
requiring that they facilitate the flow of mortgage credit serving
targeted groups, particularly through the numeric mortgage purchase
program. That is, the enterprises currently have a responsibility to
help meet the mortgage credit needs of all potential borrowers due to
the financial benefits associated with federal sponsorship, which would
not be the case for private-sector lenders under the termination and
privatization proposals. However, if new federal organizations were
established, such as a mortgage insurer, to facilitate the transition
to a mortgage finance system in which the enterprises no longer exist,
then they could be required to assume responsibility for facilitating
the flow of mortgage credit to targeted groups. For example, the
Community Reinvestment Act's requirements that insured depositories,
such as banks and thrifts, serve the credit needs of the communities in
which they operate could be extended to nondepository lenders, such as
independent mortgage lenders, which would obtain mortgage insurance
from a new federal mortgage insurer.
Moreover, if a consortium of large lenders or other financial
institutions assumed responsibility for key enterprise functions (like
MBS issuances), or purchased a substantial share of their assets, then
requirements that such institutions serve the credit needs of targeted
groups also might be justified. For example, such institutions could be
perceived as benefiting from implied federal guarantees on their debt
or being too big to fail. We note that Treasury and the Federal Reserve
have provided direct financial assistance to a range of financial and
other institutions during the current financial crisis, which may
create the perception in financial markets that the federal government
is more likely to intervene in a future crisis.
Potential Safety and Soundness Concerns:
The extent to which privatizing or terminating the enterprises
mitigates current safety and soundness and financial stability risks is
difficult to determine. Under one scenario, such risks would be
mitigated because large and complex enterprises, which might engage in
risky business practices due to the implied federal guarantee on their
financial obligations, would not exist. Instead, private lenders would
be subject to market discipline and consequently would be more likely
to make credit decisions largely on the basis of credit risk and other
market factors. However, this scenario would be complicated if a
federal entity were established to insure mortgage debt. If the federal
mortgage insurer did not set appropriate premiums to reflect the risks
of its activities, then lenders might have incentives to engage in
riskier business practices than otherwise would be the case. In similar
situations, such as the National Flood Insurance Program, federal
agencies have faced challenges in establishing appropriate premiums to
compensate for the risks that they underwrite. If large private-sector
financial institutions assumed responsibility for key enterprise
activities or purchased a significant portion of their assets, the
perception could arise that the failure of such an institution would
involve unacceptable systemic financial risks. Therefore, markets'
perceptions that the federal government would provide financial
assistance to such financial institutions could undermine market
discipline.
Moreover, limitations in the structure of the current U.S. financial
regulatory system could heighten concerns about the potential safety
and soundness risks associated with large financial institutions
assuming responsibility for key enterprise financial activities or
becoming larger due to the purchase of their assets. In a recent
report, we stated that the current fragmented regulatory system for
banks, securities firms, insurance companies, and other providers
evolved over many years and often in response to financial crises.
[Footnote 62] We stated that the large and complex financial
conglomerates that have emerged in the past decades often operate
globally across financial sectors and that federal regulators have
faced significant challenges in monitoring and overseeing their
operations. For example, the report noted that a Federal Reserve
official recently acknowledged that, under the current structure, which
consists of multiple supervisory agencies, challenges can arise in
assessing risk profiles of these institutions, particularly because of
the growth in the use of sophisticated financial products that can
generate risks across various legal entities.
Privatizing or terminating the enterprises also could increase the
relative prominence of other federal programs designed to promote
homeownership and housing opportunities, which also may have safety and
soundness implications. Due to the diminished presence of the
enterprises in mortgage finance under these proposals, market
participants, such as banks and thrifts, increasingly might turn to the
FHLBank System as a source of funding for their operations and lending
activities. The FHLBank System could enjoy an advantage over other
potential competitors in filling the void left by the enterprises
because, as a GSE benefiting from an implied guarantee, it may be able
to issue debt to fund its activities at relatively advantageous rates.
However, some FHLBanks have recently reported losses due to investments
in private-label MBS. Similarly, FHA's mortgage insurance programs
might increase if the enterprises' diminished role limits the
availability of mortgage credit in the conforming market.
Potential Oversight Structure That Could Help Ensure the Effective
Implementation of Terminating or Privatizing the Enterprises:
The development of an appropriate regulatory structure to help ensure
housing mission achievement and safety and soundness, as deemed
appropriate, would depend on the outcome of a range of contingencies
associated with options to privatize or terminate the enterprises. For
example, should Congress choose to establish a new public entity to
insure all mortgage debt, with the federal government guaranteeing the
insurance, then a new regulatory and oversight structure would be
needed to oversee the operations of such an insurer. As with other
options to reform the enterprises' structures, an appropriate structure
for such an entity might involve a regulatory agency with authorities
to carry out its activities and capital standards that reflect the risk
of the entity's activities, disclosures of risks and liabilities in the
federal budget to help ensure financial transparency, and robust
congressional oversight. Furthermore, revisions may be necessary to
help ensure that the U.S. financial regulatory system can better
oversee the risks associated with large and complex financial
institutions, which may assume responsibility for key enterprise
activities or become larger over time through the acquisition of their
assets. Our recent report identified a series of principles, such as
establishing clear regulatory goals, ensuring a focus on systemwide
financial risks, and mitigating taxpayer risks, for Congress to
consider in deciding on the most appropriate regulatory system.
[Footnote 63]
Federal Efforts to Support Housing Markets during the Conservatorships
and Certain Terms of Treasury Agreements Could Increase the Costs and
Challenges Associated with the Transition to New Enterprise Structures:
Since the beginning of the FHFA conservatorships, the enterprises have
been tasked to initiate a range of programs, such as assisting
homeowners struggling to make their mortgage payments to refinance or
modify their mortgage terms, to respond to the current crisis in
housing markets. These initiatives could benefit housing markets and,
in so doing, potentially benefit the enterprises' financial condition.
However, the initiatives also may involve additional risks and costs
for the enterprises, which could increase the costs and challenges
associated with transitioning to new structures over time. Similarly,
certain provisions in the Treasury agreements with the enterprises may
affect their long-term financial viability and complicate a transition
to a new structure. Finally, any transition to a new structure would
need to take into consideration the enterprises' dominant position
within housing finance, even during the conservatorships, and,
therefore, should be carefully implemented--perhaps in phases--to help
ensure its success.
The following points summarize several of the initiatives that the
enterprises have undertaken in response to the substantial downturn in
housing markets:
* Under the Home Affordable Refinance Program (HARP), which was
initiated in March 2009, borrowers that have current payment histories
can refinance and reduce their monthly mortgage payments at loan-to-
value ratios of up to 105 percent without obtaining mortgage insurance.
On July 1, 2009, the program was extended to apply to mortgage loans
with loan-to-value ratios of up to 125 percent.
* Under the Home Affordable Modification Program (HAMP), certain
borrowers who are delinquent, or in imminent danger of default, on
their mortgage payments may have the terms of their existing mortgages
modified in order to make payments more affordable. Specifically, the
program allows for interest rate reductions (down to 2 percent), term
extension (up to 480 months), principal forbearance, and principal
forgiveness. Under the program, the enterprises will provide up to $25
billion in incentives to borrowers and servicers for program
participation and a successful payment history.[Footnote 64]
* In November 2008, the enterprises suspended the initiation of
foreclosure proceedings on mortgages that they held in their portfolios
or on which they had guaranteed principal and interest payments for MBS
investors. This initiative subsequently was extended through March 31,
2009. In March 2009, the enterprises also suspended foreclosure sales
on mortgages that may be eligible under HAMP until borrowers'
eligibility for HAMP has been verified.
While these federal initiatives were designed to benefit homebuyers, in
recent financial filings, both Freddie Mac and Fannie Mae have stated
that the initiative to offer refinancing and loan modifications to at-
risk borrowers could have substantial and adverse financial
consequences for them. For example, Freddie Mac stated that the costs
associated with large numbers of its servicers and borrowers
participating in loan-modification programs may be substantial and
could conflict with the objective of minimizing the costs associated
with the conservatorships.[Footnote 65] Freddie Mac further stated that
loss-mitigation programs, such as loan modifications, can increase
expenses due to the costs associated with contacting eligible borrowers
and processing loan modifications. Additionally, Freddie Mac stated
that loan modifications involve significant concessions to borrowers
who are behind in their mortgage payment, and that modified loans may
return to delinquent status due to the severity of economic conditions
affecting such borrowers. Fannie Mae also has stated that, while the
impact of recent initiatives to assist homeowners is difficult to
predict, the participation of large numbers of its servicers and
borrowers could increase the enterprise's costs substantially.[Footnote
66] According to Fannie Mae, the programs could have a materially
adverse effect on its business, financial condition, and net worth.
However, FHFA officials said that they strongly believe the recent
initiatives to support the housing markets, on balance, represent the
best means available for the enterprises to preserve their assets and
fulfill their housing missions. For example, FHFA officials said that,
to the extent that their initiatives are successful in stabilizing
housing markets, the enterprises will be the major beneficiaries as the
number of delinquent mortgages and foreclosures is reduced. FHFA
officials also commented that recent modification programs, such as
HAMP, are more likely to be successful than modification initiatives
dating to 2008, which had high redefault rates. FHFA officials said
that the more recent loan-modification initiatives were more likely to
reduce borrowers' monthly payments. According to an FHFA report, the
traditional approaches to loan modifications (allowing borrowers to
bring loans current by reamortizing past due payments over the
remaining life of the loan) increased monthly payments and, therefore,
often resulted in high redefault rates.[Footnote 67] Furthermore, FHFA
officials stated that recent loan-to-value ratio refinance programs
only apply to mortgages that the enterprises already guarantee, so they
already are exposed to the credit risks on these loans. FHFA officials
said that such refinancings also should lower borrowers' payments and
thereby further reduce the enterprises' existing credit exposure.
While FHFA's positions are plausible, it is too early to reach any
conclusion about the effects that the initiatives will have on the
enterprises' financial condition and preliminary data raise potential
concerns. According to a report by the Office of the Comptroller of the
Currency (OCC) and the Office of Thrift Supervision (OTS), loan
modifications initiated in 2008 that reduced borrowers' monthly
payments by 20 percent or more had significantly lower redefault rates
after 1 year than modifications that left monthly payments unchanged or
higher.[Footnote 68] Specifically, the study found that, of the
modifications that involved reductions of 20 percent or more, 38
percent were 60 or more days past due after 1 year, whereas the rate
was nearly 60 percent for modifications that left monthly payments
unchanged or higher. However, the fact that nearly 40 percent of loan
modifications that substantially reduced monthly payments were already
60 or more days past due after 1 year raises concerns about whether the
additional costs that enterprises incur in administering such programs
will be effective. Furthermore, it is also not clear whether
initiatives to suspend foreclosure proceedings will benefit the
enterprises' financial condition. Our previous work has found that, for
mortgage providers such as Fannie Mae and Freddie Mac, foreclosure
costs may increase the longer it takes to maintain and sell foreclosed
properties.[Footnote 69] A potential risk of suspending pending
foreclosure sales is that many borrowers facing foreclosure will not be
able to obtain funds necessary to make their mortgage loan payments
current.[Footnote 70] As a result of delays in foreclosing on such
properties, the potential exists that the properties will not be
maintained or will become vacant, which could increase the enterprises'
associated costs.
Treasury's agreements with Fannie Mae and Freddie Mac, which specify
terms under which the department is to provide certain types of
financial support to them, also may have long-term financial
consequences. In connection with the agreements, quarterly dividends
declared by the enterprises are to be paid to holders of the senior
preferred stock (Treasury). These dividends accrue at 10 percent per
year and increase to 12 percent if, in any quarter, they are not paid
in cash. If either enterprise cannot pay the required dividends, then
Treasury has a claim against the assets of the enterprise for the
unpaid balance in a liquidation proceeding. Available financial data
suggest that the enterprises, while in conservatorship and over the
longer term, will face significant financial challenges in paying the
required dividends to Treasury. For example, Treasury already purchased
$50 billion in preferred stock in Freddie Mac, which translates into an
annual dividend of $5 billion, and CBO estimated that the department
will invest substantially more in the enterprise's preferred shares in
coming quarters (up to the guarantee limit of $200 billion). Prior to
the conservatorship, Freddie Mac's reported annual net income twice
came close to or exceeded $5 billion, and the dividends that it
distributed to shareholders in those years likely were substantially
lower. In addition, the agreements require that, beginning on March 31,
2010, the enterprises pay a commitment fee to Treasury to compensate
the department for the ongoing financial support that it is providing
to them. While the size of the commitment fee is subject to
negotiation, it represents another potential long-term challenge to the
enterprises' financial viability. For example, like the dividend
requirements, any unpaid commitment fees become a claim by Treasury
against the assets of the enterprises in a liquidation proceeding,
unless Treasury waives the fee.
Although it is not possible to predict what effects federal initiatives
to respond the housing crisis and the Treasury agreements with the
enterprises could have on the transition to a new structure, they could
be substantial. For example, under the proposal to reconstitute the
enterprises as for-profit GSEs, potential investors might not be
willing to invest their capital if the reconstituted GSEs had a
substantial volume of nonperforming mortgage assets or substantial
financial obligations to Treasury. To minimize this risk, the federal
government could arrange a transition process in which the government
would retain nonperforming assets in a "bad bank" and spin off the
performing assets of the enterprises to a "good bank" and key
functions, such as issuing MBS, to investors in a reconstituted GSE.
[Footnote 71] Or, the federal government could establish such a process
as a means to terminate or privatize the enterprises. However, to the
extent that the enterprises engage in activities during their
conservatorships or incur financial obligations inconsistent with
maintaining their long-term financial viability, the level of
nonperforming mortgage assets and long-term costs to taxpayers
ultimately may be higher than otherwise would be the case.
Finally, regardless of what changes are implemented, policymakers
should pay careful attention to how a potential transition is managed
to mitigate potential risks to the housing finance system. The
enterprises evolved over many years to become dominant participants in
housing finance and, in some respects, their roles have expanded during
the conservatorships. Therefore, transitioning to a new structure could
have significant consequences for housing finance and should be managed
carefully and perhaps implemented in phases with periodic evaluations
to determine if any corrective actions would be necessary. For example,
any changes likely would require regulators and institutions to make
system changes and undertake other activities that would take extensive
time to complete. Our previous work also has identified other key
issues that likely would be critical components of any transition
process.[Footnote 72] In particular, an effective communication
strategy would be necessary to help ensure that all mortgage market
participants, including lenders, investors, and borrowers, have
sufficient information to understand what changes are being made and
how and when they will be implemented. Moreover, it will be important
to put effective strategies in place to help ensure that, under
whichever reform strategy is chosen, the new financial institutions and
their regulators will have the staffing, information technology, and
other resources necessary to carry out their missions.
Agency Comments and Our Evaluation:
We provided a draft of this report to FHFA, the Federal Reserve, HUD,
and Treasury for their review and comment. While he was still the FHFA
Director, James B. Lockhart III provided us with written comments,
which are summarized below and reproduced in appendix II, as well as
technical comments, which we incorporated as appropriate.[Footnote 73]
Federal Reserve staff, HUD's Assistant Secretary for Housing-Federal
Housing Commissioner, and Treasury also provided technical comments,
which were incorporated as appropriate. We also provided excerpts of a
draft of this report to seven researchers whose studies we cited to
help ensure the accuracy of our analysis. Six of the researchers
responded and said that the draft report accurately described their
research, while one researcher did not respond.
In his comment letter, Lockhart stated that the report is timely and
does a good job of summarizing the dominant proposals for restructuring
the enterprises and summarizing their strengths and weaknesses.
Lockhart also stated that initial attention should be to the role of
mortgage finance in our society and how the government wants the
institutions and markets that supply it to function and perform. In
particular, he said this includes determining the most appropriate
roles for private and public entities, competition and competitiveness,
risks and risk management, and the appropriate channels and mechanisms
for targeting the underserviced and protecting consumers. Further, he
identified key questions and principles that he believes should be
included in the debate on restructuring the enterprises. These
principles include (1) deciding what the secondary market should look
like, before considering specific institutions; (2) ensuring that the
enterprises or any successors have well-defined and internally
consistent missions; (3) ensuring that there is a clear demarcation of
the federal government and the private sector in the secondary market;
(4) establishing a regulatory and governance structure that ensures
prudent risk-taking; and (5) ensuring that housing finance is subject
to systematically prudent supervision that incorporates countercyclical
capital to limit booms and busts.
We concur with the thrust of the view that revising the enterprises'
structures should take place in a measured way and in the context of a
broader assessment of the housing finance system. As discussed in our
report, the enterprises have been key components of the housing finance
system for many years and, therefore, any changes to their structures
are likely to have broad implications for that system and market
participants. In this regard, we stated that it will be important for
Congress to reevaluate the enterprises' roles, structures, and
performance, and consider structural reform options to facilitate
mortgage finance while mitigating safety and soundness concerns. These
options, under certain scenarios, envision very different approaches to
structuring the secondary market for mortgage loans and facilitating
housing opportunities for targeted groups, and we believe the broad
implications of these various options need to be carefully considered
before any final decisions are made. For this reason, our report
addresses implications for various participants in the mortgage
markets, including FHA. Further, we discussed that a carefully managed
and potentially lengthy transition process needs to be established to
help ensure the successful implementation of whatever structural reform
option for the enterprises is chosen by Congress and the Executive
Branch.
Additionally, Lockhart said that FHFA, in its role as the enterprises'
conservator, as well as their mission and safety and soundness
regulator, is working diligently with the Treasury and Federal Reserve
to maintain or restore safe, sound, liquid, and vibrant mortgage
markets. He said a principal focus of FHFA's efforts has been
facilitating the enterprises' participation in the Home Affordable
Modification and Refinance Programs. While he said the enterprises'
participation in these programs may result in near-term costs, he
believes the programs will result in stronger and more stable housing
markets, which will also benefit the enterprises.
Finally, he made several suggestions regarding certain aspects of the
draft report. These suggestions and our responses are described below:
* The draft report should make clear that the structural reform options
presented in the report are not exhaustive or mutually exclusive and
that hybrids of these options also are possible and may prove to be the
most appealing. We agree and, as the report notes, the options for
revising the enterprises' long-term structures generally fall along a
continuum with some overlap between key features. For example, as
Lockhart noted, options for privatizing or terminating the enterprises
may involve establishing a government entity to insure mortgages
originated by private lenders. In addition, the government entity and
reconstituted GSE options generally involve focusing enterprise
activities on issuing MBS while downsizing or eliminating their
mortgage portfolios.
* The draft report should mention the enterprises' performance in
providing liquidity to mortgage markets. We agree that any discussion
of the future roles of the GSEs should include consideration of their
roles in providing securities that support an active and liquid
mortgage market. As the report notes, providing liquidity to mortgage
markets has been a key housing mission objective of the enterprises and
that, while their secondary market activities have been credited with
helping to establish a national and liquid mortgage market, their
performance in providing support to mortgage markets during stressful
economic periods is not clear.
* While the draft report's discussion of the safety and soundness
concerns related to the government entity option is reasonably balanced
and fair, it is short on negative details. In particular, (1) the draft
report is organized in such a way that makes it easy for the reader to
conclude that the safety and soundness benefits of the government
entity option outweigh the added risks; (2) the table in the draft
report's Highlights page states that the lack of a "profit motive" for
a government entity may mitigate risk should be rephrased to state that
the option "addresses the conflict between private profits and public
sector risk bearing;" and (3) the discussion in the draft report on the
potential elimination of the enterprises' mortgage portfolios fails to
recognize that such an action is a component of some but not all
proposals to reconstitute the enterprises as GSEs or to establish a
government entity, and therefore, mentioning the benefit of doing so
under one option (the government entity option) and not the other (the
reconstituted GSE option) is a significant inconsistency.
Regarding (1), we do not agree that the order of the text in the draft
report implied that the benefits of the government entity option
outweigh its risks. While this option offers potential safety and
soundness advantages such as addressing deficiencies in the traditional
enterprise structures and eliminating their mortgage portfolios, it
also has potentially significant drawbacks, which need to be
considered. In particular, we stated that managing the enterprises'
ongoing MBS business may be complicated and challenging, and government
entities may lack the resources and expertise necessary to manage such
challenges and risks effectively. Regarding (2), we agree with the
thrust of this comment and have modified the text in the table in the
Highlights page to make it consistent with the related figure and text
in the body of the report. Regarding (3), we agree that any assessment
of the options for revising the housing enterprises' long-term
structure should include discussion of the implications of retaining
mortgage portfolios. As described in the report, the government entity
options we identified advocated the elimination of the enterprises'
portfolios. In contrast, the options we identified for reconstituting
the enterprises as GSEs generally called for reducing the enterprises'
portfolios while one proposal called for their complete elimination.
The report includes analysis of the potential implications of taking
such steps regarding the enterprises' mortgage portfolios under both
options, as well as the possible elements of regulatory and oversight
structures that could mitigate any potential safety and soundness and
systemic stability risks.
We are sending copies of this report to interested congressional
committees and members. In addition, we are sending copies to FHFA,
Treasury, the Federal Reserve, HUD, financial industry participants,
and other interested parties. The report also is available at no charge
on the GAO Web site at [hyperlink, http://www.gao.gov].
If you or your staff have any questions about this report, please
contact William B. Shear at (202) 512-8678 or shearw@gao.gov or Richard
J. Hillman at (202) 512-8678 or hillmanr@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. GAO staff who made major contributions
to this report are listed in appendix III.
Signed by:
Gene L. Dodaro:
Acting Comptroller General of the United States:
List of Committees:
The Honorable Christopher J. Dodd:
Chairman:
The Honorable Richard C. Shelby:
Ranking Member:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Joseph I. Lieberman:
Chairman:
The Honorable Susan M. Collins:
Ranking Member:
Committee on Homeland Security and Governmental Affairs:
United States Senate:
The Honorable Tim Johnson:
Chairman:
The Honorable Mike Crapo:
Ranking Member:
Subcommittee on Financial Institutions:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Robert Menendez:
Chairman:
The Honorable David Vitter:
Ranking Member:
Subcommittee on Housing, Transportation and Community Development:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Barney Frank:
Chairman:
The Honorable Spencer Bachus:
Ranking Member:
Committee on Financial Services:
House of Representatives:
The Honorable Edolphus Towns:
Chairman:
The Honorable Darrell Issa:
Ranking Member:
Committee on Oversight and Government Reform:
House of Representatives:
The Honorable Paul E. Kanjorski:
Chairman:
The Honorable Scott Garrett:
Ranking Member:
Subcommittee on Capital Markets, Insurance and Government Sponsored
Enterprises:
Committee on Financial Services:
House of Representatives:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
The objectives of our report were to (1) discuss how the enterprises'
roles, structures, and activities have changed over time and their
performance in achieving key housing mission objectives; (2) identify
various options for revising the enterprises' eventual structure; (3)
analyze these options in terms of their potential capacity to achieve
key housing mission and safety and soundness objectives; and (4)
discuss how the federal government's management of the conservatorships
and response to the housing crisis could affect any transition.
To address the first objective, we reviewed reports and studies on the
enterprises and their regulation, including GAO reports, as well as
reports from the Department of Housing and Urban Development (HUD), the
Federal Housing Finance Agency (FHFA), the Office of Federal Housing
Enterprise Oversight (OFHEO), the Congressional Budget Office (CBO),
the Congressional Research Service (CRS), and independent researchers.
We also reviewed legislative and charter documents, as well as an
internal history of Fannie Mae, and financial performance data from a
variety of sources. Through this research, we sought to identify key
housing mission, safety and soundness, and other objectives that have
been associated with the enterprises over the years, as well as their
performance in meeting such objectives. In doing so, we identified and
summarized recent literature that addressed the impact of the
enterprises on affordability and opportunities for target groups. While
GAO reviewed these studies and included those that were sufficiently
methodologically sound for our limited purposes, users of this report
should note that these studies are based on data prior to 2001 and
contain limitations. Finally, we used data from the Securities Industry
and Financial Markets Association (SIFMA) and OFHEO. As SIFMA's data on
mortgage-related issuance were consistent with other data sources and
highlight well-established trends in mortgage-backed securities (MBS)
and collateralized mortgage obligation activity, we found them and the
OFHEO data on the balance sheets of the enterprises sufficiently
reliable for our purposes.
To address the second objective, we reviewed a variety of studies and
proposals that have been made prior to and during the conservatorships
to revise the enterprises' structures. The inclusion of these studies
and proposals is purely for research purposes and does not imply that
we deem them definitive or without limitations. We also met with the
authors of many of these studies and with researchers who have
knowledge about housing finance, the operations of the enterprises, or
who have made proposals to revise the enterprises' structures. We met
with representatives from FHFA, the Department of the Treasury
(Treasury), the Federal Reserve, HUD, the Government National Mortgage
Association (Ginnie Mae), CBO, the enterprises, bank and mortgage
organizations, and trade and community groups. These interviews
provided us with the different viewpoints about the proposals.
For the third objective, we analyzed the proposed options for
restructuring the enterprises in terms of the potential each proposal
offered to achieve key housing mission and safety and soundness
objectives. In our analysis, we also relied on principles associated
with effective regulatory oversight. While it is not possible to
conclusively determine the potential implications of the various
proposals, we grounded our analysis of likely outcomes on previous
research and evaluations. We also sought to include, where appropriate,
assessments of how recent developments in financial markets
(particularly actions by federal agencies to provide financial support
to troubled banks and other institutions) could affect the various
options. We recognize that a variety of factors, such as the condition
of credit markets and the financial performance of the enterprises
while in conservatorship, could change over time and affect our
analysis of the options.
For the final objective, which discusses how the federal government's
management of the conservatorships and response to the housing crisis
could affect the transition of the enterprises to a new structure, we
reviewed the actions undertaken by FHFA, Treasury, and the Federal
Reserve, as authorized by the Housing Economic and Recovery Act of
2008. We also reviewed financial data from Fannie Mae and Freddie Mac,
including their quarterly 10Q and annual 10K filings. We reviewed and
considered the future impact on the enterprises' financial condition
from recent initiatives such as the Homeowner Affordability and
Stability Act and foreclosure initiation suspensions. We also discussed
relevant issues with Treasury and enterprise representatives.
We conducted this performance audit from October 2008 to September
2009, from Washington, D.C., and in accordance with generally accepted
government auditing standards. Those standards require that we plan and
perform the audit to obtain sufficient, appropriate evidence to provide
a reasonable basis for our findings and conclusions based on our audit
objectives. We believe that the evidence obtained provides a reasonable
basis for our findings and conclusions based on our audit objectives.
[End of section]
Appendix II: Comments from the Federal Housing Finance Agency:
Federal Housing Finance Agency:
Office of the Director:
1700 G Street, N.W.
Washington, D.C. 20552-0003:
202-414-3800; 202-414-3823 (fax):
August 19, 2009:
Mr. Wesley Phillips, Assistant Director:
Financial Markets and Community Investment:
Government Accountability Office:
441 G St., NW:
Washington, DC 20458:
Dear Mr. Phillips:
Thank you for the opportunity to review and comment on the GAO draft
report entitled Fannie Mae and Freddie Mac: Analysis of Options for
Revising the Housing Enterprises' Longterm Structures (GAO-09-782). As
both the regulator of the housing GSEs (Fannie Mae, Freddie Mac, and
the Federal Home Loan Bank System) and the conservator of Fannie Mae
and Freddie Mac, the Federal Housing Finance Agency (FHFA) has a keen
interest in the recovery of the American housing and housing finance
sectors. FHFA appreciates the timeliness of GAO's contribution to
understanding the choices Congress and the Administration confront with
respect to Fannie Mac and Freddie Mac (the Enterprises). The report
does a good job of summarizing the dominant proposals for restructuring
the Enterprises and assessing some of their strengths and weaknesses.
First, I hope that in focusing attention primarily on the futures of
specific institutions, we don't put the cart before the horse. Our
initial attention should be to the role of mortgage finance in our
society and how we want the institutions and markets that supply it to
function and perform. In particular, that includes determining the most
appropriate roles for private and public sector entities, competition
and competitiveness, risks and risk management, cyclicality, and the
appropriate channels and mechanisms for targeting the underserviced and
protecting consumers. In my June 3, 2009 testimony to the House
Financial Services Committee, I posed some key questions which
policymakers both in Congress and the executive branch must confront:
1. How can mortgage lending, including mortgage securitization, be
changed to better serve our society? What is the role of regulation in
achieving that goal?
2. How can financial institutions involved in mortgage lending and
their supervision be reformed in order to protect overall financial
stability better?
3. Beyond prudential regulation and supervision, does the government
need to perform directly any specific functions in the secondary
mortgage market? If so, how could the government best perform any such
functions?
As the key questions above suggest, very important decisions have to be
made about the future of the mortgage market and the appropriate role
of the secondary mortgage market, including the roles of government
regulation and programs, before we get to the future of the Enterprises
themselves.
I also stated in that testimony and in speeches a number of principles
that I believe should guide decisions. Those principles include:
1. Decide what the secondary market should look like, before
considering specific institutions.
2. The Enterprises or any successors should have a well-defined and
internally consistent mission.
3. There should be a clear demarcation of the respective roles of the
federal government and the private sector in the secondary mortgage
market, and any federal risk-bearing should he provided explicitly and
at actuarial cost.
4. Regulatory and governance structure must ensure risk-taking is
prudent.
5. Housing finance should be subject systemically prudent supervision
that incorporates countercyclical capital to limit booms and busts.
Whether Congress and the Administration adopt some or all of these
principles, FHFA is proceeding under the authorities provided by the
Housing and Economic Recovery Act of 2008 (HERA) to address those that
it can. Since September 2008, FHFA is acting as both the conservator of
Fannie Mae and Freddie Mac and the mission and safety and soundness
regulator of all the housing GSEs. As such, FHFA is working with the
housing GSEs, Treasury, and the Federal Reserve to maintain or restore
safe, sound, liquid, and vibrant mortgage markets. FHFA is also working
diligently and creatively to find ways to reduce the cyclical effects
of our regulations and of GSE behavior on housing and housing finance
and to integrate the public missions of the housing GSEs with
institutional and systemic safety and soundness.
A principal focus of our efforts has been facilitating Enterprise
participation in the Home Affordable Modification and Refinance
Programs (HAMP and HARP). These programs seek to both aid distressed
homeowners and stabilize housing markets by reducing the inventory of
houses for sale during a period of market distress. FHFA believes that,
while the Enterprises' participation in those programs may result in
near-term costs, they will ultimately benefit from the stronger and more
stable housing markets.
Elsewhere, FHFA has provided you specific suggestions on the report. I
would like to reiterate three of those comments here.
* The options analyzed are not necessarily exhaustive or mutually
exclusive. We should recognize that, ultimately, some hybrid of those
options and others may prove to he the most appealing. One such
possibility would be a market characterized by many privately owned
issuers of MBS with the government providing insurance against
catastrophic losses, either directly or in partnership with private
companies.
* In considering the performance in achieving key housing finance
support objectives, their important role in providing securities that
form the basis for an active and liquid TBA market for mortgage-backed
securities (MBS) should be mentioned.
* While, overall the discussion of the potential safety and soundness
concerns related to the government options is reasonably balanced and
fair, it is short on negative details. In addition, the order of the
arguments makes it easy for a reader to conclude that the safety and
soundness benefits outweigh the added risks. It is unclear that such a
conclusion is supported by the evidence. Some effort should he expended
to mitigate that misinterpretation. Finally, FHFA has a number of
concerns about the summary table entries related to this section. In
the first summary table at the front of the report, the phrase "may
mitigate risk due to the lack of a profit motive" could he rephrased as
"addresses the conflict of interest between private profits and public
sector risk bearing." The lack of a profit motive is neither sufficient
nor necessary to insure good risk management. In addition, "the
elimination of existing mortgage portfolios" is a component of certain,
but not all, proposals to reestablish the Enterprises as GSEs and
proposals to establish a government corporation or agency. Mentioning
the safety and soundness benefit of eliminating those portfolios under
one set of proposals and not the other is a significant inconsistency.
One aspect of this issue that is not directly addressed relates to the
Enterprises' fundamental role as insurers of MBS. My own experience at
OFHEO, Social Security, the Pension Benefit Guaranty Corporation
(PBGC), and now FHFA, has taught me that government insurance comes
with significant risks of moral hazard and perverse incentives. In
addition, a key advantage of a well-managed insurance program is that
money is charged in the form of premiums in good times to offset losses
during future bad times. Government insurance programs, including the
FDIC have found it difficult to charge adequate premiums, especially in
good times. This set of issues is touched on later, in the context of
proposals to reconstitute the GSEs, but applies to any proposals that
implicitly or explicitly include an insurance role for the government.
Again, we thank you for the opportunity to comment on your draft report
and look forward to working with you and your staff in the future.
Sincerely,
Signed by:
James B. Lockhart III:
Director:
[End of section]
Appendix III: GAO Contact and Staff Acknowledgments:
GAO Contact:
William B. Shear, (202) 512-8678, or shearw@gao.gov:
Staff Acknowledgments:
In addition to the individual named above, Wesley M. Phillips,
Assistant Director; Triana Bash; Martha Chow; Lawrance Evans, Jr.; Marc
Molino; Robert Pollard; Barbara Roesmann; Stacy Spence; Paul Thompson;
and Barbara Williams made key contributions to this report.
[End of section]
Footnotes:
[1] The Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289
(July 30, 2008), established FHFA, which is responsible for the safety
and soundness and housing mission oversight of Fannie Mae, Freddie Mac,
and the other housing government-sponsored enterprise, the Federal Home
Loan Bank System.
[2] Lockhart announced his resignation on August 6, 2009, and left FHFA
on August 28, 2009.
[3] On September 7, 2008, Treasury agreed to provide up to $100 billion
in financial support to each enterprise through the purchase of their
preferred stock so that the enterprises maintain a positive net worth.
In February 2009, Treasury agreed to increase this commitment to $200
billion per enterprise. Treasury also agreed to purchase the
enterprises' mortgage-backed securities and establish a lending
facility to meet their borrowing requirements if needed.
[4] The CBO figure is based on its March 2009 estimate that the market
value of the enterprises' liabilities exceeded their assets by about
$290 billion in 2008-2009 (their existing business) and $99 billion in
estimated federal subsidy costs for their activities between 2010-2019.
This estimate can change from one reporting period to the next due to
fluctuations in market values.
[5] These Federal Reserve activities are described in more detail later
in this report.
[6] Congress initially chartered Fannie Mae in 1938 but did not
establish it as a shareholder-owed corporation until 1968. Congress
initially established Freddie Mac in 1970 as an entity within the
FHLBank System and reestablished it as a shareholder-owned corporation
in 1989.
[7] For example, the enterprises typically purchased mortgages with
loan-to-value ratios of 80 percent or less (mortgages with down
payments of at least 20 percent) and required private mortgage
insurance on mortgages with higher loan-to-value ratios. The
enterprises also had a limit, known as the conforming loan limit, on
the size of mortgages purchased by the enterprises. Mortgages above
this limit are called jumbo mortgages. The conforming conventional
market differs from other markets, such as the subprime market, which
generally have differing underwriting standards, or markets where
mortgages are insured or guaranteed by the federal government, such as
through programs that the Federal Housing Administration or the
Department of Veterans Affairs administers.
[8] Each enterprise's portfolio also includes MBS that it issued.
[9] Federal Housing Enterprises Financial Safety and Soundness Act of
1992, Pub. L. No. 102-550, title XIII; see 12 U.S.C. §§ 4561-4564. HERA
transferred HUD's authorities and responsibilities for the goals to
FHFA (§§ 1122, 1128).
[10] The enterprises' charters convey certain other benefits, such as
exemptions from state and local income taxes.
[11] Each enterprise's charter act specifies that its debt obligations
and MBS are to clearly indicate that they are not guaranteed by the
United States and do not constitute a debt or obligation of the United
States or any U.S. agency or instrumentality other than the enterprise
itself. 12 U.S.C. § 1719(b), (d) (Fannie Mae); 12 U.S.C. § 1455(h)
(Freddie Mac).
[12] Temporary authority for Treasury to provide financial support
provided through the purchase of enterprise securities and debt
obligations is set forth in section 1117 of HERA.
[13] After the end of any quarter in which either Fannie Mae's or
Freddie Mac's balance sheet reflects that total liabilities exceed
total assets, the enterprises have 15 business days to request funds
under the terms of the agreement. Treasury then has 60 days to provide
the funds, as necessary, up to the maximum amount of the guarantee.
[14] Comparing the amounts Fannie Mae and Freddie Mac have received to
date, $34 billion and $51 billion respectively, to their income
(adjusted to 2008 real dollars) earned during the 10-year period that
included their highest profits reveals that Fannie Mae has received
more than 70 percent of its 10-year earnings, and Freddie Mac has
received more than 100 percent of its 10-year earnings.
[15] Fannie Mae, Freddie Mac, and the FHLBanks issue securities for
federal agency housing debt. The guaranteed MBS are those guaranteed by
Fannie Mae, Freddie Mac, and Ginnie Mae.
[16] Federal Home Loan Bank Act, 47 Stat. 725 (July 22, 1932).
[17] National Housing Act, 48 Stat. 1246, 1252 (June 27, 1934).
[18] National Housing Act Amendments of 1938, 52 Stat. 8, 23 (Feb. 3,
1938).
[19] 62 Stat. 1207 (July 1, 1948).
[20] Housing Act of 1954, Pub. L. No. 68-560 (1954).
[210] Housing and Urban Development Act of 1968, Pub. L. No. 90-448
(1968).
[22] Emergency Home Finance Act of 1970, Pub. L. No. 91-351, title III
(1970).
[23] Thrifts generally funded long-term, fixed-rate mortgages that they
held in their portfolios with deposits, which were regulated. When
short-term interest rates rose above levels that thrifts were permitted
to offer to depositors, depositors sought investment alternatives, such
as money market funds, that offered higher yields. Thus, thrifts faced
difficulties in funding their mortgage portfolios.
[24] Freddie Mac became a publicly held corporation under the charter
set forth in the Financial Institutions Reform, Recovery and
Enforcement Act of 1989, Pub. L. No. 101-73 § 731.
[25] GAO, Housing Enterprises: Potential Impacts of Severing Government
Sponsorship, [hyperlink, http://www.gao.gov/products/GAO/GGD-96-120]
(Washington, D.C.: May 13, 1996) and Glenn B. Canner and Wayne
Passmore, "Residential Lending to Low-Income and Minority Families:
Evidence from the 1992 HMDA Data," Federal Reserve Bulletin, February
1994, 70-108.
[26] For a comparison of these authorities, see GAO, Comparison of
Financial Institution Regulators' Enforcement and Prompt Corrective
Action Authorities, [hyperlink,
http://www.gao.gov/products/GAO-01-322R] (Washington, D.C.: Jan. 31,
2001).
[27] GAO, Government-Sponsored Enterprises: A Framework for
Strengthening GSE Governance and Oversight, [hyperlink,
http://www.gao.gov/products/GAO-04-269T] (Washington, D.C.: Feb. 10,
2004) and GAO, Government-Sponsored Enterprises: Federal Oversight
Needed for Nonmortgage Investments, [hyperlink,
http://www.gao.gov/products/GAO/GGD-98-48] (Washington, D.C.: July 28,
1998).
[28] [hyperlink, http://www.gao.gov/products/GAO/GGD-98-48].
[29] Pub. L. No. 101-508, title XIII (1990). Under the act, the credit
subsidy cost of direct loans and loan guarantees is the net present
value of the estimated long-term cost to the government at the time the
credit is provided of such programs, less administrative expenses. The
act was intended to improve disclosures about the risks associated with
government direct loans and guarantee programs and assist Congress in
making budget decisions about such programs.
[30] GAO, Budget Issues: Profiles of Government-Sponsored Enterprises,
[hyperlink, http://www.gao.gov/products/GAO/AFMD-91-17] (Washington,
D.C.: February 1991).
[31] [hyperlink, http://www.gao.gov/products/GAO/GGD-96-120].
[32] In 1996, we reported on our participation in research with CBO,
HUD, and Treasury that, among other things, included analysis on the
degree the advantageous borrowing rates the enterprises derived from
their government sponsorship was passed on to borrowers. We estimated
that the benefit to homebuyers on interest rates on fixed rate single
family mortgages below the conforming loan limits ranged from 15-35
basis points (a basis point is equal to one one-hundredth of a
percent). This amounted to a savings of about $10-25 on the monthly
payments on a $100,000 mortgage balance. See GAO-96-120. More recent
research conducted by Federal Reserve staff suggests that the savings
to borrowers from the enterprises' activities range from 0-7 basis
points. See Passmore, Wayne, Shane M. Sherlund, and Gilliam Burgess,
"The Effect of Housing Government-Sponsored Enterprises on Mortgage
Rates," Real Estate Economics, Vol. 33, Fall 2005, pp. 427-463; and
Passmore, Wayne, Diana Hancock, Andreas Lehnert, and Shane Sherlund,
"Federal Reserve Research on Government-Sponsored Enterprises,"
Proceedings from the 42th Annual Conference on Bank Structure and
Competition, May 2006.
[33] [hyperlink, http://www.gao.gov/products/GAO/GGD-96-120].
[34] In addition to the enterprises' MBS and debt obligations, the
Federal Reserve's purchases include FHLBank debt obligations and Ginnie
Mae guaranteed MBS.
[35] GAO, Federal Housing Enterprises: HUD's Mission Oversight Needs to
Be Strengthened, [hyperlink,
http://www.gao.gov/products/GAO/GGD-98-173] (Washington, D.C.: July 28,
1998).
[36] Brent Ambrose and Thomas Thibodeau, "Have the GSE Affordable
Housing Goals Increased the Supply of Mortgage Credit?" Regional
Science and Urban Economics 34 (2004).
[37] Raphael Bostic and Stuart Gabriel, "Do the GSEs Matter to Low-
income Housing Markets? An Assessment of the Effects of GSE Loan
Purchase Goals on California Housing Outcomes," Journal of Urban
Economics 59 (2006).
[38] Xudong An and Raphael Bostic, "GSE Activity, FHA Feedback, and
Implications for the Efficacy of the Affordable Housing Goals," Journal
of Real Estate Finance and Economics 36 (2008).
[39] See, GAO, Federal Housing Administration: Decline in the Agency's
Market Share Was Associated with Product and Process Developments of
Other Mortgage Market Participants, [hyperlink,
http://www.gao.gov/products/GAO-07-645] (Washington, D.C.: June 29,
2007).
[40] Abt Associates, "Study of the Multifamily Underwriting and the
GSEs' Role in the Multifamily Market: Final Report," prepared for HUD
(August 2001).
[41] House Committee on Financial Services, Subcommittee on Capital
Markets, Insurance, and Government Sponsored Enterprises, testimony of
James B. Lockhart III, "The Present Condition and Future Status of
Fannie Mae and Freddie Mac," 111th Cong., 2nd sess., June 3, 2009.
[42] See, for example, Dwight M. Jaffee, "Reforming Fannie and
Freddie," Regulation, Winter 2008-2009, 52-57, and Thomas H. Stanton,
"Lessons from Public Administration: Recommendations for the Future of
Fannie Mae and Freddie Mae," presented to the 45th Annual Conference on
Bank Structure and Competition, Federal Reserve Bank of Chicago, May 7,
2009.
[43] Stanton, "Lessons from Public Administration."
[44] Jaffee, "Reforming Fannie and Freddie."
[45] Robert E. Litan and Martin N. Baily, "Fixing Finance: A Roadmap
for Reform," Initiative on Business and Public Policy, Brookings
Institution, Washington, D.C., February 17, 2009.
[46] The financing of multifamily projects may not be as amenable to
securitization, or the issuance of MBS, than single-family mortgages
for several reasons, according to Fannie Mae. For example, Fannie Mae
said that many multifamily loans are securitized into single-pool loans
providing less diversification for investors. Moreover, repayment of
loans secured by multifamily loans typically depends upon the
successful operation of the related properties rather than the
existence of independent income and assets of the borrowers.
Multifamily loans are typically underwritten and structured
individually and may have flexible features that give the borrower the
ability to add, release, or substitute the property securing the loan
under certain conditions. The underlying property types vary and may
include conventional market-rate apartments, affordable housing,
seniors housing, student housing, manufactured housing communities, and
cooperative housing. Further, Fannie Mae said multifamily loans are
typically structured with 10-year loan terms, but may be of varying
lengths, some of which appeal to investors more than others. Most
multifamily loans have prepayment provisions that require the borrower
to pay a fee if the loan is voluntarily repaid prior to maturity.
Prepayment provisions appeal to investors; however, loans with
variances from the standard provisions are not as liquid because they
provide less predictability and are more difficult for MBS investors to
model.
[47] CRS, Fannie Mae's and Freddie Mac's Financial Problems, RL-34661
(Washington, D.C.:, May 20, 2009).
[48] 74 Fed. Reg. 26989 (June 5, 2009). The proposed rules would
provide for FHFA's imposition of limits on executive compensation and
prior approval of termination benefits. They would supersede the OFHEO
compensation regulation, which currently applies.
[49] Mortgage Bankers Association, "Key Considerations for the Future
of the Secondary Mortgage Market and the Government Sponsored
Enterprises," Washington, D.C., January 2009.
[50] This discussion is based on issues raised in the following: Robert
S. Seiler, Jr., "Fannie Mae and Freddie Mac as Investor-owned Public
Utilities," Journal of Public Budgeting, Accounting & Financial
Management II, no. 1 (1999).
[51] Former Treasury Secretary Henry M. Paulson, Jr., speech before the
Economic Club of Washington, January 8, 2009.
[52] Because privatization of the enterprises in effect would terminate
their GSE status, we are treating termination and privatization of the
enterprises as equivalent in this report.
[53] Federal Reserve Chairman Ben S. Bernanke, "The Mortgage Meltdown,
the Economy, and Public Policy" (presented at the University of
California at Berkeley/University of California at Los Angeles
Symposium, Berkeley, California, October 31, 2008).
[54] Arnold Kling, "Freddie Mac and Fannie Mae: An Exit Strategy for
the Taxpayer," Cato Institute Briefing Papers, no. 106 (Washington,
D.C.: Sept. 8, 2008). For additional information on privatization and
transition issues, see Peter Wallison, Thomas H. Stanton, and Bert Ely,
Privatizing Fannie Mae, Freddie Mac, and the Federal Home Loan Banks:
Why and How, The AEI Press (Washington, D.C.: 2004); and HUD/Policy
Development and Research, Studies on Privatizing Fannie Mae and Freddie
Mac (Washington, D.C.: 1996).
[55] Diana Hancock and Wayne Passmore, "Three Mortgage Innovations for
Enhancing the American Mortgage Market and Promoting Financial
Stability" (The University of California at Berkeley/University of
California Los Angeles Symposium, Berkeley, California, October 31,
2008).
[56] HERA amended the Federal Housing Enterprises Financial Safety and
Soundness Act of 1992 to require Fannie Mae and Freddie Mac to set
aside an amount each fiscal year equal to 4.2 basis points for each
dollar of unpaid principal balance of its total new business purchases
and transfer 65 percent of the amount to HUD to fund the Housing Trust
Fund and 35 percent of the amount to the Capital Magnet Fund, a trust
fund in Treasury's Community Development Financial Institutions Fund.
(Pub. L. No. 110-289 § 1131). On June 3, 2009, the FHFA Director stated
that FHFA suspended enterprise contributions to the Housing Trust Fund
in light of enterprise losses and their draws on Treasury's Senior
Preferred Stock Purchase facility.
[57] See GAO, Housing Finance: Ginnie Mae Is Meeting Its Mission but
Faces Challenges in a Changing Marketplace, [hyperlink,
http://www.gao.gov/products/GAO-06-9] (Washington, D.C.: Oct. 31,
2005).
[58] See GAO, Federal Housing Administration: Modernization Proposals
Would Have Program and Budget Implications and Require Continued
Improvement in Risk Management, [hyperlink,
http://www.gao.gov/products/GAO-07-708] (Washington, D.C.: June 29,
2007) and GAO, Information Technology: HUD Needs to Strengthen Its
Capacity to Manage and Modernize its IT Environment, [hyperlink,
http://www.gao.gov/products/GAO-09-675] (Washington, D.C.: July 31,
2009).
[59] House Committee on Financial Services, testimony of James A.
Heist, Assistant Inspector General for Audit, U.S. Department of
Housing and Urban Development, 111th Cong., 2nd sess., January 9, 2009.
[60] For example, the FHLBanks manage the Affordable Housing Program,
which assists in the development of affordable housing for low-and
moderate-income households, through contributions of 10 percent of
their previous year's net earnings.
[61] [hyperlink, http://www.gao.gov/products/GAO/GGD-96-120].
[62] GAO, Financial Regulation: A Framework for Crafting and Assessing
Proposals to Modernize the Outdated U.S. Financial Regulatory System,
[hyperlink, http://www.gao.gov/products/GAO-09-216] (Washington, D.C.:
Jan. 8, 2009).
[63] [hyperlink, http://www.gao.gov/products/GAO-09-216].
[64] Under HAMP, Treasury will provide up to $50 billion in interest-
rate reduction and incentives to servicers, mortgage holders/investors,
and borrowers for the modification of nonenterprise loans.
[65] Freddie Mac, "Form 10-K: Annual Report for the Fiscal Year Ended
December 31, 2008."
[66] Fannie Mae, "Form 10-Q: Quarterly Report for the Quarterly Period
Ended September 30, 2008."
[67] Federal Housing Finance Agency, Foreclosure Prevention Report:
First Quarter 2009 (Washington, D.C.: 2009).
[68] OCC and OTS, "Mortgage Metrics Report, First Quarter 2009"
(Washington, D.C.: April 2009).
[69] GAO, Single-Family Housing: Opportunities to Improve Federal
Foreclosure and Property Sale Processes, [hyperlink,
http://www.gao.gov/products/GAO-02-305] (Washington, D.C.: Apr. 17,
2002) and GAO, Department of Veterans Affairs: Actions Needed to
Strengthen VA's Foreclosed Property Management Contractor Oversight,
GAO-08-60 (Washington, D.C.: Nov. 15, 2007).
[70] At the foreclosure sale, the mortgage provider, such as Fannie Mae
or Freddie Mac, obtains title to the foreclosed property.
[71] Such proposals generally involve the federal government
maintaining existing guarantees on the assets in the "bad bank" as well
as assets in the "good bank" as may be required.
[72] See GAO, Homeland Security: Critical Design and Implementation
Issues, [hyperlink, http://www.gao.gov/products/GAO-02-957T]
(Washington, D.C.: July 17, 2002).
[73] Lockhart announced his resignation on August 6, 2009, and left
FHFA on August 28, 2009.
[End of section]
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