oversight

Housing Finance: Prolonged Conservatorships of Fannie Mae and Freddie Mac Prompt Need for Reform

Published by the Government Accountability Office on 2019-01-18.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States Government Accountability Office
               Report to Congressional Addressees




               HOUSING FINANCE
January 2019




               Prolonged
               Conservatorships of
               Fannie Mae and
               Freddie Mac Prompt
               Need for Reform




GAO-19-239
                                               January 2019

                                               HOUSING FINANCE
                                               Prolonged Conservatorships of Fannie Mae and
                                               Freddie Mac Prompt Need for Reform
Highlights of GAO-19-239, a report to
congressional addressees




Why GAO Did This Study                         What GAO Found
Since 2008, the federal government             Federal support of the housing finance market remains significant even though
has greatly increased its role in              the market has largely recovered since the 2007–2009 financial crisis. While
financially supporting housing markets.        down from the peak in 2009, in 2017, the federal government directly or indirectly
In September 2008, FHFA placed                 guaranteed about 70 percent of single-family mortgage originations.
Fannie Mae and Freddie Mac under
conservatorship, which created an              •   The Federal National Mortgage Association (Fannie Mae) and the Federal
explicit fiscal exposure for the federal           Home Loan Mortgage Corporation (Freddie Mac)—two government-
government. As of October 2018, the                sponsored enterprises (enterprises) that purchase and securitize mortgages
dollar amounts of their outstanding                into mortgage-backed securities (MBS)—securitized and guaranteed about
MBS have grown by more than $800                   46 percent of mortgage originations in 2017.
billion since the end of 2008.                 •   In 2017, federal programs, such as those offered by the Federal Housing
Since 2013, GAO has designated the
                                                   Administration (FHA), insured about 25 percent of mortgage originations.
federal role in housing finance as a
high-risk area. GAO examines (1)               Together, the enterprises and the Government National Mortgage Association
recent housing market developments,            (Ginnie Mae)—a federally owned corporation that guarantees MBS backed by
(2) risks and challenges posed by the          federally insured mortgages—have issued or guaranteed 95 percent or more of
current federal role, including ongoing        all MBS issued annually since 2008 (see figure).
conservatorship, and (3) housing               However, recent market trends pose risks to these entities and the housing
finance reform proposals and their
                                               finance system. For example, mortgage lending standards have loosened slightly
strengths and limitations.
                                               in recent years, which could increase the risk of borrower default—especially in a
To address these issues, GAO                   recession or downturn in the housing market—and losses to federal entities.
reviewed housing finance data; FHFA            Nonbanks have increased their presence in mortgage lending and servicing,
and enterprise reports; and 14 housing         which involves collecting monthly mortgage payments, among other duties. For
finance reform proposals introduced in         instance, the share of nonbank originations of FHA-insured mortgages increased
Congress or proposed by industry               from 56 percent in fiscal year 2010 to 86 percent in 2017. The share of nonbank
stakeholders since 2014. GAO also              servicers of mortgages in enterprise MBS also grew from 25 percent in 2014 to
convened panels with housing finance           38 percent as of the third quarter of 2018. While nonbank lenders and servicers
experts and stakeholders (including            have helped provide access to mortgage credit, they are not subject to federal
consumer advocates, mortgage
                                               safety and soundness regulations.
originators, insurers, and investors),
who developed reform proposals,                Single-Family Mortgage-Backed Security Issuance, Federal and Private, 2003–2017, Adjusted
testified before Congress, or                  for Inflation
participated in prior GAO studies.

What GAO Recommends
Congress should consider legislation
for the future federal role in housing
finance that addresses the structure of
the enterprises, establishes clear and
prioritized goals, and considers all
relevant federal entities, such as FHA
and Ginnie Mae.



View GAO-19-239. For more information,         Note: Fannie Mae and Freddie Mac purchase mortgages and issue and guarantee mortgage-backed
contact Daniel Garcia-Diaz at (202) 512-8678   securities (MBS). Ginnie Mae guarantees MBS backed by federally-insured mortgages. Private-label
or GarciaDiazD@gao.gov                         MBS do not have a government guarantee.

                                                                                              United States Government Accountability Office
Highlights of GAO-19-239 (Continued)

The Federal Housing Finance Agency (FHFA) has taken actions to lessen some of Fannie Mae and Freddie Mac’s risk
exposure. For example, under FHFA’s direction, the enterprises have reduced the size of their riskier retained mortgage
portfolios which hold assets that expose them to considerable interest rate and other risks from a combined $1.6 trillion in
2008 to $484 billion in 2017. Since 2013, the enterprises also have transferred increasing amounts of risk on their
guaranteed MBS to private investors and insurers through credit risk transfer programs. However, federal fiscal exposure
remains significant. The Department of the Treasury’s remaining funding commitment through the senior preferred stock
purchase agreements—which provide financial support to the enterprises—leaves taxpayers exposed to risk, especially in
the event of adverse market or other conditions and given the recent growth in the enterprises' guarantee business. The
value of outstanding MBS on which the enterprises guarantee principal and interest payments to investors grew from
about $2.1 trillion in 2003 to about $4.8 trillion in 2017. The long duration of the conservatorships also raises uncertainty
among market participants. Several experts and stakeholders GAO interviewed said that they have hesitated to make
longer-term strategic plans and goals due to potential housing finance reforms that could markedly affect their industries.
The figure below shows 2003–2017 trends in the enterprises’ guarantee business and retained mortgage portfolios.
Enterprises’ Outstanding Mortgage-Backed Securities and Retained Mortgage Portfolios, 2003–2017




Note: Dollar amounts represent unpaid principal balance at year-end. The enterprises hold some of their mortgage-backed securities in their own and
each other’s retained mortgage portfolios.


GAO reviewed 14 housing finance reform proposals from Congress, agencies, industry groups, and think tanks. The
proposals generally fit into four different models: reconstituted enterprises, a multiple guarantor system with an explicit
federal guarantee, a government corporation, and a completely privatized market without an explicit federal guarantee.
The 14 proposals generally meet key elements of GAO’s framework for assessing potential changes to the housing
finance system, such as addressing fiscal exposure, protecting investors, and considering the implications of the transition
to a new system. However, many proposals lack clearly defined and prioritized goals or do not address the role of other
federal entities in the housing finance system, such as FHA and Ginnie Mae—two key elements in GAO’s framework. By
incorporating these elements, policymakers could facilitate a more focused and comprehensive transition to a new
housing finance system and provide greater certainty to market participants.




                                                                                                   United States Government Accountability Office
Contents


Letter                                                                                1
               Background                                                             4
               Government Continues Significant Support of Housing Market but
                 Recent Trends Present Risks to Enterprises and Others              12
               FHFA Has Taken Actions to Reduce the Enterprises’ Exposure,
                 but Risks, Uncertainty, and Challenges Remain                      34
               Reform Proposals We Reviewed Aim to Manage Fiscal Exposure,
                 but Some Do Not Have Clear Goals or a System-Wide
                 Approach                                                           49
               Conclusions                                                          65
               Matter for Congressional Consideration                               65
               Agency Comments                                                      65

Appendix I     Objectives, Scope, and Methodology                                   67



Appendix II    Housing Finance Reform Proposals Reviewed                            71



Appendix III   GAO Contact and Staff Acknowledgements                               73


Table
               Table 1: Elements of GAO’s Framework for Assessing Potential
                       Changes to the Housing Finance System                        11

Figures
               Figure 1: Overview of Primary and Secondary Mortgage Markets           6
               Figure 2: Federal Housing Finance Agency National House Price
                        Index, 2003–2017                                            13
               Figure 3: Percentage of Enterprise-Purchased Mortgages 90 or
                        More Days Delinquent, 2003–2017                             14
               Figure 4: Dollar Volume and Percentage of Single-Family
                        Mortgage Loan Originations by Product Type, 2003–2017       16
               Figure 5: Percentage of New Single-Family Mortgages with
                        Federal Guarantees, 2003–2017                               18
               Figure 6: Dollar Volume and Percentage of Single-Family
                        Mortgage-Backed Security Issuance by Source,
                        2003–2017                                                   20


               Page i                                         GAO-19-239 Housing Finance
Figure 7: Combined Loan-to-Value Ratio for Mortgages
         Purchased by the Enterprises, 2003–2017                        23
Figure 8: Borrower Credit Score for Mortgages Purchased by the
         Enterprises, 2003–2017                                         24
Figure 9: Dollar Volume of Fannie Mae Retained Portfolio Assets
         and Portfolio Cap, 2003–2017                                   36
Figure 10: Dollar Volume of Freddie Mac Retained Portfolio
         Assets and Portfolio Cap, 2003–2017                            37
Figure 11: Illustrative Example of Enterprises’ Loss Sharing Under
         a Debt Issuance Credit Risk Transaction                        41
Figure 12: Dollar Volume of Outstanding Fannie Mae and Freddie
         Mac Mortgage-Backed Securities Held by External
         Investors, 2003–2017                                           45




Page ii                                           GAO-19-239 Housing Finance
List of Abbreviations

CBO                        Congressional Budget Office
CFPB                       Consumer Financial Protection Bureau
Dodd-Frank Act             Dodd-Frank Wall Street Reform and
                           Consumer Protection Act
Enterprises                Fannie Mae and Freddie Mac
Fannie Mae                 Federal National Mortgage Association
Federal Reserve            Board of Governors of the Federal
                           Reserve System
FHA                        Federal Housing Administration
FHFA                       Federal Housing Finance Agency
Freddie Mac                Federal Home Loan Mortgage Corporation
Ginnie Mae                 Government National Mortgage Association
HERA                       Housing and Economic Recovery Act
HUD                        Department of Housing and Urban Development
MBS                        mortgage-backed securities
Treasury                   Department of the Treasury
VA                         Department of Veteran Affairs




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Page iii                                                      GAO-19-239 Housing Finance
                       Letter




441 G St. N.W.
Washington, DC 20548




                       January 18, 2019

                       The Honorable Maxine Waters
                       Chairwoman
                       Committee on Financial Services
                       House of Representatives

                       The Honorable Sean P. Duffy
                       House of Representatives

                       In September 2008, the Federal Housing Finance Agency (FHFA) placed
                       two government-sponsored enterprises (enterprises)—the Federal
                       National Mortgage Association (Fannie Mae) and the Federal Home Loan
                       Mortgage Corporation (Freddie Mac)—into conservatorships out of
                       concern that their deteriorating financial condition threatened the stability
                       of the financial markets. However, this action also created an explicit
                       fiscal exposure for the federal government—that is, the government
                       assumed the responsibility for losses incurred by the enterprises. In the
                       meantime, the enterprises’ futures remain uncertain and as of October
                       2018, the dollar amounts of their outstanding mortgage-backed securities
                       (MBS) had grown by more than $800 billion since the end of 2008. 1

                       Since 2013, we have designated the federal role in housing finance as a
                       high-risk issue because of the significant risks the current federal role
                       poses to taxpayers and the stability of U.S. financial system. 2 In
                       November 2016, we suggested that Congress consider establishing
                       objectives for the federal role in the housing finance system and a
                       transition plan for the enterprises’ exit from conservatorship. 3 In the last
                       few years, several proposals have emerged that outline potential reforms
                       to the housing finance system intended to address the federal fiscal
                       exposure and role in housing finance, conservatorship of the enterprises,

                       1
                        In the secondary mortgage market, institutions purchase loans from primary market loan
                       originators and then either hold the loans in their own portfolios or pool the loans into MBS
                       that are sold to investors. The secondary market provides liquidity and reduces risk for
                       mortgage originators.
                       2
                         For our most recent update on high-risk issues, see GAO, High-Risk Series: An Update,
                       GAO-17-317 (Washington, D.C.: Feb. 15, 2017).
                       3
                        See GAO, Federal Housing Finance Agency: Objectives Needed for the Future of Fannie
                       Mae and Freddie Mac After Conservatorships, GAO-17-92 (Washington, D.C.: Nov.17,
                       2016).




                       Page 1                                                         GAO-19-239 Housing Finance
and market-related issues. In prior work, we developed a framework to
help assess potential changes to the housing finance system. 4 We also
reported that any changes would involve trade-offs and that policymakers
should consider priorities in relation to the goals of the housing finance
system.

As of early January 2019, Congress had not yet enacted legislation that
established objectives for reforming the housing finance system or
establishing the future structure of the enterprises. As conservatorship of
the enterprises enters its eleventh year, uncertainty remains regarding
changes to the housing finance system. We prepared this report under
the authority of the Comptroller General to assist Congress with its
oversight responsibilities. We examined:

•   recent developments in the housing and financial markets and their
    implications for the safety and soundness of the enterprises; 5
•   the extent to which conservatorship improved the condition of the
    enterprises, and the risks and challenges the current federal role,
    including ongoing conservatorship, poses to the enterprises and other
    aspects of the housing finance system; and
•   housing finance reform options that have been proposed and their
    relative strengths and limitations.

To address our objective on recent developments in the housing and
financial markets that could affect the safety and soundness of the
enterprises, we reviewed and analyzed house prices and mortgage
delinquency rates from FHFA, and mortgage origination and securitization
data from Inside Mortgage Finance (a housing market data provider),
among other data. To examine trends in the housing market, we reviewed
prior GAO work that identified and analyzed key national housing market
indicators, including house prices and loan performance, since the 2007–
2009 financial crisis. 6


4
See GAO, Housing Finance System: A Framework for Assessing Potential Changes,
GAO-15-131 (Washington, D.C.: Oct. 7, 2014).
5
 We did not include the Federal Home Loan Bank System (also a government-sponsored
enterprise) in our review because we focused on Fannie Mae and Freddie Mac and recent
developments affecting their safety and soundness.
6
 See GAO-15-131 and GAO, Mortgage Reforms: Actions Needed to Help Assess Effects
of New Regulations, GAO-15-185 (Washington, D.C.: June 25, 2015).




Page 2                                                    GAO-19-239 Housing Finance
To address our objective on risks and challenges that conservatorship
poses to the status of Fannie Mae, Freddie Mac, and other aspects of the
housing finance system, we reviewed FHFA reports (such as the 2017
Report to Congress), FHFA Office of Inspector General reports, and
selected academic literature. We also reviewed Fannie Mae’s and
Freddie Mac’s filings with the Securities and Exchange Commission and
quarterly financial supplements, and reports from credit rating agencies.
We assessed the reliability of the data used for both objectives by
reviewing related documentation, corroborating trends across multiple
data sources, and interviewing agency officials. We determined the data
were sufficiently reliable to report on recent trends in the housing market
and developments under the conservatorships of the enterprises.

To address our third objective, we reviewed 14 proposals for reforming
various aspects of the single-family housing finance system. We selected
proposals introduced in 2014–2018 that were (1) introduced in Congress,
either in legislation or released as discussion drafts, and (2) introduced by
industry stakeholders or were discussed in Congressional hearings. We
used GAO’s framework for assessing potential changes to the housing
finance system to analyze the content and assess the potential strengths
and limitations of the proposals. 7 We categorized the proposals under
different models and identified potential strengths and limitations based
on our review of the proposals, prior GAO reports, Congressional Budget
Office (CBO) reports, and industry stakeholder reports.

To address all three objectives, we interviewed officials at FHFA, the
Department of Housing and Urban Development (HUD), and the
Department of the Treasury (Treasury). We also convened four expert
and stakeholder panels representing (1) mortgage originators and
insurers, (2) securitizers and investors, (3) consumer and affordable
housing advocates, and (4) researchers. We selected the experts and
stakeholders because they developed reform proposals, testified before
Congress on housing finance reform or participated in prior GAO studies
of housing finance issues. For more information on our scope and
methodology, see appendix I.

We conducted this performance audit from March 2018 to January 2019
in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain

7
    GAO-15-131.




Page 3                                              GAO-19-239 Housing Finance
                         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
Housing Finance System   In the primary market, lenders originate mortgage loans to borrowers to
                         purchase homes. To evaluate the creditworthiness of a potential borrower
                         (called underwriting), the lender considers the borrower’s credit scores
                         and history, monthly debts including mortgage payments relative to
                         income (debt-to-income ratio), and the amount of the mortgage loan
                         relative to the home’s value (loan-to-value ratio). Borrowers with strong
                         credit histories typically receive prime mortgages with the most
                         competitive interest rates and terms. Lenders generally require borrowers
                         to purchase private mortgage insurance when the loan-to-value ratio is
                         higher than 80 percent. Some borrowers also may qualify for federal
                         mortgage insurance programs (discussed later in this section).

                         Mortgage lending creates certain risks:

                         •   Credit risk is the risk that the borrower will default on the mortgage
                             by failing to make timely payments.
                         •   Prepayment risk is the risk that borrowers will pay off the principal of
                             the loan before the mortgage term ends. Prepayment reduces or
                             eliminates future interest payments. The lender must relend or
                             reinvest the prepaid amount and may have only lower-interest options
                             available for lending or investing the funds if interest rates have
                             decreased.
                         •   Interest rate risk is the risk that an increase in interest rates will
                             reduce the value of a loan for the lender. For example, a lender might
                             fund mortgage lending through short-term deposits. If interest rates
                             rise and the lender previously made a long-term fixed-rate mortgage
                             at a lower rate, the difference between the interest payments the
                             lender receives from the mortgage and the interest the lender has to
                             pay to its depositors decreases.
                         •   Liquidity risk is the risk that an institution will be unable to meet its
                             financial obligations as they come due without incurring unacceptable
                             losses. For example, firms can be exposed to liquidity risk by funding
                             longer-term asset purchases with shorter-term debt obligations.



                         Page 4                                               GAO-19-239 Housing Finance
After origination, mortgages are serviced until they are paid in full or
closed due to nonpayment. Servicers can provide borrowers with account
statements, respond to customer service questions, and collect monthly
payments, among other duties. 8 The servicer can be the same institution
that originated the loan or the servicer can change as institutions sell
servicing rights.

Lenders hold mortgage loans in their portfolios or sell them to institutions
in the secondary market (see fig. 1). Lenders sell their loans to transfer
risk (such as interest rate risk in the case of fixed-rate mortgages) or to
increase liquidity. Secondary market institutions can hold the mortgages
in their portfolios or pool them into MBS that are sold to investors.
Participants in the secondary market include federal entities, issuers of
private-label MBS, and investors. Private institutions, primarily investment
banks, may issue MBS (known as private-label securities) which are
backed by mortgages that are not federally insured and do not conform to
the enterprises’ requirements.




8
    For more information about mortgage loan servicing, see GAO-15-131.




Page 5                                                       GAO-19-239 Housing Finance
Figure 1: Overview of Primary and Secondary Mortgage Markets




                                       Page 6                  GAO-19-239 Housing Finance
Federal Participation in the   The federal government participates in the primary and secondary
Housing Finance System         mortgage markets as both an actor and a regulator. In the primary
                               market, the federal government operates mortgage guarantee and
                               insurance programs to promote homeownership for certain types of
                               borrowers. For example, the Federal Housing Administration (FHA),
                               Department of Veterans Affairs (VA), Department of Agriculture’s Rural
                               Housing Service, and HUD’s Office of Public and Indian Housing offer
                               programs that insure mortgages against default or guarantee lenders
                               payment of principal and interest.

                               In the secondary market, the federal government facilitates mortgage
                               lending through the enterprises (discussed below) and the Government
                               National Mortgage Association (Ginnie Mae). Ginnie Mae is a federally
                               owned corporation within HUD that guarantees the timely payment of
                               principal and interest to investors in securities issued through its MBS
                               program. Ginnie Mae-guaranteed MBS consist entirely of mortgages
                               insured or guaranteed by federal agencies (such as FHA) and are issued
                               by financial institutions it approves. The federal government also
                               regulates the housing finance system through FHFA, which oversees the
                               enterprises; the Bureau of Consumer Financial Protection, also known as
                               the Consumer Financial Protection Bureau (CFPB); and the federal
                               banking regulators, which enforce regulatory standards for mortgage
                               lending. 9


Enterprises                    Congress chartered Fannie Mae and Freddie Mac as for-profit,
                               shareholder-owned corporations in 1968 and 1989, respectively. 10 They
                               share a primary mission to enhance the liquidity, stability, and affordability
                               of mortgage credit. The enterprises generally purchase mortgages that
                               meet certain criteria for size, features, and underwriting standards (known
                               as conforming loans) and hold the loans in their own portfolios or pool
                               them into MBS that are sold to investors. In exchange for a fee, the
                               enterprises guarantee the timely payment of interest and principal on
                               MBS that they issue.

                               9
                                   FHFA also oversees the Federal Home Loan Bank System.
                               10
                                Congress initially chartered Fannie Mae in 1938 but did not establish it as a shareholder-
                               owned corporation until 1968. Congress initially established Freddie Mac in 1970 as an
                               entity within the Federal Home Loan Bank System and reestablished it as a shareholder-
                               owned corporation in 1989.




                               Page 7                                                        GAO-19-239 Housing Finance
                  The enterprises also have obligations to support housing for certain
                  groups. Following the enactment of the Federal Housing Enterprises
                  Financial Safety and Soundness Act of 1992, the enterprises have been
                  required to meet specific goals for the purchase of mortgages supporting
                  underserved groups (such as low- and moderate-income families) or
                  certain geographic areas. In 2008, the Housing and Economic Recovery
                  Act (HERA) tasked the enterprises to fund new affordable housing
                  programs, including the Housing Trust Fund and the Capital Magnet
                  Fund. The enterprises fund these programs with a dollar amount based
                  on their unpaid balance of new business, purchases, and the funds
                  distribute the money to states and housing organizations to support
                  affordable housing. 11


Conservatorship   HERA established authorities for providing capital support to the
                  enterprises and established FHFA as an independent regulatory agency
                  for the enterprises. 12 HERA also authorized the Director of FHFA to
                  appoint FHFA as a conservator or receiver for the enterprises. 13 FHFA
                  put the enterprises into conservatorship in September 2008.

                  FHFA has a statutory responsibility to ensure that the enterprises operate
                  in a safe and sound manner and that their operations and actions of each
                  regulated entity foster a liquid, efficient, competitive, and resilient national
                  housing finance market. FHFA sets strategic goals for its conservatorship
                  of the enterprises. According to FHFA, the enterprises’ boards of directors
                  oversee day-to-day operations, but certain matters are subject to FHFA
                  review and approval. For example, FHFA officials told us that FHFA
                  reviews and approves some pilot programs. Fannie Mae and Freddie Mac
                  retain their government charters and continue to operate legally as
                  business corporations.


                  11
                   Pub. L. No. 110-289, § 1131, 122 Stat. 2654, 2711-2727 (2008) (codified at 12 U.S.C.
                  §§ 4567, 4568, 4569).
                  12
                   Pub. L. No. 110-289, §§ 1101-1103, 122 Stat. 2654, 2661-2664 (2008) (codified at 12
                  U.S.C. §§ 4511-4513).The enterprises were previously regulated by the Office of Federal
                  Housing Enterprise Oversight, an independent office in HUD.
                  13
                     According to FHFA, conservatorship is the legal process in which a person or entity is
                  appointed to establish control and oversight of a company to put it in a sound and solvent
                  condition. In a conservatorship, the powers of the company’s directors, officers, and
                  shareholders are transferred to the designated conservator. In contrast, receivership has
                  the goal of liquidating an entity by selling or transferring its remaining assets.




                  Page 8                                                        GAO-19-239 Housing Finance
                         Using authority provided in HERA, Treasury has committed to providing
                         up to $445.6 billion in capital support to Fannie Mae and Freddie Mac
                         while they are in conservatorship through the senior preferred stock
                         purchase agreements. If Fannie Mae or Freddie Mac has a net worth
                         deficit at the end of a financial quarter, Treasury will provide funds to
                         eliminate the deficit. Under the most recent agreement in December
                         2017, the enterprises must pay Treasury a dividend of all their quarterly
                         net income above a $3 billion capital reserve that each enterprise is
                         allowed to retain.


Reforming the Housing    Since the 2007–2009 financial crisis, Congress has taken steps to
Finance System and Our   improve regulation and consumer protection related to the housing
                         finance system. For example, to address challenges related to limitations
Framework for
                         on mortgage information, HERA requires FHFA to collect market data.
Considering Reform       The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Proposals                Frank Act) created CFPB, which has undertaken a number of consumer
                         protection initiatives related to mortgage lending and servicing. 14 The
                         Dodd-Frank Act also updated the Truth in Lending Act to prohibit lenders
                         from making certain mortgage loans without regard to a consumer’s
                         ability to repay the loan (known as the ability-to-pay rule). A lender is
                         presumed to have met the ability-to-repay requirement when it originates
                         a qualified mortgage—a category of loans that have certain more stable
                         features that make it more likely a borrower will repay the loan.

                         Congress also has considered proposals to make significant changes to
                         the housing finance system. During the 113th Congress (January 2013–
                         January 2015), three proposals—the Housing Finance Reform and
                         Taxpayer Protection Act of 2014, S. 1217; the FHA Solvency Act of 2013,
                         S. 1376; and the Protecting American Taxpayers and Homeowners Act of
                         2013, H.R. 2767—were reported out of committee but no further action
                         was taken. In September 2018, the Protecting American Taxpayers and
                         Homeowners Act of 2018 (H.R. 6746) was reintroduced in the 115th
                         Congress and referred to committee. As of the end of the 115th
                         Congressional session, no further action had been taken. Industry groups




                         14
                          Pub. L. No. 111-203, § 1011, 124 Stat. 1376, 1964 (2010) (codified as 12 U.S.C. §
                         5491).




                         Page 9                                                      GAO-19-239 Housing Finance
and think tanks also have published reform proposals. 15 We discuss
reform proposals made since 2014 in more detail later in this report.

Federal agencies also have commented on housing finance reform. In
early 2018, the Director of FHFA sent a letter to the Chairman and
Ranking Member of the Senate Committee on Banking, Housing, and
Urban Affairs stating that conservatorship is not sustainable and needs to
end, and provided suggestions on how the enterprises could be reformed.
For example, the letter states that the housing finance system should
preserve 30-year fixed-rate mortgages, end taxpayer bailouts for failing
firms, maintain liquidity, and provide a level playing field for lenders of all
sizes. It also states that secondary market activities should be managed
by shareholder-owned firms chartered by a regulator and operating as
utilities with an explicit paid-for federal guarantee on MBS issued by
regulated firms. In June 2018, the Office of Management and Budget
released recommendations to reform the federal government in a number
of areas, including housing finance. 16 The recommendations propose
privatizing the enterprises, allowing new private entities to enter the
market, and providing an explicit federal guarantee on MBS that could
only be accessed in limited, exigent circumstances.

In a 2014 report, we outlined a framework composed of nine elements we
consider to be critically important to help policymakers assess or craft
proposals to change the housing finance system (see table 1). 17




15
  For example, the Mortgage Bankers Association and Urban Institute have released
reform proposals. See Mortgage Bankers Association, GSE Reform: Creating a
Sustainable, More Vibrant Secondary Market (Washington, D.C.: April 2017); and Jim
Parrott et al., A More Promising Road to GSE Reform (Washington, D.C: Urban Institute,
March 2016).
16
 Office of Management and Budget, Delivering Government Solutions in the 21st
Century: Reform Plan and Reorganization Recommendations (Washington, D.C.: June
2018).
17
     GAO-15-131.




Page 10                                                    GAO-19-239 Housing Finance
Table 1: Elements of GAO’s Framework for Assessing Potential Changes to the Housing Finance System

Element                                   Description
Clearly defined and prioritized housing   Broad goals for the housing finance system should be clearly articulated and relevant so
finance system goals                      that government and market participants can effectively conduct activities to implement
                                          their missions. Additionally, market and government performance can be assessed
                                          against those broad goals. These goals should recognize broader housing policy
                                          objectives, as well. Where trade-offs among the broad goals exist, the goals should be
                                          prioritized.
Policies and mechanisms that are          Housing finance policies and mechanisms should be aligned with the broader goals of
aligned with goals and other economic     housing finance. Changes in housing finance should consider the full range of options for
policies                                  government actions—such as direct participation in markets through government
                                          guarantees, oversight and regulation, data collection and dissemination, and tax or other
                                          federal incentives to promote greater private market participation—and show how
                                          policies and mechanisms interact to achieve the goals on a comprehensive basis, while
                                          minimizing fragmentation, overlap, and duplication. In light of weaknesses exposed
                                          during the financial crisis these policies and mechanisms should help to align incentives,
                                          provide more information and transparency, and restrain excessive risk-taking. Proposals
                                          should also reflect how these mechanisms will interact with broader economic policies.
Adherence to an appropriate financial     In 2009, GAO proposed a framework for a financial regulatory system that included some
regulatory framework                      of the elements listed in this table as well as ensuring that regulation was appropriately
                                          comprehensive, consistent, flexible, adaptable, and had a system-wide focus
                                          (GAO-09-216). A regulatory system should also ensure that regulators have
                                          independence from inappropriate influence; have sufficient resources, clout, and
                                          authority to carry out and enforce statutory missions; and are clearly accountable for
                                          meeting regulatory goals.
Government entities that have capacity    Government entities will need adequate skills and resources to understand, price, and
to manage risks                           manage risks. These entities would also need the capacity to ensure that their
                                          counterparties in the private sector have the capacity to manage the risks inherent in
                                          their activities.
Mortgage borrowers are protected and      Borrowers need consistent, useful information, as well as legal protections, including
barriers to mortgage market access are    disclosures, sales practice standards, and suitability requirements, throughout the
addressed                                 mortgage life cycle. Any barriers facing creditworthy borrowers in accessing mortgage
                                          markets should be addressed. Key issues will be to encourage innovation to reduce
                                          barriers while ensuring that products are easily understood, such as through
                                          standardization and developing better tools to assess creditworthiness.
Protection for mortgage securities        Investors in the secondary market require adequate, reliable information to assess
investors                                 secondary-market risks. This would include providing clear information on securitizer and
                                          trustee responsibilities as they relate to investors. As with borrower protection, some
                                          standardization may be useful; however, care must be taken to ensure that certain
                                          protections do not discourage beneficial innovation.
Consideration of cyclical nature of       Housing finance has been characterized by cycles that have alternated between loose
housing finance and impact of housing     credit standards and those that are tight. Because housing is a significant part of the
finance on financial stability            economy, these cycles may pose risks to financial and economic stability. Government
                                          should determine whether actions related to housing finance are procyclical or
                                          countercyclical and consider making actions less procyclical. Government may also want
                                          to consider the appropriateness of countercyclical measures. Actions also should
                                          address the threat housing finance poses for financial stability when there are incentives
                                          for excessive risk taking.




                                          Page 11                                                       GAO-19-239 Housing Finance
Element                                   Description
Recognition and control of fiscal         Choices about policies and mechanisms will result in different levels of fiscal exposure.
exposure and mitigation of moral hazard   Wherever possible, exposures should be made explicit and costs recognized. Actions
                                          should be taken to minimize unexpected costs and to mitigate any moral hazard created
                                          by government policies and support.
Emphasis on implications of the           Because changing the housing finance system may lead to substantial changes in the
transition.                               marketplace, issues related to transitioning from the current system to a new one should
                                          be emphasized in any proposal for change. Any action that would severely limit market
                                          liquidity during the transition should be of particular concern.
Source: GAO. | GAO-19-239




                                          The housing market has recovered since the financial crisis, with
Government                                significant federal support. Indicators of recovery include rising house
Continues Significant                     prices and declining mortgage delinquency rates. However, the federal
                                          government has continued to support the housing market with guarantees
Support of Housing                        on more than two-thirds of new mortgages each year since 2008, either
Market but Recent                         through government-insured originations or by guaranteeing timely
                                          payment to investors on mortgage loans purchased and securitized by
Trends Present Risks                      the enterprises. The government also has continued to play a very
to Enterprises and                        substantial role in the secondary market, guaranteeing around 95 percent
                                          or more of all MBS issued annually since 2008. But recent trends—some
Others                                    loosening of underwriting standards, the rise of nonbank mortgage
                                          lenders and servicers, and less access to affordable housing and
                                          homeownership—may pose additional risks and challenges to the
                                          housing market and participants, including the enterprises.


Enterprises Have                          Several indicators demonstrate that the housing market has recovered
Benefited from Housing                    since the financial crisis of 2007–2009. For example, real national
                                          average house prices have consistently risen each year since 2012 (see
Recovery but Government
                                          fig. 2). The rise in house prices also has been complemented by
Still Supports a Majority of              consistent economic growth, declining unemployment, and low mortgage
Mortgages                                 rates since 2009. Higher house prices have some positive implications for
                                          the financial soundness of the enterprises: higher prices can reduce the
                                          enterprises’ potential losses due to defaulted loans because the
                                          enterprises can recover more value from properties securing the loans.




                                          Page 12                                                      GAO-19-239 Housing Finance
Figure 2: Federal Housing Finance Agency National House Price Index, 2003–2017




                                       Note: October 2011 = 100. Index adjusted for inflation using the Consumer Price Index of the Bureau
                                       of Labor Statistics.



                                       Serious delinquency rates (90 or more days delinquent) for mortgages
                                       purchased by Fannie Mae and Freddie Mac have declined steadily and
                                       since 2014 have remained between 1 and 2 percent for both enterprises
                                       (see fig. 3). Examining delinquency rates for mortgages by origination
                                       year reveals significant differences for mortgages originated before and
                                       after the financial crisis. According to Fannie Mae and Freddie Mac
                                       reports, mortgages originated since 2009 have had lower delinquency
                                       rates than those originated before 2009. For example, in 2017, Fannie
                                       Mae’s serious delinquency rate was 6.6 percent for mortgages originated
                                       in 2005–2008, compared to 0.5 percent for mortgages originated since
                                       2009. As of October 2018, mortgages originated since 2009 represented
                                       more than 90 percent of Fannie Mae’s and 80 percent of Freddie Mac’s
                                       outstanding held loans and guaranteed MBS. Serious delinquency rates




                                       Page 13                                                             GAO-19-239 Housing Finance
                                       for mortgages insured by FHA are higher on average than those
                                       purchased by the enterprises but generally have followed similar trends. 18

Figure 3: Percentage of Enterprise-Purchased Mortgages 90 or More Days Delinquent, 2003–2017




                                       Note: Rates are based on the number of loans held and backing enterprise mortgage-backed
                                       securities.



                                       Compared to pre-2007 levels, trends in mortgage originations indicate a
                                       smaller-volume market largely composed of prime conforming and
                                       government-insured mortgages, as shown in figure 4. During 2008–2017,
                                       total mortgage origination volume—the dollar value of mortgage loans—
                                       remained below pre-crisis levels. Much of the decrease in volume
                                       resulted from large declines in prime jumbo and nonprime originations




                                       18
                                         The purpose of FHA’s mortgage insurance is to encourage lenders to make mortgages
                                       available to borrowers, including those who may have difficulty qualifying for conventional
                                       mortgage credit. Therefore, the loans they insure may tend to be riskier on average than
                                       the conventional loans purchased by the enterprises.




                                       Page 14                                                          GAO-19-239 Housing Finance
since 2008. 19 Prime jumbo and nonprime originations represented a
significant share of originations (market share) before 2007 but declined
sharply since 2008. Prime jumbo market share recovered somewhat,
increasing from a low of 6 percent in 2009 to approximately 18 percent of
originations each year since 2014. Riskier nonprime originations remain
very low compared to their pre-crisis levels. 20 Meanwhile, federally
insured mortgages (such as those insured by FHA or guaranteed by VA)
grew significantly in 2008 and retained a market share between 19 and
25 percent in 2008–2017. Finally, prime conforming origination volume
varied year-to-year but these mortgages have represented the majority of
originations since 2007. 21 Federally insured and prime conforming
mortgages represented 80 percent or more of originations every year
since 2008.




19
  Nonprime mortgages include subprime, Alt-A, non-qualified mortgage loans, and other
non-agency products not sold to the enterprises or federally insured. Subprime mortgages
are generally made to borrowers with weaker credit and feature higher interest rates and
fees than prime loans, while Alt-A mortgages generally serve borrowers whose credit
histories are close to prime, but the loans may have one or more higher-risk
characteristics such as limited documentation of income or assets or higher loan-to-value
ratios. Jumbo mortgages are prime mortgage loans for amounts larger than the maximum
eligible for purchase by the enterprises.
20
   Nonprime originations increased slightly in 2016 and 2017 but still represented 2 percent
or less of originations since 2009. We previously reported that many pre-crisis nonprime
mortgages had nontraditional and higher-risk features that may increase the likelihood of
borrowers defaulting. Many of these products would not have met the criteria for a
qualified mortgage (a category of loans that have certain, more stable features that help
make it more likely that a borrower will be able to afford the loan). See GAO, Nonprime
Mortgages: Analysis of Loan Performance, Factors Associated with Defaults, and Data
Sources; GAO-10-805 (Washington, D.C: Aug. 24, 2010), GAO-15-131 and GAO-15-185
for more information on riskier mortgage products.
21
  Yearly variations in prime mortgage origination volume fluctuate based on changes in
the volume of new mortgages to refinance an existing mortgage.




Page 15                                                       GAO-19-239 Housing Finance
Figure 4: Dollar Volume and Percentage of Single-Family Mortgage Loan Originations by Product Type, 2003–2017




                                        Note: Figures include first-lien mortgages only. A first-lien mortgage creates a primary lien against
                                        real property and has priority over subsequent mortgages. Prime mortgages are made to borrowers
                                        with strong credit histories and provide the most attractive interest rates and loan terms. Conforming
                                        loans are those eligible for purchase by Fannie Mae and Freddie Mac. Jumbo loans are larger than
                                        the maximum amount eligible for purchase by Fannie Mae and Freddie Mac. Nonprime loans refer to
                                        loans with more liberal underwriting standards, without qualifying mortgage protections, or those
                                        made to borrowers with nontraditional documentation or weaker credit. Government-insured
                                        originations include those insured by the Federal Housing Administration and guaranteed by the
                                        Department of Veterans Affairs. Dollar amounts were adjusted for inflation and reflect real 2017
                                        dollars.




                                        Page 16                                                               GAO-19-239 Housing Finance
The federal government has continued to support a significant share of
the mortgage markets since the financial crisis. For instance, while down
from the peak in 2009, the federal government has guaranteed more than
two-thirds of new mortgages since 2014, either by insuring mortgages or
by guaranteeing timely payment to investors on loans purchased and
securitized by the enterprises (see fig. 5). 22 Government-insured
mortgages declined leading up to the financial crisis, largely due to the
availability of nonprime mortgages and securitization by fully private
institutions. But when the availability of these products declined sharply,
government agencies such as FHA and VA insured or guaranteed
significantly higher volumes of mortgages. For instance, the share of
mortgages insured or guaranteed by federal agencies grew from 6
percent ($134 billion) in 2007 to more than 20 percent ($328 billion) in
2008. 23 As of 2017, federally insured mortgages were 25 percent ($444
billion) of total originations. Similarly, as the share of conventional
mortgages held in banks’ portfolios declined during the financial crisis, the
enterprises purchased and securitized large volumes of these
mortgages. 24 The share of mortgage originations purchased by the
enterprises peaked at 65 percent in 2008 and still accounted for nearly
half of new mortgages in 2017.




22
  In this report, we refer to mortgages guaranteed by the federal government as those
insured or guaranteed through federal programs such as FHA and VA as well as
conventional mortgages securitized or held in portfolio by the enterprises while they have
explicit financial backing from Treasury through the senior preferred stock purchase
agreements. The enterprises do not guarantee mortgage originations but rather the timely
payment of principal and interest to investors on mortgages they securitize.
23
 We adjusted dollar amounts of mortgage originations and MBS issuance from Inside
Mortgage Finance data for inflation to real 2017 dollars using the Bureau of Economic
Analysis’s implicit price deflator.
24
   We estimated originations held in portfolio based on the difference of the value of
mortgages originated and the value of mortgages securitized by year as reported by
Inside Mortgage Finance.




Page 17                                                        GAO-19-239 Housing Finance
Figure 5: Percentage of New Single-Family Mortgages with Federal Guarantees, 2003–2017




                                       Note: Figures include first-lien mortgages only. A first-lien mortgage creates a primary lien against
                                       real property and has priority over subsequent mortgages. Before September 2008, mortgages
                                       purchased and securitized by the enterprises did not have an explicit federal guarantee. Conventional
                                       originations are mortgages not insured or guaranteed by a federal agency such as the Federal
                                       Housing Administration (FHA) or the Department of Veterans Affairs (VA). Government-insured
                                       originations include those insured by FHA and guaranteed by VA. We estimated the enterprises’
                                       conventional purchases using their volume of mortgage-backed security issuance backed by
                                       unseasoned conventional loans, as reported by Inside Mortgage Finance. Estimates of enterprise
                                       purchases do not include purchases of seasoned loans, government-insured loans, or those held in
                                       Fannie Mae’s or Freddie Mac’s retained mortgage portfolios. Nongovernment originations are
                                       conventional mortgage originations not securitized by the enterprises.




                                       Page 18                                                              GAO-19-239 Housing Finance
The federal government also has maintained a very substantial role in the
secondary mortgage market since the financial crisis. The enterprises and
Ginnie Mae guaranteed around 95 percent or more of all MBS issued
each year since 2008, despite a nearly decade-long economic expansion.
In line with the rise in federally insured originations, Ginnie Mae’s market
share increased substantially, from 5 percent ($110 billion) in 2007 to 22
percent ($301 billion) in 2008, and about 33 percent ($455 billion) in 2017
(see fig. 6). 25 Conversely, private-label MBS issuance since 2008 has
been minimal, as many private-label issuers left the market and nonprime
originations declined. 26




25
  As previously discussed, Ginnie Mae-guaranteed MBS are composed entirely of
federally insured mortgages (such as FHA loans).
26
  A majority of private-label MBS issuance since the financial crisis has been for
nonperforming loans, reperforming loans (those on which borrowers have resumed
payments), or resecuritizations of previously issued MBS. Since 2008, less than 1 percent
of new mortgage originations have been securitized as private-label MBS. While jumbo
origination volume has increased since 2008, only about 3 percent was securitized in
2017.




Page 19                                                      GAO-19-239 Housing Finance
Figure 6: Dollar Volume and Percentage of Single-Family Mortgage-Backed Security Issuance by Source, 2003–2017




                                       Note: Dollar amounts were adjusted for inflation and reflect real 2017 dollars. Private-label MBS are
                                       issued by private institutions and do not have a federal guarantee.


                                       The growth in the market share of Ginnie Mae and the enterprises
                                       resulted in part from actions by Congress and the Board of Governors of
                                       the Federal Reserve System (Federal Reserve). Congress increased the
                                       loan limits for FHA-insured loans and loans eligible for securitization by



                                       Page 20                                                               GAO-19-239 Housing Finance
                             the enterprises. 27 The federal government also made its backing of
                             securities issued by the enterprises explicit by committing to provide them
                             financial assistance, and Ginnie Mae continued to provide guarantees for
                             securities backed by federally insured mortgages. 28 According to several
                             mortgage originators, securitizers, investors, and researchers with whom
                             we spoke, the enterprises will continue to dominate the MBS market
                             because the federal guarantee through conservatorship offers a
                             competitive advantage over other participants without such a guarantee.

                             In response to the financial crisis, the Federal Reserve provided
                             additional support for the mortgage market, becoming one of the largest
                             purchasers of MBS issued by the enterprises and guaranteed by Ginnie
                             Mae. Among other impacts, this action made these securities somewhat
                             more attractive to secondary market participants. In June 2017, when the
                             Federal Reserve’s MBS holdings had peaked at $1.78 trillion, it
                             announced plans to gradually reduce its MBS holdings as part of its
                             efforts to reduce the size of its balance sheet. As of November 2018, the
                             Federal Reserve had $1.66 trillion in MBS holdings.


Recent Trends in the         Recent trends—particularly changes in underwriting standards and
Housing Market May           borrowers’ credit risk profiles, the rise of nonbank mortgage lenders and
                             servicers, and limited access to affordable housing and homeownership—
Present Risks and
                             pose risks and challenges to the housing market and participants,
Challenges                   including the enterprises.

Underwriting Standards and   Indicators of borrower credit risk and surveys of loan officers indicate a
Borrower Credit Risk         loosening of underwriting standards in recent years. 29 More specifically,
                             indicators of borrower credit risk for mortgages the enterprises purchased

                             27
                              While FHA loans still represent the majority of federally insured mortgages, the volume
                             and market share of VA loans have grown more significantly relative to FHA since 2011.
                             28
                                Fiscal exposures may be explicit in that the federal government is legally required to pay
                             for the commitment; alternatively, it may be implicit in that the exposure arises from
                             expectations based on current policy or past practices. Before 2008, securities issued by
                             the enterprises were explicitly not backed by the U.S. government. However, in response
                             to the financial crisis, the government’s agreement to provide temporary assistance to
                             cover their losses up to a set amount created a new explicit exposure. FHFA and the
                             enterprises have made efforts to manage this exposure ( for example by transferring some
                             additional risk to the private market). We discuss these efforts later in this report.
                             29
                                Underwriting standards include factors that may influence the capacity of the borrower to
                             repay a loan, such as the level of the borrower’s equity invested in the property,
                             indebtedness, and overall creditworthiness of the borrower.




                             Page 21                                                        GAO-19-239 Housing Finance
suggest underwriting standards tightened in 2008 but loosened slightly
since 2012, which could pose increased risk to the enterprises.
Specifically, average combined loan-to-value ratios (for all loans on the
property) and debt-to-income ratios have increased, while average
borrower credit scores have declined. 30 The enterprises and FHA include
assessments of these measures in setting their underwriting standards.
As discussed earlier in the report, mortgages originated since 2009 have
performed much better than those originated before 2008, but remain
untested by a large-scale stressful economic event.

Furthermore, mortgages to refinance an existing mortgage (as opposed
to mortgages for purchasing a home) declined since 2012. According to
FHFA officials, credit scores, loan-to-value ratios, and debt-to-income
ratios tend to be stronger for refinance mortgages than purchase
mortgages. FHFA and HUD officials also told us that reduced refinancing
volume due to rising interest rates may put additional pressure on lenders
to maintain volume and profitability by offering more relaxed credit terms
to borrowers.

Average combined loan-to-value ratios for mortgages purchased by the
enterprises peaked in 2014 and have remained roughly similar to pre-
crisis levels (see fig.7). In December 2014, FHFA began allowing the
enterprises to purchase mortgages with loan-to-value ratios up to 97
percent. 31 In the first three quarters of 2018, 22 percent of mortgages
Fannie Mae purchased included a loan-to-value ratio over 90 percent,
which is higher than shares in 2005–2008. FHA’s loan-to-value ratio is
limited to 96.5 percent, and the average among borrowers has remained
relatively consistent around 93 percent since 2008. 32 The higher the loan-
to-value ratio when a loan is originated, the less equity borrowers will

30
   These figures reference a subset of fully amortizing, full documentation, conventional
fixed-rate mortgages purchased by the enterprises. They exclude mortgages with certain
features, such as balloon amortization, or other features to be more reflective of current
underwriting guidelines.
31
  Due to the riskier nature of these loans, the enterprises require mortgages with loan-to-
value ratios over 80 percent to have some form of credit enhancement, most commonly
private mortgage insurance. Many of these loans also have been targeted for credit risk
transfer, which is discussed later in this report.
32
  FHA loans often have additional down-payment assistance features that may change
how loan-to-value ratios traditionally would be reported. Depending on these features, the
reported loan-to-value of an FHA-insured mortgage could be up to nearly 5 percentage
points higher if it were reported using standards outside of FHA’s.




Page 22                                                        GAO-19-239 Housing Finance
                                       have in their homes and the more likely they are to default on mortgage
                                       obligations, especially during times of financial stress or falling home
                                       values. 33 Additionally, house price valuation—measured by the price-to-
                                       rent ratio—has increased substantially since 2012 to levels last seen in
                                       2004. 34 Higher valuations could increase the risk of future price
                                       decreases—which would reduce collateral values that protect the
                                       enterprises against losses in the event of default—or more modest price
                                       increases. This could signal increased risk when associated with higher
                                       loan-to-value ratios.

Figure 7: Combined Loan-to-Value Ratio for Mortgages Purchased by the Enterprises, 2003–2017




                                       Note: Values represent weighted average based on unpaid principal balance. Data for 2017 are as of
                                       September 30, 2017.
                                       Average credit scores for enterprise-purchased loans rose significantly
                                       from their pre-crisis lows and remained historically high through 2012 but

                                       33
                                            GAO-15-185.
                                       34
                                         We calculated the price-to-rent ratio using FHFA’s purchase-only house price index and
                                       the Bureau of Labor Statistics’ owners’ equivalent rent of primary residence.




                                       Page 23                                                            GAO-19-239 Housing Finance
                                        have since slightly declined (see fig. 8). 35 The average credit score of
                                        FHA-insured borrowers, while lower than those for loans purchased by
                                        the enterprises, followed a trend similar to those of the enterprises.
                                        Generally, a higher score indicates a greater credit quality and potentially
                                        lower likelihood of default. Lenders continue to use credit scores as a
                                        primary means of assessing whether to originate a loan to a borrower.

Figure 8: Borrower Credit Score for Mortgages Purchased by the Enterprises, 2003–2017




                                        Note: Values represent weighted average based on unpaid principal balance. Data for 2017 are as of
                                        September 30, 2017.




                                        35
                                         A credit score is a numeric value that represents a borrower’s potential credit risk, based
                                        on his or her credit history.




                                        Page 24                                                            GAO-19-239 Housing Finance
Average debt-to-income ratios for mortgages purchased by the
enterprises remained below their pre-crisis levels but have deteriorated
since 2012, and the share of high debt-to-income mortgages rose. 36
Additionally, according to Fannie Mae financial reports, in the first three
quarters of 2018, roughly 25 percent of mortgages it purchased included
a borrower debt-to-income ratio over 45 percent, up from roughly 7
percent of mortgages in the first three quarters of 2017.

The share of high debt-to-income ratios for FHA-insured borrowers also
has risen significantly. For example, nearly half (49 percent) of FHA-
insured borrowers in fiscal year 2017 had high debt-to-income ratios,
surpassing the previous high of 45 percent of borrowers in 2009. 37
According to FHA, as of March 2018, about 24 percent of mortgages
included debt-to-income ratios above 50 percent, up from 20 percent of
mortgages in March 2017. The Dodd-Frank Act requires mortgage
lenders to make “a reasonable, good faith determination” of a borrower’s
ability to repay the loan. A lender that originates a “qualified mortgage” is
presumed to have met this requirement. All qualified mortgages must
meet mandatory requirements including restrictions on points and fees,
and loan structure. In addition, the borrower’s debt-to-income ratio must
be 43 percent or less; however, loans eligible for purchase by the
enterprises or to be insured by the FHA, VA or USDA are not subject to a
specific debt-to-income ratio. 38


36
  Lenders use debt-to-income ratio as a key indicator of a borrower’s capacity to repay a
loan. The ratio represents the percentage of a borrower’s income that goes toward all
recurring debt payments, including the mortgage payment. A higher ratio is generally
associated with a higher risk that the borrower will have cash flow problems and may miss
mortgage payments. An increase in debt-to-income ratios is consistent with a widening of
credit availability for borrowers with higher debt burdens. According to Freddie Mac, debt-
to-income reporting standards may vary by lender and may be missing or excluded in
some cases.
37
   In this instance, we define high debt-to-income ratios as 43 percent or greater. Debt-to-
income ratios above 43 percent do not meet the criteria for qualified mortgage protections,
with some exceptions. A qualified mortgage is a category of loans that have certain, more
stable features that help make it more likely that a borrower will be able to afford the loan.
38
   To implement the ability-to-repay and qualified mortgage provisions of the Dodd-Frank
Act, CFPB issued a rule amending Regulation Z, which implements the Truth In Lending
Act. CFPB’s rule includes an exemption from the 43 percent debt-to-income cap for
mortgages eligible for purchase by the enterprises. This applies only as long as the
enterprises remain in federal conservatorship or until January 2021, whichever comes
first. The Dodd-Frank Act also required HUD, VA, and USDA to issue rules to implement
the qualified mortgage provisions. Mortgages eligible for insurance or guarantee by FHA,
VA, or RHS generally are qualified mortgages under these regulations




Page 25                                                         GAO-19-239 Housing Finance
                           Additionally, according to results from the October 2018 Senior Loan
                           Officer Opinion Survey on Bank Lending Practices, more loan officers
                           reported loosening than tightening their underwriting standards for
                           enterprise-eligible mortgages every quarter from 2015 through the second
                           quarter of 2018. More officers reported loosening their standards for
                           government-insured mortgages during 12 of the last 16 quarters. 39

Nonbank Mortgage Lenders   Our review found that the increased role of nonbank mortgage lenders
and Servicers              and servicers in recent years has helped provide liquidity and access to
                           mortgage credit but also presented additional liquidity risks. FHFA and
                           HUD officials reported that the share of nonbanks mortgage originators
                           and servicers grew since the financial crisis. According to data from
                           Inside Mortgage Finance, nonbanks originated roughly half of all
                           mortgages sold to the enterprises in 2017 and the first three quarters of
                           2018. Of the top 10 mortgage sellers to the enterprises in the first three
                           quarters of 2018, six were nonbanks that originated more than 20 percent
                           of all enterprise purchases during that period. Nonbank servicers of loans
                           backing enterprise MBS have grown from 25 percent in 2014 to 38
                           percent as of the third quarter of 2018. For FHA-insured mortgages,
                           nonbank originations represented 74 percent in 2003, declined to 56
                           percent in 2010, and then increased to 86 percent in fiscal year 2017. 40

                           While FHFA and HUD officials told us nonbanks have helped provide
                           access to mortgage credit, several stakeholders and experts in all four of
                           our panels identified the increased presence of nonbank lenders as a
                           current risk in the housing finance system. A 2018 paper published by the
                           Brookings Institution cited that nonbanks are exposed to significant
                           liquidity risks in their funding of mortgage originations and servicing of
                           mortgages, because nonbank lenders rely more on credit lines provided
                           mostly by banks, securitizations involving multiple players, and more




                           39
                             The Federal Reserve generally conducts the survey quarterly and includes up to 80
                           large domestic banks and 24 U.S. branches and agencies of foreign banks. The survey
                           asks about changes in the standards and terms of loans (including residential mortgage
                           loans) and demand for loans.
                           40
                             As described above, the volume of FHA-insured originations was much lower in 2003
                           than in 2017.




                           Page 26                                                     GAO-19-239 Housing Finance
frequent trading of mortgage servicing rights than banks. 41 For instance,
during times of financial stress, lenders to nonbanks have the right to
quickly pull their lines of credit and seize and sell the underlying collateral
if nonbanks do not maintain certain levels of net worth. HUD officials
identified similar risks and added that this may reduce borrower access to
credit in the event of financial stress or a liquidity crisis.

Additionally, while nonbanks are subject to some federal and state
oversight, they are not federally regulated for safety and soundness.
State regulators may require nonbanks to be licensed and may examine
their financial soundness and compliance with relevant state laws, but
there are no such federal regulations, unlike with banks. The Conference
of State Bank Supervisors has a series of initiatives with the goal of all
state regulators adopting a nationwide nonbank licensing and supervisory
system by 2020. CFPB oversees nonbank issuers for compliance with
consumer financial protection laws but not for financial safety and
soundness. We reported in 2016 that incomplete information on the
identity of nonbank servicers may hinder those responsible for their
oversight. 42

The lack of federal safety and soundness oversight of nonbank lenders
and servicers may pose risks for the enterprises and federal housing
finance entities. The enterprises conduct financial and operational
reviews of their counterparties in accordance with FHFA guidance. But,
as we reported in 2016, FHFA does not have the authority to
independently evaluate the safety and soundness of entities that conduct



41
   Nonbank issuers typically rely on credit lines provided by warehouse lenders, which tend
to be commercial and investment banks. Warehouse lending is a process by which
lenders extend lines of credit to nonbanks to fund mortgages until the nonbank finds a
willing investor. Warehouse lenders can adjust the terms or cancel lines if nonbanks
violate any of the covenants of the contract, including maintaining certain levels of net
worth and profitability. For more information, see You Suk Kim, Steven M. Laufer, et al.,
“Liquidity Crises in the Mortgage Market,” Brookings Papers on Economic Activity, Spring
2018 (Washington, D.C.: 2018).
42
  To improve CFPB’s ability to monitor the consumer effect of nonbank servicers, we
recommended that CFPB take action to collect more comprehensive data on the identity
and number of nonbank mortgage servicers in the market. To address the
recommendation, CFPB analyzed National Mortgage Licensing System data and identified
880 additional servicers, resulting in a list of 1,050 mortgage servicing entities. See GAO,
Nonbank Mortgage Servicers: Existing Regulatory Oversight Could Be Strengthened,
GAO-16-278 (Washington, D.C.: Mar. 10, 2016).




Page 27                                                       GAO-19-239 Housing Finance
business with the enterprises. 43 In 2014, the FHFA Office of Inspector
General found that nonbank lenders may have limited financial capacity
and are not subject to federal safety and soundness oversight, creating
an increased risk that these counterparties could default on their financial
obligations. 44 They also found that rapid business growth among specialty
servicers could put stress on their operational capacity or overrun their
quality control procedures, potentially increasing representation and
warranty claims and credit losses on mortgages they sell to the
enterprises. Representation and warranty claims allow the enterprises
and other federal entities to recover some losses from lenders in the
event of misrepresentation by the seller. From 2009 through 2013, the
enterprises received $98.5 billion through repurchase requests to sellers
(that is, they required sellers to repurchase the enterprises’ interests in
the loans). According to the FHFA Office of Inspector General, due to
lower capital levels, nonbanks may be less able to honor these
representation and warranty commitments. 45

FHFA and HUD officials also told us nonbanks have helped increase
servicing capacity. We previously reported that nonbank servicers provide
benefits to the housing market through increased capacity to service
delinquent loans and contribute to liquidity by broadening participation in
the market for mortgage servicing rights. 46 In particular, larger numbers of
individual servicers also can reduce market concentration, suggesting
that servicers may be more likely to behave competitively and can, for
instance, increase innovation. Furthermore, large nonbanks are generally
not as interconnected with the financial system as large banks, potentially
limiting broader market effects in the event of the failure of a single large
nonbank servicer. 47


43
   FHFA has indirect oversight of third parties that do business with the enterprises,
including nonbanks that service loans on the enterprises’ behalf. However, their oversight
of third parties is through contractual provisions rather than statutory authority. In 2016,
we recommended that Congress consider granting FHFA authority to examine third
parties that do business with the enterprises. See GAO-16-278. As of November 2018,
Congress had not yet taken action on this issue.
44
   Federal Housing Finance Agency, Office of Inspector General, Recent Trends in the
Enterprises’ Purchases of Mortgages from Smaller Lenders and Nonbank Mortgage
Companies, EVL-2014-010 (Washington, D.C.: July 17, 2014).
45
     Federal Housing Finance Agency, Office of Inspector General, EVL-2014-010.
46
     See GAO-16-278.
47
     GAO-16-278.




Page 28                                                        GAO-19-239 Housing Finance
                     But the enterprises and Ginnie Mae likely would incur costs in the event
                     of a failure of a large nonbank servicer whose portfolio cannot be easily
                     absorbed by others. Mortgage servicers must continue making payments
                     to investors when borrowers do not make payments. For mortgages
                     backed by the enterprises, servicers can be reimbursed for principal and
                     interest and certain other expenses, but they must finance them in the
                     interim. Servicers of mortgage pools guaranteed by the enterprises must
                     advance payments until the borrower is 120 days delinquent on the
                     loan. 48 Servicers of Ginnie Mae-guaranteed pools are not limited in how
                     long they must advance principal and interest on delinquent loans, and
                     they additionally may be required to absorb losses not covered by FHA
                     insurance or VA guarantees. In the event of a failure of a large nonbank
                     servicer with a not readily absorbable portfolio, Ginnie Mae and the
                     enterprises likely would bear most of the associated costs, and
                     consumers also likely would see some effects, such as service
                     interruptions. 49 In 2015, FHFA and Ginnie Mae raised their minimum
                     financial eligibility requirements for sellers and servicers (including for net
                     worth, capital ratio, and liquidity criteria for counterparties), but these
                     requirements may not fully account for the high interest rate and default
                     risks that nonbanks face.

Affordable Housing   Challenges related to affordable housing and access to homeownership
                     also remain. Fannie Mae and Freddie Mac are subject to affordable
                     housing goals for their purchases of single-family and multifamily
                     mortgages that benefit families with lower incomes. 50 However, a number
                     of factors affect the development of affordable housing and access to
                     homeownership. For example, according to a 2018 study on the state of
                     the nation’s housing, competition for the historically low supply of existing
                     homes on the market has pushed up home prices in most metropolitan



                     48
                       According to FHFA officials, servicers of pools guaranteed by Fannie Mae must advance
                     payments of both principal and interest on delinquent loans. For those guaranteed by
                     Freddie Mac, the servicer advances interest payments but Freddie Mac advances
                     principal payments. Servicers are also responsible for advancing additional costs and
                     payments such as property taxes.
                     49
                          GAO-16-278.
                     50
                       The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 created
                     this provision. Pub. L. No. 102-550, § 1331-1334, 106 Stat. 3672, 3956-3961 (1992),
                     which was amended by the Housing and Economic Recovery Act of 2008, Pub. L. No.
                     110-289, §1128, 122 Stat. 2654, 2696-2703 (2008) (codified as 12 U.S.C. §4561-4564).




                     Page 29                                                    GAO-19-239 Housing Finance
areas, raising concerns about affordability. 51 The study also noted that
although better housing quality accounts for some of the increase in
housing prices, sharply higher costs for building materials and labor,
among other factors, have made housing construction considerably more
expensive. Land prices also increased as population growth in
metropolitan areas increased demand for well-located sites. Along with
rising housing costs, the study also reported that weak income growth
among low- and moderate-income households contributed to affordability
pressures. As homeownership becomes less affordable with house price
increases, the enterprises’ affordable housing goals become more difficult
to achieve. For example, for calendar year 2016, Freddie Mac met all of
its affordable housing goals, and Fannie Mae met most of its affordable
housing goals, but failed to meet its goal for the single-family home
purchase, very-low income category. 52 For calendar year 2017, based on
FHFA’s preliminary determinations, Fannie Mae met all of its affordable
housing goals, but Freddie Mac missed its single-family home purchase
goals for both the very low-income and low-income categories.

Experts and stakeholders we interviewed identified other contributing
challenges. For example, a few experts and stakeholders cited lower
levels of lending in minority communities and to low- and moderate-
income borrowers, which are typically most in need of affordable housing,
as contributing challenges. A few other experts and stakeholders stated
that borrowers increasingly have been holding other types of debt, such
as student loan debt, which makes it more difficult for them to obtain an
affordable mortgage. Lastly, the qualified mortgage rule exception, which
may have helped some borrowers with a debt-to-income ratio above 43
percent to obtain a mortgage, expires in 2021 or earlier if conservatorship
of the enterprises ends before then. When this happens, this could also
hinder the ability of certain borrowers with a debt-to-income ratio higher
than 43 percent to obtain mortgages.




51
 Joint Center for Housing Studies at Harvard University, The State of the Nation’s
Housing (2018), (Cambridge, Mass.: June 19, 2018).
52
  Fannie Mae also failed to meet its calendar year 2016 single- family, low-income
refinance goal.




Page 30                                                      GAO-19-239 Housing Finance
Enterprises Have           Fannie Mae and Freddie Mac have taken actions in recent years that
Expanded or Plan to        could further increase the scope of their activities and present challenges
                           or barriers to entry for other market participants.
Expand Activities That
Could Present Challenges
for Other Market
Participants
Mortgage Insurance         Both enterprises have recently introduced pilot programs that affect
                           mortgage insurance decisions and terms typically made by lenders. In
                           2018, Fannie Mae introduced a pilot program to offer an enterprise-paid
                           mortgage insurance option—an alternative to the borrower-paid and
                           lender-paid options currently available. Under the program’s structure,
                           Fannie Mae is the entity responsible for purchasing mortgage insurance
                           on loans with high loan-to-value ratios. To do so, Fannie Mae secures an
                           insurance arrangement from a qualified insurer, which in turn transfers
                           the risk to a panel of approved reinsurers. Fannie Mae pays the mortgage
                           insurance premiums, while the lender is responsible for paying an
                           additional, loan-level price adjustment.

                           Freddie Mac launched a similar pilot program earlier in 2018 known as
                           the Integrated Mortgage Insurance program. Under this program,
                           simultaneous with purchasing single-family mortgages, Freddie Mac
                           purchases mortgage insurance from a panel of pre-approved reinsurance
                           companies that it has allocated risk among. In addition, the reinsurers
                           post collateral to provide further assurance that claims will be paid, and
                           they cannot deny or rescind coverage.

                           According to Fannie Mae and Freddie Mac documents, these pilot
                           programs allow the enterprises to better manage their counterparty risk
                           and streamline the operational requirements of participating lenders. For
                           example, each participating reinsurer undergoes a thorough counterparty
                           review in order to be approved for participation in the programs.
                           Additionally, under the programs, lenders are not required to purchase
                           mortgage insurance for loans with loan-to-value ratios above 80 percent,
                           which would simplify the process of selling loans to the enterprises.
                           However, according to several experts and stakeholders with whom we
                           spoke, by allowing the enterprises to play a role in selecting the mortgage
                           insurer, these pilot programs widen the scope of activities of the
                           enterprises. They also allow them to become more dominant by
                           potentially growing their role beyond the secondary market and into the
                           primary market. They explained that these programs promote greater


                           Page 31                                            GAO-19-239 Housing Finance
                   vertical integration of private-sector activities into the enterprises, and
                   create challenges for market participants. For example, they stated that
                   they promote an uneven playing field in the private market by allowing for
                   different terms and standards for enterprise-paid mortgage insurance
                   versus other sources of private capital.

Other Activities   Experts and stakeholders also identified other enterprise pilot programs
                   or activities, such as Freddie Mac’s financing of nonbank mortgage
                   servicers and the enterprises’ standardization efforts, as potential
                   challenges. Freddie Mac’s Mortgage Servicing Rights pilot program
                   provides financing to nonbank servicers, with some limitations, secured
                   by the servicers’ mortgage servicing rights. The program is intended to
                   address impediments nonbank mortgage servicers face in obtaining
                   financing and extends credit to nonbank mortgage servicers when they
                   need access to cash. However several experts and stakeholders with
                   whom we spoke stated that this could lead to certain servicers having a
                   competitive advantage. For example, they stated that under this program,
                   Freddie Mac may target its financing at the biggest servicers and charge
                   comparatively low interest rates, putting small lenders and servicers at a
                   disadvantage. The enterprises also have efforts to standardize appraisal
                   data, loan applications, and closing disclosures. While these efforts are
                   intended to streamline and standardize aspects of the mortgage process,
                   several experts and stakeholders explained that the results of these
                   activities can be costly to smaller lenders and servicers who have to bear
                   the costs of adapting their systems to enterprise requirements. They also
                   indicated that participants in the primary market have become reliant on
                   the enterprises for standards and innovation. Several experts and
                   stakeholders also stated that the cost for market participants to adopt new
                   programs or standards set by the enterprises can be high and could
                   inhibit other participants from entering the housing finance market.

                   In addition, the enterprises are currently developing a common
                   securitization platform to support the issuance of a common single
                   mortgage-backed security by both enterprises. 53 The platform will support

                   53
                     Common Securitization Solutions, LLC (a joint venture owned by the enterprises) has
                   been developing a common securitization platform under FHFA’s direction and guidance.
                   According to FHFA, the platform will perform many office operations for the uniform
                   mortgage-backed security—a joint initiative between Fannie Mae and Freddie Mac, under
                   the direction of FHFA, to develop a single mortgage-backed security that the enterprises
                   will issue to finance fixed-rate mortgage loans backed by one- to four-unit single-family
                   properties—as well as most of the enterprises’ current securitization functions for single-
                   family mortgages.




                   Page 32                                                       GAO-19-239 Housing Finance
the enterprises’ single-family mortgage securitization activities, including
issuance by both enterprises of a common mortgage-backed security to
be known as the uniform mortgage-backed security. FHFA expects the
issuance of the uniform mortgage-backed security to improve the overall
liquidity of the enterprises’ securities and promote liquidity of the nation’s
housing finance markets. The common securitization platform also would
integrate the various securitization infrastructure systems within each
enterprise, which is expected to lower costs and increase efficiency.

However, several stakeholders we interviewed explained that the platform
presents concerns. For example, mortgage securitizers and investor
stakeholders who participated on our panels expressed concern about
the platform and its availability to other market participants. Specifically,
they stated that the goal of the project has, at times, been unclear and
that it has been difficult to tell to what extent or when the platform will be
accessible to other secondary market participants. They also stated that if
the platform would not be accessible to other secondary market
participants, it would take away opportunities from participants willing and
able to pool eligible securities. FHFA officials told us the platform
currently is intended for use only by Fannie Mae and Freddie Mac, but
that the agency is aware that potential reforms to the housing finance
system may bring about the inclusion of other guarantors. As such, the
platform is being designed to be adaptable for use by other participants in
the secondary market in the future. 54 (We discuss recent proposals to
reform the housing finance system in detail later in this report.)




54
 For more discussion on FHFA’s strategic goal of building a securitization infrastructure,
see GAO-17-92.




Page 33                                                       GAO-19-239 Housing Finance
FHFA Has Taken
Actions to Reduce the
Enterprises’
Exposure, but Risks,
Uncertainty, and
Challenges Remain
FHFA Has Taken Actions         FHFA-directed actions (including retained mortgage portfolio reductions,
to Reduce the Enterprises’     credit risk transfer, and foreclosure prevention) have improved the
                               condition of the enterprises by mitigating some of the enterprises’
Risk Exposure
                               exposures to potential losses.

Retained Mortgage Portfolios   Under the direction of FHFA and in accordance with the requirements of
                               the senior preferred stock purchase agreements between Treasury and
                               the enterprises, the enterprises have substantially reduced the size of
                               their retained mortgage portfolios since 2008. 55 The portfolios invest in
                               mortgages the enterprises purchased but did not securitize, mortgages
                               bought out of securities due to delinquency status or other reasons, MBS
                               they purchased from each other or from private issuers, and their own
                               MBS repurchased from other investors.

                               The enterprises can earn higher returns from their retained mortgage
                               portfolios than from issuing guaranteed MBS, but the portfolios can
                               expose the enterprises to greater risks. Specifically, the enterprises retain
                               the credit risk on mortgages they securitize because of their guarantee,
                               but transfer the interest rate and liquidity risk to investors. However,
                               holding whole mortgages and MBS in their retained mortgage portfolios
                               entails the enterprises retaining liquidity, and interest rate risk, in addition
                               to credit risk. We previously reported that the enterprises’ large retained
                               mortgage portfolios exposed them to considerable interest rate risk and




                               55
                                 The senior preferred stock purchase agreements set annual caps on the retained
                               mortgage portfolios that decrease each year. The enterprises have been able to meet
                               these caps each year.




                               Page 34                                                    GAO-19-239 Housing Finance
that riskier assets they held represented a disproportionate share of their
total credit-related losses in 2007 and 2008. 56

According to FHFA, Fannie Mae reduced its retained mortgage portfolio
from $792 billion in 2008 to $231 billion in 2017, and Freddie Mac
reduced its retained mortgage portfolio from $804 billion in 2008 to $253
billion in 2017 (see figs. 9 and 10). Additionally, these reductions have
prioritized the sale of less-liquid assets such as private-label MBS and
reperforming loans. 57 For example, Freddie Mac reduced the share of
less-liquid assets in its retained mortgage portfolio from 41 percent in
2016 to 34 percent in 2017, in part by selling $9.2 billion in unpaid
principal balance of private-label MBS and $8.2 billion of reperforming
loans. 58




56
   GAO, Fannie Mae and Freddie Mac: Analysis of Options for Revising the Housing
Enterprises’ Long-term Structures, GAO-09-782 (Washington, D.C.: Sept. 10, 2009).
57
  Reperforming loans are mortgages that were previously delinquent but are performing
again because payments on the mortgages have become current with or without the use
of loan modification.
58
 Most of the annual reductions in their retained mortgage portfolios were the result of
voluntary and involuntary prepayments. Much of the reduction in Fannie Mae’s own MBS
held in its retained mortgage portfolio came by selling the MBS or mortgages in the MBS
being paid off or delinquent mortgages being purchased out of MBS.




Page 35                                                     GAO-19-239 Housing Finance
Figure 9: Dollar Volume of Fannie Mae Retained Portfolio Assets and Portfolio Cap, 2003–2017




                                         Note: Other MBS includes mostly Freddie Mac and Ginnie Mae MBS. While under conservatorship,
                                         Fannie Mae must reduce the size of its retained mortgage portfolios to levels below an amount
                                         agreed upon in the senior preferred stock purchase agreement. Dollar amounts are nominal.




                                         Page 36                                                          GAO-19-239 Housing Finance
Figure 10: Dollar Volume of Freddie Mac Retained Portfolio Assets and Portfolio Cap, 2003–2017




                                         Note: Other MBS includes mostly Fannie Mae and Ginnie Mae MBS. While under conservatorship,
                                         Freddie Mac must reduce the size of its retained mortgage portfolios to levels below an amount
                                         agreed upon in the senior preferred stock purchase agreement. Dollar amounts are nominal.



Guarantee Fees                           Guarantee fees are the principal source of revenue for the enterprises
                                         and are intended to cover administrative expenses, expected costs that
                                         result from the failure of some borrowers to make their payments, and the
                                         cost of holding the modeled capital amount necessary (if the enterprises
                                         held capital) to protect against potentially large, unexpected losses in a
                                         severe stress environment. In March 2008, the enterprises modified their
                                         guarantee fees to include additional risk-based price adjustments to
                                         account for certain risk factors, including corresponding loan-to-value
                                         ratio and credit score. FHFA has made modifications to these fees and in
                                         2015, raised fees for factors such as loan purpose (for example, cash-out
                                         refinances and investment properties), and jumbo conforming loans. As
                                         we noted above, the enterprises are not permitted to retain capital against
                                         losses over a cap of $3 billion. Nevertheless, FHFA established



                                         Page 37                                                           GAO-19-239 Housing Finance
                       guarantee fee levels it deemed consistent with the amount of capital the
                       enterprises would need if they were not in conservatorship and could
                       retain capital.

Credit Risk Transfer   Under FHFA’s direction, the enterprises have transferred increasing
                       amounts of credit risk on their guaranteed MBS to the private market
                       since 2013. When the enterprises purchase mortgages and issue
                       guaranteed MBS, they retain the credit risk of those mortgages—that is,
                       they are exposed to potential losses if a borrower cannot pay back the
                       mortgage. The enterprises have transferred an increasing amount of
                       credit risk on some of the mortgages they guarantee through a variety of
                       credit risk transfer structures. According to FHFA, from 2013 through
                       June 2018, the enterprises cumulatively transferred a portion of the credit
                       risk on loans with an unpaid principal balance of $2.5 trillion through
                       these structures. 59 The amount of risk transferred varies by transaction.

                       According to a Congressional Research Service report, in these
                       transactions, the enterprises continue to guarantee their MBS, but they
                       transfer some of the credit risk to other private market entities to offset
                       some of the enterprises’ risk. 60 The private entity absorbs this portion of
                       credit risk (and possible losses should they occur) but is compensated for
                       doing so. According to FHFA, from 2013 through the second quarter of
                       2018, debt issuance structures have accounted for more than 70 percent
                       of the total amount of risk in force transferred through these programs. 61
                       According to FHFA and Federal Reserve staff reports, use of additional
                       structures has increased since 2013 and has allowed more diverse




                       59
                          In its Credit Risk Transfer Progress Report, FHFA refers to the amount of credit risk
                       transferred by the enterprises as risk in force. FHFA reported that the cumulative risk in
                       force on this amount was $81 billion, or 3.2 percent of the unpaid principal balance. They
                       also reported that as of mid-2015, actual loss rates for Freddie Mac varied from near 0 to
                       about 3.5 percent, peaking for mortgages originated in 2006 and 2007. See Federal
                       Housing Finance Agency, Credit Risk Transfer Progress Report (Washington, D.C.: Nov.
                       1, 2018); and Overview of Fannie Mae and Freddie Mac Credit Risk Transfer
                       Transactions, (Washington, D.C.: August 2015).
                       60
                          Sean M. Hoskins, FHFA’s Administrative Reform of Fannie Mae, Freddie Mac, and the
                       Housing Finance System, (Congressional Research Service, Washington, D.C.: July 7,
                       2016).
                       61
                        Debt issuance structures include Fannie Mae’s Connecticut Avenue Securities and
                       Freddie Mac’s Structured Agency Credit Risk.




                       Page 38                                                       GAO-19-239 Housing Finance
investors to participate in the mortgage credit risk market. 62 FHFA
establishes credit risk transfer objectives for the enterprises, which in
2017 were to transfer credit risk on at least 90 percent of the unpaid
principal balance of their single-family loans meeting certain criteria. 63
Both enterprises achieved this objective in 2017.

Under the debt issuance structure, the enterprises sell debt to investors
and receive the proceeds up front at the time of the sale. 64 Different
portions of debt are often issued for a given deal that corresponds to a
different loss position, and this can vary by each deal. The enterprises
repay the debt typically over a period of 10 to 12 years based on the
performance of a reference pool of mortgages, in which the investor
earns a higher return if the mortgages perform well and a lower return




62
  Other methods for credit risk sharing with private entities include insurance risk transfers
(Credit Insurance Risk Transfer and Agency Credit Insurance Structure), where the
enterprises pay reinsurance companies to take on some of the credit risk on pools of
mortgages the enterprises own; deeper mortgage insurance, where mortgage insurers
agree ahead of time to cover more losses than they currently agree to cover; front-end
collateralized lender recourse transactions (L Street Securities), where originating lenders
or aggregators retain a portion of the credit risk associated with the mortgages they sell to
the enterprises in exchange for a reduced guarantee fee charge on the loans from the
enterprises; and senior-subordinate securitization (Wisconsin Avenue Securities and
Whole Loan Securities), where subordinate tranches of MBS sold to investors are subject
to credit losses and senior tranches sold to investors are guaranteed repayment. The
enterprises also have multifamily credit risk transfer structures. See David Finkelstein,
Andreas Strzodka, and James Vickery, Credit Risk Transfer and De Facto GSE Reform,
Federal Reserve Bank of New York Staff Reports, No. 838, February 2018) and Federal
Housing Finance Agency, Credit Risk Transfer Progress Report, Fourth Quarter 2017
(Washington, D.C.: Mar. 29, 2017).
63
 Targeted loan categories in 2017 were single-family fixed-rate mortgages with loan-to-
value ratios greater than 60 percent and original term greater than 20 years, with some
exclusions.
64
   According to FHFA, these transactions are effectively fully collateralized by these
payments, meaning the enterprises essentially have no counterparty or reimbursement
risk with this structure.




Page 39                                                         GAO-19-239 Housing Finance
should they perform poorly. 65 According to FHFA, in 2017, the enterprises
moved generally to retaining the first 0.5 percent of losses in most debt
issuance transactions. 66 The enterprises retain all risk above the amount
transferred to investors (referred to as the detach point). 67 They also
retain 5 percent of the portions of debt sold to align their incentives with
those of investors. Figure 11 is an illustrative example of loss allocation
under a hypothetical debt issuance transaction with an attach point of 0.5
percent and a detach point of 4 percent.




65
   The total outstanding balance of the reference pool of mortgages underlying debt
issuance transactions is divided into different notes, called tranches, that have differing
levels of seniority. Borrowers’ scheduled and unscheduled principal payments on
mortgages in the reference pool are used to repay the most senior tranche still
outstanding at any given point, whereas losses on mortgages in the reference pool are
used to reduce the principal balance of the most subordinate tranche outstanding. The
amount of loss coverage investors provide is also reduced as borrowers repay their
mortgages. After the debt has matured, the enterprises would retain all remaining risk.
However, according to a Federal Reserve staff report, after 10 years the remaining
mortgages will generally have little remaining credit risk. Additionally, according to FHFA,
the average life of a pool of mortgages is less than 10 years. See Finkelstein, Strzodka,
and Vickery, Credit Risk Transfer and De Facto GSE Reform; and Federal Housing
Finance Agency, Overview of Fannie Mae and Freddie Mac Credit Risk Transfer
Transactions.
66
   According to FHFA, in 2015–2016, the enterprises started to transfer to investors a
portion of first losses on mortgage pools in their debt issuance transactions. Feedback
from market participants confirmed that selling the first 0.5 percent of losses is expensive
because investors know there will be some degree of expected credit losses for any
portfolio of mortgages regardless of economic circumstances. Based on this, the
enterprises moved generally to retaining the first 0.5 percent of losses in most
transactions.
67
  According to FHFA, one way to measure the amount of credit risk transferred can be the
difference between the attach and detach points on a transaction. For example, if the
attach point is 0.5 percent, the enterprise is responsible for credit losses up to 0.5 percent
of the unpaid principal balance of the loan pool. If the detach point is 4 percent, the
enterprise is responsible for credit losses above 4 percent of the loan pool. Credit losses
between the attach point of 0.5 percent and the detach point of 4 percent are the
responsibility of the investors in the credit risk transfer product, with the enterprises also
retaining some of this amount.




Page 40                                                         GAO-19-239 Housing Finance
Figure 11: Illustrative Example of Enterprises’ Loss Sharing Under a Debt Issuance
Credit Risk Transaction




Note: The level of loss refers to the share of credit losses as a percentage of the outstanding unpaid
principal balance of a pool of mortgages. Credit events in the reference pool reduce principal and
interest payments to private investors. Amounts and percentages are for illustrative purposes only
and can change or vary by transaction. The enterprises retain 5 percent of the portions of debt (and
potential associated losses) that are sold.


In the absence of specific capital requirements, these risk transfers can
act like capital by helping absorb losses on these pools during a financial
downturn. Several reports on credit risk transfer have considered losses
above the detach points of debt issuance transactions as those that might
occur only in a catastrophic economic event, similar to or exceeding the
2007–2009 financial crisis, especially given the improvement of




Page 41                                                               GAO-19-239 Housing Finance
underwriting standards compared to pre-crisis mortgages. 68 According to
a 2018 Federal Reserve staff paper, the enterprises’ current guarantee
fee revenues should be sufficient to cover their small first-loss position. 69
While guarantee fee revenues may be adequate to cover the enterprises’
first-loss position if they were retaining capital, each enterprise can retain
up to a maximum of $3 billion in capital while they are under
conservatorship. According to its quarterly financial statement, as of June
2018, Fannie Mae retained roughly $7 billion in outstanding first-loss
credit risk across debt issuance, insurance risk transfers, and lender-risk
sharing transactions. 70 According to its quarterly financial supplement, as
of June 2018, Freddie Mac retained nearly $6 billion in outstanding first-
loss credit risk in debt issuance, insurance risk transfer, and deep
mortgage insurance transactions. 71 Any losses on these amounts that
exceed the enterprises’ capital reserves would be borne by the federal
government.

The enterprises have transferred portions of the credit risk on higher
shares of their newly acquired mortgages, but the program remains
untested during stressful economic periods and could have limited
capacity for further growth. According to FHFA, mortgages targeted for
credit risk transfer have increased as a share of the enterprises’ total
acquisitions, from 41 percent in 2013 to 65 percent in 2017. FHFA
officials said the enterprises are also experimenting with how much first-
loss risk to sell and are beginning to target some loans originated in 2008
or prior for credit risk transfer. However, according to reports from Federal
Reserve staff and the Congressional Budget Office, efforts to further
expand credit risk transfer through these means may have mixed cost-
saving potential to the enterprises depending on economic



68
 See Congressional Budget Office, Transferring Credit Risk on Mortgages Guaranteed by
Fannie Mae or Freddie Mac (Washington, D.C.: Dec. 14, 2017); Laurie Goodman, Credit
Risk Transfer: A Fork in the Road (Washington, D.C.: Urban Institute, June 2018); and
Federal Housing Finance Agency, Overview of Fannie Mae and Freddie Mac Credit Risk
Transfer Transactions.
69
     See Transferring Credit Risk on Mortgages Guaranteed by Fannie Mae or Freddie Mac.
70
   Insurance risk transfers do not include private mortgage insurance, which is discussed in
the following section. See Federal National Mortgage Association Form 10-Q
(Washington, D.C.: Aug. 2, 2018).
71
 Freddie Mac, Second Quarter 2018: Financial Results Supplement (McLean, Va.: July
31, 2018).




Page 42                                                       GAO-19-239 Housing Finance
                            circumstances. 72 Additionally, mortgage investors and securitizers, and
                            researchers with whom we spoke told us credit risk transfer has been a
                            popular investment and an important tool for distributing risk. However,
                            they also said the market for credit risk may dry up during stressful
                            economic periods and leave the enterprises—and potentially taxpayers
                            while Treasury supports the enterprises—holding more risk.

Insurer Counterparty Risk   The enterprises have taken steps to enhance their counterparty
                            monitoring of private mortgage insurers under FHFA’s direction. The
                            enterprises’ charters require them to obtain some form of credit
                            enhancement, most commonly private mortgage insurance, on acquired
                            mortgages with loan-to-value ratios above 80 percent. 73 When losses
                            occur on these mortgages, private mortgage insurers are the first to take
                            losses, before credit risk transfer investors (if applicable) and the
                            enterprises. From 2013 through the first half of 2018, private mortgage
                            insurers provided $278 billion of insurance coverage on about $1.1 trillion
                            in unpaid principal balance on mortgages with high loan-to-value ratios.
                            The enterprises are responsible for any losses that might arise from the
                            default of a private mortgage insurer, making these insurers the
                            enterprises’ largest sources of counterparty risk.

                            FHFA and the enterprises updated eligibility requirements for private
                            mortgage insurers that do business with the enterprises by establishing
                            financial standards to demonstrate adequate resources to pay claims and
                            operational standards relating to quality control processes and
                            performance metrics. The changes, effective December 31, 2015, were
                            intended to help ensure stability of mortgage insurance companies that
                            are counterparties of the enterprises, reducing risk to the enterprises and
                            the federal government. 74 However, in 2018 the FHFA Office of Inspector
                            General identified the increasing insured volume and the concentration of
                            a few insurers—a total of six insurers as of 2017—with monoline business

                            72
                             See Finkelstein, Strzodka, and Vickery; and Transferring Credit Risk on Mortgages
                            Guaranteed by Fannie Mae or Freddie Mac.
                            73
                              Private mortgage insurance coverage is separate from credit risk transfer structures that
                            may involve insurance or reinsurance companies. Other forms of credit enhancement
                            include the seller agreeing to repurchase or replace the mortgage, or the seller retaining
                            participation in the loan.
                            74
                             The enterprises also updated eligibility requirements for private mortgage insurers in
                            September 2018. The revised eligibility requirements reflect changes to the financial and
                            operational requirements for the enterprises' mortgage insurance counterparties and
                            become effective on March 31, 2019.




                            Page 43                                                       GAO-19-239 Housing Finance
                         models in a cyclical housing market as risks to the enterprises’ private
                         mortgage insurance coverage.75 The Office of Inspector General also
                         found that the credit ratings for these insurers were lower than the
                         historical standards of the enterprises.

Foreclosure Prevention   Because mortgage defaults are the enterprises’ primary source of risk
                         exposure, one of the strategic goals of the conservatorship is to maintain
                         foreclosure prevention activities (such as permanent loan modifications,
                         modifications with principal forbearance, and short sales). Such activities
                         assist homeowners facing foreclosure and can reduce potential losses on
                         delinquent loans. According to FHFA data, as of the end of June 2018,
                         the enterprises have taken more than 4 million foreclosure prevention
                         actions since the start of the conservatorships in September 2008.
                         Additionally, FHFA and the enterprises extended the Home Affordable
                         Refinance Program (which allowed homeowners who owed as much or
                         more than their home was worth to refinance their home) through the end
                         of 2018. From 2009 through 2017, nearly 3.5 million qualifying
                         homeowners refinanced their mortgages through this program. In
                         December 2016, the enterprises also implemented a permanent loan
                         modification and mortgage assistance program. The program allows more
                         borrowers to qualify for a home retention solution, targets a 20 percent
                         reduction in monthly payments, and may reduce costs to the enterprises
                         associated with foreclosure.


Continued Treasury       Treasury’s remaining funding commitment through the senior preferred
Support Presents an      stock purchase agreements leaves taxpayers exposed to risk, especially
                         in the event of adverse market or other external conditions and
Ongoing Federal Fiscal
                         considering the recent growth in the enterprises’ guarantee business.
Exposure                 Total MBS outstanding guaranteed by the enterprises and held by
                         external investors has increased each year since 2012. As of the end of




                         75
                          A monoline is a business that focuses on operating in one specific financial area. Private
                         mortgage insurers limit their business activity to writing mortgage insurance and thus
                         cannot diversify to reduce risk. Because housing defaults are cyclical, such insurers may
                         be called upon to make massive insurance payments when defaults spike. See Federal
                         Housing Finance Agency, Office of Inspector General, Enterprise Counterparties:
                         Mortgage Insurers, WPR-2018-002 (Washington, D.C.: Feb. 16, 2018).




                         Page 44                                                       GAO-19-239 Housing Finance
                                        2017, the enterprises’ combined MBS outstanding held by external
                                        investors peaked at $4.8 trillion (see fig. 12). 76

Figure 12: Dollar Volume of Outstanding Fannie Mae and Freddie Mac Mortgage-Backed Securities Held by External Investors,
2003–2017




                                        Note: The enterprises hold some of their own mortgage-backed securities in their retained mortgage
                                        portfolios. These amounts are not included in this figure. Dollar amounts are nominal.


                                        Under the terms of the senior preferred stock purchase agreements with
                                        Treasury, Fannie Mae and Freddie Mac do not maintain a capital
                                        cushion—as a private financial institution would—to guard against the risk
                                        of unexpected losses such as those that might occur during a recession
                                        or downturn in the housing market. Instead, Treasury, through taxpayer
                                        funds, committed $445.6 billion of financial support to the enterprises. As
                                        of August 2018, Treasury had provided the enterprises with $191.4 billion

                                        76
                                          The enterprises hold some of their own MBS in their retained mortgage portfolios, which
                                        combined for an additional $181 billion at the end of 2017. Including their own MBS held in
                                        their retained portfolios, the enterprises combined had more than $4.9 trillion in MBS
                                        outstanding.




                                        Page 45                                                            GAO-19-239 Housing Finance
of the total amount since they were placed under conservatorship in
2008, leaving $254.1 billion in potential taxpayer exposure should
Treasury need to provide additional support. 77 In return, the enterprises
must pay to Treasury as dividends all of their quarterly positive net worth
amount (if any) over $3 billion. 78 Thus, any losses on this amount not
recovered through loss-mitigation efforts or covered by private investors
or insurers would be borne by taxpayers through additional financial
support from Treasury.

While private institutions could absorb a share of losses on mortgages
covered by credit risk transfer and private mortgage insurance (discussed
earlier in this section), any additional losses would come from Treasury’s
remaining funding commitment through the senior preferred stock
purchase agreements. Because of this arrangement, credit rating
agencies have linked the enterprises’ strong long-term credit ratings
directly to that of the U.S. government and their equity to Treasury’s
remaining funding commitment.

Since the second quarter of 2012, Fannie Mae and Freddie Mac have not
required additional support from Treasury, with the exception of the first
quarter of 2018, when both enterprises required Treasury support due to
devaluation of their deferred tax assets as a result of changes to the tax
code. 79 As of the end of September 2018, the enterprises had
cumulatively returned $285.8 billion to Treasury through senior preferred




77
  Results of 2018 stress tests (mandated by the Dodd-Frank Act) projected that the
enterprises likely would require additional Treasury draws in the event of an economic
downturn. Taxpayers could be exposed to some of these risks even absent an explicit
federal guarantee if the housing market were structured in such a way that an implicit
federal guarantee was expected in order to preserve financial stability.
78
   The enterprises previously were required to reduce their capital bases to $0 by January
2018, but in December 2017, FHFA raised this amount to $3 billion each to cover
fluctuations in income in the normal course of each enterprise’s business. In summer
2018, FHFA issued a proposed rule to establish enterprise risk-based and minimum
leverage capital requirements, but as proposed the rule would continue to be suspended
while the enterprises are under conservatorship.
79
   The reduction in the U.S. corporate income tax rate resulting from the enactment of the
Tax Cuts and Jobs Act on December 22, 2017, required that Fannie Mae and Freddie
Mac record a reduction in the value of their deferred tax assets during the fourth quarter of
2017. FHFA submitted a request to Treasury on behalf of Fannie Mae for $3.7 billion and
Freddie Mac for $312 million.




Page 46                                                        GAO-19-239 Housing Finance
                             stock agreement dividend payments. 80 However, in addition to economic
                             circumstances, changes in market conditions or other external factors—
                             such as changes in interest rates, house prices, accounting standards, or
                             events such as natural disasters—could lead to volatility in the
                             enterprises’ quarterly financial results, potentially requiring additional
                             taxpayer support.


Duration of                  The extended duration of the conservatorships continues to create
Conservatorships Leaves      uncertainty about the goals and future role of the enterprises. We
                             previously reported that FHFA’s priorities can shift, sometimes due to
Future Role of Enterprises   changes in leadership. 81 For example, FHFA initially outlined its
Uncertain and Presents       understanding of its conservatorship obligations and how it planned to
Challenges                   fulfill those obligations in a 2010 letter to Congress. In February 2012,
                             FHFA sent Congress a strategic plan that set three strategic goals for
                             conservatorship and elaborated on how FHFA planned to meet its
                             conservatorship obligations. However, under a new Director in 2014,
                             FHFA issued an updated strategic plan that reformulated its three
                             strategic goals. 82 This same Director’s term expired in early January
                             2019, and the process is underway for a new, permanent Director to be
                             confirmed. The upcoming change in leadership could shift priorities for
                             the conservatorships again and change enterprise goals. Continuing
                             conservatorship also presents challenges to FHFA, as it has to balance
                             its role as conservator with its role as regulator. FHFA must follow the
                             mandates assigned to it by statute and the missions assigned to the
                             enterprises by their charter. This entails consistently balancing governing
                             of the enterprises, ensuring they employ sound risk-management
                             practices, and ensuring they continue to serve as a reliable source of
                             liquidity and funding for housing finance.

                             In our interviews with experts and stakeholders, at least one expert or
                             stakeholder from each of the groups (mortgage originators, mortgage
                             securitizers and investors, academics and researchers, and consumer
                             80
                               In December 2011, Congress directed FHFA in the Temporary Payroll Tax Cut
                             Continuation Act of 2011 to increase the guarantee fees the enterprises charge lenders by
                             0.1 percentage points. The proceeds from this fee increase are remitted to Treasury at the
                             end of each quarter and are not a replacement for the reimbursement for the costs or
                             subsidy provided to the enterprises by the federal government. Pub. L. No. 112-78, § 401,
                             125 Stat.1288 (2011) (codified as 12 U.S.C. § 4547).
                             81
                                  GAO-17-92.
                             82
                                  GAO-17-92.




                             Page 47                                                      GAO-19-239 Housing Finance
advocates) also identified the duration of the conservatorships as a
challenge. For example, they said that the duration of the conservatorship
has led to a more substantial role for the enterprises than envisioned
when they were placed under conservatorship, which could make
potential changes to their structure more difficult to implement.

The duration of the conservatorships also has led to uncertainties in the
housing finance market. As we previously reported, under
conservatorship, the enterprises are subject to agency policy decisions
and are insulated from competition and other market forces. As a result,
according to several mortgage originators and securitizers, and consumer
groups with which we spoke, uncertainty about the future of the
enterprises also makes it challenging for them to develop their own
strategic plans and goals. They explained that they hesitate to make
longer-term strategic plans and goals due to potential housing finance
reform changes, particularly to the enterprises, that could markedly affect
their industries.

Additionally, the dominant role of the federal government in guaranteeing
MBS since the crisis has continued, and private capital generally has not
been positioned to absorb losses in the secondary mortgage market
during a potential economic downturn. The current structure of the
secondary mortgage market will continue to leave taxpayers at risk to
potential losses. The significant federal role in the housing market likely
will continue if the enterprises remain under conservatorship and without
a defined future role.




Page 48                                            GAO-19-239 Housing Finance
                            We assessed 14 proposals for housing finance reform against our
Reform Proposals We         framework to assess potential changes to the housing finance system.
Reviewed Aim to             The framework consists of nine elements we determined to be critically
                            important, such as recognition and control of federal fiscal exposure,
Manage Fiscal               protections for investors and borrowers, and clear goals (see the
Exposure, but Some          Background for more information). 83 We found that the proposals
                            generally aim to manage fiscal exposure—the risk the housing finance
Do Not Have Clear           system poses to the federal government and taxpayers—but only six
Goals or a System-          have clear goals and only seven consider other federal housing finance
                            entities, such as FHA or Ginnie Mae, in addition to the enterprises.
Wide Approach
Each Type of Reform         Reform proposals we reviewed generally fit into four different models: (1)
Proposal Has Strengths      reconstituted enterprises, (2) multiple guarantor, (3) government
                            corporation, or (4) privatization (termination of the enterprises). Based on
and Limitations
                            our review of the proposals, relevant literature, and expert interviews,
                            each model has potential strengths and limitations.

Reconstituted Enterprises   Four proposals we reviewed call for the enterprises to be recapitalized
                            and then released from conservatorship, retaining their federal charters.
                            Under these proposals, the enterprises would be regulated by an
                            independent regulator that would oversee their safety and soundness.
                            These proposals also recommend a federal guarantee on MBS under the
                            senior preferred stock purchase agreement or by legislation. To mitigate
                            fiscal exposure from the enterprises, the proposals include the
                            continuation of credit risk transfer programs, and also require the
                            enterprises to have risk-based capital reserves. In its report analyzing
                            alternative housing finance market structures, CBO reported that under
                            this model, taxpayers would have a higher exposure to risk compared
                            with the multiple-guarantor and privatization models. 84


                            83
                              GAO-15-131. The 14 proposals we reviewed (8 from Congress or federal agencies, 4
                            from industry groups, and 2 from think tanks) were all released or introduced from 2014
                            through September 2018. For a list of the proposals we reviewed, see appendix II.
                            84
                               Congressional Budget Office, Transitioning to Alternative Structures for Housing
                            Finance: An Update (Washington, D.C.: August 2018). For each alternative market
                            structure, CBO used an illustrative example to estimate the model’s impacts. Thus, CBO’s
                            estimated impacts may vary based on the specifics of the illustrative example. CBO also
                            estimated that during normal economic times, each model discussed in our report would
                            have little to no impact on mortgage interest rates, house prices, and the availability of 30-
                            year fixed-rate mortgages.




                            Page 49                                                         GAO-19-239 Housing Finance
According to industry stakeholders, potential strengths of this model
include feasibility, minimal market disruption, and the continuation of
policies familiar to key stakeholders. For example, one proposal argues
that its reforms could be completed under existing legal authority, with no
new legislation required. 85 Five primary market stakeholders in our panels
also stated that they would prefer a system similar to the current model
with minor reforms because larger changes might disrupt the market and
have unforeseen consequences. Industry stakeholders that rely on
specific policies of the enterprises also generally support a
recapitalization and release model. For example, four associations of
small lenders have released statements in support of reconstituting the
enterprises to ensure the continuation of the cash window. 86 In addition,
groups that advocate for financial inclusion and civil rights also have
expressed support for reconstituting the enterprises to ensure the
continuation of the affordable housing goals and other policies to help
low-income borrowers.

However, this model may not include sufficient safeguards to mitigate the
risk that the enterprises—even in a reconstituted form—could pose to the
stability of the mortgage market. As previously discussed, as of 2017, the
enterprises issue more than half of new MBS and, in our panels, two
participants from industry groups criticized the enterprises for their
expansion into other areas of the housing market. In 2018, a former
FHFA director stated in Congressional testimony that the enterprises
were more entrenched in the market than ever before, the market
depended entirely on them, and any weaknesses in their risk
management could disrupt the entire housing market. 87 If the enterprises
were recapitalized without sufficient safeguards, shareholders again
might have incentive to take on excessive risk.

85
  Moelis & Company LLC. Blueprint for Restoring Safety and Soundness to the GSEs
(June 2017).
86
  Through the cash windows, lenders can sell individual loans directly to the enterprises
and retain servicing rights. Community Home Lenders Association, Inc., CHLA GSE
Reform Plan (Arlington, Va.: Mar. 29, 2017); Community Mortgage Lenders of America,
CMLA Policy on GSE Reform: Time for Reform and Preservation (Washington, D.C.:
2016); Independent Community Bankers of America, ICBA Principles for GSE Reform and
a Way Forward (Washington, D.C.: 2017); and National Association of Federally Insured
Credit Unions, Housing Finance Reform Principles (Arlington, Va.: June 21, 2017).
87
 A Failure to Act: How a Decade without GSE Reform Has Once Again Put Taxpayers at
Risk, House Financial Services Committee, 115th Cong. (Sept. 6, 2018); statement of
Edward J. DeMarco, President, Housing Policy Council.




Page 50                                                     GAO-19-239 Housing Finance
                           To mitigate these concerns, two of the four proposals recommend that the
                           reconstituted enterprises operate as utilities. Utilities have a regulated
                           rate of return, which supporters say would limit profit-maximizing
                           motivations and encourage more prudential behavior and underwriting
                           standards. 88 The utility model is traditionally used in industries that tend to
                           operate as monopolies or near monopolies, such as the electric power
                           industry. Some industry experts believe that the securitization market
                           operates similarly to a monopoly. 89 Three industry stakeholders, two
                           researchers, and one participant from a consumer protection group we
                           interviewed also supported restructuring the enterprises as utilities.
                           Additionally, three industry groups representing small lenders endorsed
                           turning the enterprises into utilities. 90

Multiple-Guarantor Model   Six of the proposals we reviewed recommend transitioning to a system
                           with multiple guarantors operating in the secondary market. Under this
                           model, multiple private-sector firms would purchase eligible mortgages
                           and aggregate them into MBS. The MBS would be eligible for an explicit
                           federal guarantee if the guarantor arranged for private credit
                           enhancements to absorb a certain amount of loss and if it met certain
                           regulatory criteria, such as securitizing mortgages that comply with all
                           qualified mortgage standards. A federal agency—FHFA or a successor—
                           would charge and collect guarantee fees from the guarantors and set
                           capital requirements. The six proposals use the guarantee fees to fund a
                           mortgage insurance fund that would provide the federal guarantee.
                           According to CBO’s analysis, under this model, taxpayers would have
                           less exposure to risk compared with models for reconstituted enterprises
                           or a government corporation, but more than under a fully private market. 91


                           88
                             Another potential way to encourage safer underwriting practices would be to have the
                           reconstituted enterprises transition to cooperatives mutually owned by lenders. For more
                           information about these specific models, see Patricia C. Mosser et al., The Capital
                           Structure and Governance of a Mortgage Securitization Utility, Federal Reserve Bank of
                           New York Staff Reports, no. 644, (New York, N.Y.: October 2013) and GAO, The
                           Cooperative Model as a Potential Component of Structural Reform Options for Fannie
                           Mae and Freddie Mac, GAO-11-33R (Washington, D.C.: Nov. 15, 2010).
                           89
                              For example, see Mosser et al., and Andrew Davidson, “Four Steps Forward:
                           Streamline, Share Risk, Wrap, and Mutualize,” Housing Finance Reform Incubator
                           (Washington, D.C.: Urban Institute, July 2016).
                           90
                            Community Home Lenders Association, Inc., Community Mortgage Lenders of America,
                           and Independent Community Bankers of America.
                           91
                             Congressional Budget Office, Transitioning to Alternative Structures for Housing
                           Finance: An Update.




                           Page 51                                                      GAO-19-239 Housing Finance
Proposals within this model vary in a few key ways:

•    Enterprises: Four of the six proposals call for the enterprises to
     become guarantors in the new system, while two call for them to be
     put into receivership and replaced with successor entities. One of the
     proposals that would keep the enterprises recommends that they and
     other guarantors operate as utilities and another suggests the
     enterprises remain in the new system but transition to be mutually
     owned by lenders instead of shareholders.
•    Securitization: Three of the six proposals would retain the common
     securitization platform, while one proposal would rely on Ginnie Mae-
     approved issuers, allowing them to issue securities including
     mortgages that obtained credit enhancement from a private guarantor
     (instead of just federal programs). One proposal that retains the
     common securitization platform would convert the platform into a
     government corporation that issues securities from any regulator-
     approved entity. 92 The fifth proposal would rely on both Ginnie Mae
     issuers and the common securitization platform to issue securities.
     The sixth proposal does not specify an entity to issue securities.
•    Number of guarantors: Proposals vary in the number of guarantors
     needed in the new system. For example, the Mortgage Bankers
     Association’s proposal suggests having more than two guarantors,
     while Moody’s Chief Economist said in a congressional testimony that
     from five to seven would be feasible (using the private mortgage
     insurance industry as a guide). 93

The potential strengths of this model include the benefits arising from
competition and replacing reliance on two large firms with multiple smaller
guarantors. The Mortgage Bankers Association’s proposal stated that,
while subject to strong regulations, guarantors can compete on price,
products, and service. Multiple guarantors could provide lenders with a
variety of options to sell their loans, instead of just the enterprises. More


92
  The Congressional Research Service defines a government corporation as “an agency
of the federal government, established by Congress to perform a public purpose, which
provides a market-oriented product or service and is intended to produce revenue that
meets or approximates its expenditures.” Kevin R. Kosar, Federal Government
Corporations: An Overview, RL30365 (Washington, D.C.: June 8, 2011).
93                                                                            th
  Sustainable Housing Finance Part III, House Financial Services Committee, 115 Cong.
(Nov. 7, 2017); statement of Mark Zandi, Chief Economist, Moody’s Analytics; and
Mortgage Bankers Association.




Page 52                                                    GAO-19-239 Housing Finance
                         competition also could encourage innovation in the secondary market. 94
                         The secondary mortgage market also might reduce its reliance on two
                         “too-big-to-fail” entities with multiple guarantors. Because credit risk would
                         be more dispersed across a number of entities, the failure of one firm
                         would be less likely to disrupt the broader system, thus reducing the
                         likelihood the government would have to rescue a struggling firm.

                         According to four representatives of investor groups and a former HUD
                         official we interviewed, a potential limitation of the multiple-guarantor
                         model is that it could be difficult for new firms to enter the market and
                         compete with the enterprises. One proposal addresses this concern by
                         terminating the enterprises. However, if there are only a few guarantors,
                         the failure of any one firm could pose a systemic risk and might require
                         federal assistance. In addition, two researchers we interviewed said that
                         because the guarantors would operate in the same market and thus
                         would face the same market trends, having multiple guarantors might not
                         diversify risk. For example, in a financial crisis, it is possible that all the
                         guarantors would struggle and in such a scenario, the government would
                         have to assist many firms.

                         Some industry experts expressed concern that competition could have
                         negative consequences. We previously reported that leading up to the
                         financial crisis, the enterprises faced new competition from private-label
                         securitizers and, in the absence of strong federal oversight, they relaxed
                         their underwriting standards to regain market share. 95 Thus, two
                         researchers, four primary market stakeholders, and a former HUD official
                         we interviewed warned that a system dependent on competing entities
                         could face similar risks, particularly if oversight and regulation were not
                         strong. Five of the proposals we reviewed would require all guaranteed
                         securitized mortgages to meet qualified mortgage standards, limiting
                         potential reductions in underwriting standards, and one of the five also
                         would address this concern by regulating the guarantors as utilities.

Government Corporation   Two proposals would replace Fannie Mae and Freddie Mac with a single
                         government corporation that would issue MBS. For example, in one
                         proposal we reviewed, lenders would sell loans meeting certain
                         requirements (such as qualified mortgages) to the corporation, which
                         would operate the common securitization platform to issue MBS with a

                         94
                              Mortgage Bankers Association.
                         95
                              GAO-09-782 and GAO-15-131.




                         Page 53                                               GAO-19-239 Housing Finance
federal guarantee. The government corporation would manage fiscal
exposure by transferring credit risk to the private sector and through
capital requirements set by an independent regulator. The two proposals
also would use guarantee fees to fund a mortgage insurance fund that
would add an additional level of taxpayer protection. Based on its
analysis, CBO reported that under this model, taxpayers would have
more exposure to financial risk than under the multiple guarantor or
privatization models. 96

The potential benefits of a government corporation include stable lending
during financial crises, equitable lender access, and better targeting of
underserved groups. According to CBO, a government agency is more
likely than private actors to promote stable mortgage lending during
financial crises due to federal support. 97 Additionally, according to a
proposal by a think tank, a government corporation could provide lenders
of all sizes with equal access to securitization, potentially reducing
barriers to entry for new firms in the primary market. 98 We previously
reported that compared with other models, a government corporation
would be well-positioned to facilitate lending to targeted groups because it
does not have potentially conflicting priorities, such as maximizing
shareholder value. 99

Finally, a key benefit of creating a government corporation would be to
mitigate the potential challenges posed by relying on private-sector
entities (reconstituted enterprises, multiple guarantors, or a fully private
market). For example, we previously reported that as for-profit
corporations with government sponsorship, the enterprises had an
incentive to engage in potentially profitable but risky business practices,
in part because of the perception of an implied federal guarantee. 100 In
contrast, a government corporation would not be motivated by profit and

96
  Congressional Budget Office, Transitioning to Alternative Structures for Housing
Finance: An Update.
97
  Congressional Budget Office, Transitioning to Alternative Structures for Housing
Finance: An Update.
98
  Parrott et al. Previously, the enterprises offered discounted guarantee fees to lenders
that sold large volumes of loans, which favored larger lenders. In 2012, FHFA directed the
enterprises to take steps to reduce these disparities in guarantee fees.
99
     GAO-09-782.
100
      GAO-09-782.




Page 54                                                      GAO-19-239 Housing Finance
                thus should have less incentive to engage in potentially risky actions. The
                government corporation also could end reliance on a few large private
                firms by transferring securitization to a single entity in the public sector.

                There are potential limitations to relying on a government agency to
                support the secondary market. According to CBO, under this model, the
                government would still retain most credit risk and thus originators might
                not have a strong incentive to thoroughly vet borrowers’ credit risk, which
                could lead to potential losses. We also reported in 2009 that because of
                the limitations on government entities relative to private firms, a
                government corporation might have more difficulty in attracting and
                retaining capable staff, responding to market developments, or promoting
                innovation. If unaddressed, these issues could pose safety and
                soundness concerns because the agency might not have the skills and
                capabilities to assess risks and manage a complex industry. 101

Privatization   Two proposals we reviewed would terminate the enterprises and
                completely privatize the housing finance industry, with no federal
                guarantee on MBS. Under these proposals, the enterprises’ charters
                would be revoked and the enterprises would be wound down over a
                multiyear transition period during which their guarantee fees would
                increase and their loan limits decrease until they no longer guaranteed
                new mortgages. One proposal would keep the common securitization
                platform and make it available to all market participants, but it would
                operate as a nongovernmental entity and would be prohibited from
                guaranteeing MBS.

                The main benefit of this model would be to minimize fiscal exposure by
                having private firms form the secondary market for mortgages that are not
                federally insured, similar to the private-label MBS sector before the crisis.
                CBO noted that private actors should have a stronger incentive to control
                lending risk without a government backstop. Additionally, if a number of
                firms replaced the enterprises, then a largely private market likely would
                reduce the systemic risk of relying on a few large firms. 102




                101
                   GAO-09-782 and Congressional Budget Office, Transitioning to Alternative Structures
                for Housing Finance: An Update.
                102
                   Congressional Budget Office, Transitioning to Alternative Structures for Housing
                Finance: An Update.




                Page 55                                                       GAO-19-239 Housing Finance
                           However, a fully privatized market has some potential limitations related
                           to an implied federal guarantee, and credit availability. CBO reported that
                           although taxpayers’ would have less explicit exposure to risk compared to
                           the other models, risk exposure could be very high even without an
                           explicit guarantee. That is, the government likely would assist or prevent
                           the failure of private firms in an economic downturn to ensure financial
                           stability (also known as an implicit federal guarantee). We previously
                           reported that private-sector actors may benefit from an implicit guarantee
                           and this may incentivize firms to engage in potentially risky actions and
                           expose the government to potential losses. Additionally, privatizing the
                           market could increase fiscal exposure through FHA. The CBO report
                           noted that a privatized model could reduce the availability of credit to
                           marginal borrowers, and predicted it would lead to a large increase in
                           FHA-insured loans. A largely private market also might not sustain
                           mortgage lending during periods of economic stress. For example, the
                           private-label market largely disappeared after the 2007–2009 financial
                           crisis and has yet to recover, as previously discussed. Finally, CBO
                           reported that during a financial crisis, there could be large increases in
                           mortgage interest rates, large declines in house prices, and limited
                           availability of 30-year fixed-rate mortgages.


Proposals Generally Meet   The 14 proposals we reviewed generally meet the following elements of
Some Key Reform            our housing finance reform framework: recognizing and controlling federal
                           fiscal exposure, protecting mortgage investors, adhering to an appropriate
Elements
                           regulatory framework with government entities that have the capacity to
                           manage risks, emphasizing the implications of the transition to a new
                           housing finance system, protecting mortgage borrowers and addressing
                           market barriers, and considering market cyclicality and impacts on
                           financial stability. 103 Legislative proposals and those from other sources
                           generally address these elements in similar ways.

Fiscal Exposure and        Every reform proposal we reviewed attempts to recognize and control
Government Guarantee       federal fiscal exposure—the risk that the federal government and
                           taxpayers will have to provide financial support to the housing finance
                           system. Twelve of the 14 proposals we reviewed support an explicit
                           government guarantee on MBS. Some supporters of a federal guarantee
                           maintain that if the government were to support the mortgage industry in

                           103
                              See GAO-15-131 and the Background in this report for more information on the
                           elements of the framework.




                           Page 56                                                    GAO-19-239 Housing Finance
                           a crisis, then such support should be explicit, which will allow it to be
                           priced and reflected in the federal budget. In addition, every expert with
                           whom we spoke—including industry stakeholders, consumer advocates,
                           researchers, and former agency officials—supported an explicit
                           government guarantee on MBS. In 11 proposals, the federal guarantee
                           would be administered through a mortgage insurance fund managed by a
                           federal regulator and funded through guarantee fees.

                           To manage and limit fiscal exposure, the 12 proposals structure the
                           federal guarantee so that it would only be accessed after a certain
                           amount of private-sector loss. Private capital would be introduced through
                           increased, risk-based capital requirements for the enterprises, successor
                           entities, or new market entrants (such as guarantors). The proposals also
                           would continue to transfer credit risk to the private sector. These
                           proposals vary in how much private capital would be required ahead of
                           the government guarantee. For example, one proposal would require 10
                           percent but another proposal would require 5 percent. In its proposed rule
                           for enterprise capital requirements, FHFA reported that capital reserves of
                           about 5.5 percent would have covered the enterprises’ losses during the
                           financial crisis. 104 However, according to CBO, the initial increases in
                           capital requirements could increase mortgage interest rates. 105

                           The two proposals without an explicit federal guarantee aim to address
                           fiscal exposure by eliminating the enterprises and relying entirely on the
                           private sector. However, some industry experts have asserted that there
                           likely will always be an implied federal guarantee for the housing finance
                           market (even without the enterprises) as the federal government will not
                           allow the market to fail. These experts stated that they believe that this
                           guarantee should be explicitly recognized and accounted for in the federal
                           budget.

Protections for Mortgage   Thirteen of 14 proposals fully meet the element of providing protections
Securities Investors       for mortgage securities investors. We previously reported that investors
                           need to receive consistent, useful information to assess risks. 106 We also

                           104
                             Enterprise Capital Requirements, 83 Fed. Reg. 33312 (July 17, 2018). Before the
                           2007–2009 financial crisis, the enterprises were required to hold capital reserves of 2.5
                           percent for most assets (whole loans) and 0.45 percent for MBS outstanding.
                           105
                              Congressional Budget Office, Transitioning to Alternative Structures for Housing
                           Finance: An Update.
                           106
                                 GAO-15-131.




                           Page 57                                                        GAO-19-239 Housing Finance
                         reported that prior to the crisis, MBS investors may have lacked reliable
                         information to accurately assess the credit risk of their investments.
                         Twelve reform proposals we reviewed attempt to remedy these
                         weaknesses by first providing an explicit federal guarantee on MBS. In a
                         2017 testimony, a former FHFA Director said that a federal guarantee
                         signaled to MBS investors that they were protected from credit risk and a
                         meaningful segment of investors would not continue to invest in this
                         market without the guarantee. 107

                         In addition to the federal guarantee, proposals would aim to protect
                         investors in the following ways:

                         •      Increased transparency: Proposals recommend providing investors
                                with more information on the mortgages underlying MBS. If investors
                                had more information about asset quality, it would help them to more
                                accurately price risk. 108 For example, one proposal would require
                                market participants to make available to investors all documents
                                (including servicing reports) related to the mortgage loans
                                collateralizing the security.
                         •      Standard securitization platform: Currently, the enterprises each
                                have their own platforms to issue MBS and different rules governing
                                their MBS. To improve investor protections, FHFA and others
                                recommend a standard platform for issuing securities. As previously
                                discussed, FHFA has been developing such a platform, which will
                                result in a both enterprises issuing a uniform security.

Federal Regulators and   Twelve of 14 proposals emphasize an appropriate regulatory framework
Regulatory Framework     with federal regulators that have the capacity to manage risk. 109
                         Proposals generally recommend that an independent federal agency,
                         such as FHFA or a successor, regulate housing finance market
                         participants. The regulator also may oversee the securitization platform.
                         Three proposals that would expand Ginnie Mae recommend that Ginnie

                         107
                            Principles of Housing Finance Reform, Senate Committee on Banking, Housing, and
                                            th
                         Urban Affairs, 115 Cong. (June 29, 2017); statement of Edward J. DeMarco, President of
                         the Housing Policy Council.
                         108
                               GAO-15-131.
                         109
                            This section addresses two elements of the framework: adherence to an appropriate
                         financial regulatory framework and government entities that have capacity to manage
                         risks. We address them together because of the similarity in the information we gathered
                         from the proposals for each element.




                         Page 58                                                      GAO-19-239 Housing Finance
                               Mae become an independent agency to strengthen its counterparty
                               oversight capabilities.

                               The proposals also generally recommend that the regulator have risk-
                               management capabilities to determine market participants’ capital
                               requirements. The regulator also would be able to adjust these and other
                               requirements, such as credit risk transfer targets, based on market
                               circumstances. In 11 proposals, the regulator would set and collect
                               guarantee fees and use these fees to create a fund for mortgage
                               insurance that would act as the federal guarantee on MBS. However, we
                               previously noted that federal agencies sometimes have faced challenges
                               in accurately pricing risk in other insurance programs, such as deposit or
                               flood insurance. 110

Emphasis on the Implications   Eleven of the 14 proposals we reviewed fully consider the implications of
of the Transition              transitioning to a new system and mitigating potential disruptions.
                               Because transitioning to a new system could disrupt market operations
                               and consumers’ access to mortgage credit, we previously noted the
                               importance of a deliberate, well-defined transition. 111 In our expert panels,
                               participants from investor groups noted that unless there is a clear
                               transition plan (particularly one that addresses any changes to the
                               enterprises), it would be difficult for new market entrants and investors to
                               plan accordingly. The 11 proposals that meet this element include
                               multiyear transitions to help minimize disruption. For example, one
                               proposal that would eliminate the enterprises would allow for a 10-year
                               transition to a new fully privatized system and create a temporary federal
                               entity to oversee the transition.

                               Five primary market stakeholders and a representative from a consumer
                               advocacy group we interviewed emphasized the importance of minimizing
                               market disruption and maintaining market liquidity. These industry experts
                               noted that some parts of the system currently work well, and these
                               aspects should be maintained and transitioned in reform. The 11
                               proposals would transition the enterprises to the new market structure or
                               transition their personnel and facilities to successor entities.

                               One proposal that does not meet this element does not discuss transition
                               plans. Two other proposals do not fully meet this element because they

                               110
                                     GAO-15-131.
                               111
                                     GAO-15-131.




                               Page 59                                              GAO-19-239 Housing Finance
                                 do not address what would happen to the enterprises’ current assets,
                                 human capital, and intellectual property.

Protecting Mortgage Borrowers    Nine of 14 reform proposals explicitly address protections for mortgage
and Addressing Barriers to the   borrowers. The relevant policy mechanisms to protect mortgage
Mortgage Market                  borrowers include maintaining CFPB’s qualified mortgage and ability-to-
                                 repay rules, as well as additional services to support borrowers. For
                                 example, one proposal would increase support for programs that help
                                 prepare renters to become homeowners. Another proposal recommends
                                 modifying servicing guidelines for nonperforming loans to ensure
                                 consumers are treated fairly and would establish consistent procedures
                                 for servicers. The five proposals that do not fully meet this element do not
                                 address it at all or do not describe specific programs or policies.

                                 Eleven of 14 proposals explicitly address barriers to accessing the
                                 mortgage market. For example, eight proposals aim to maintain access to
                                 30-year fixed-rate mortgages, a key instrument for promoting access to
                                 homeownership. Eleven proposals would support funds dedicated to
                                 affordable housing, such as the Housing Trust Fund and Capital Magnet
                                 Fund, through fees on securitized loans. 112 Five proposals also would
                                 collect fees for a new Market Access Fund dedicated to increasing the
                                 number of families able to achieve homeownership and access credit.
                                 However, two proposals would eliminate the Housing Trust Fund.

                                 Proposals vary in their support of the enterprises’ affordable housing
                                 goals. Eight proposals call for the affordable housing goals to be
                                 eliminated and eight industry stakeholders we interviewed doubted the
                                 effectiveness of such goals, stating that homeownership should not be
                                 addressed through the secondary market. In 2009, we reported that there
                                 was limited evidence to support the effectiveness of the enterprises’
                                 affordable housing goals in supporting homeownership for the targeted
                                 groups. 113 However, affordable housing and consumer advocates we
                                 interviewed stated that they want to maintain the goals because they

                                 112
                                    The Housing Trust Fund—established by HERA, Pub. L. No. 110-289, § 1131, 122
                                 Stat. 2654, 2712—is a program to increase and preserve the supply of affordable housing
                                 for extremely low- and very low-income households, including homeless families. The
                                 Capital Magnet Fund was established through the same act to provide grants for
                                 programs that support affordable housing and economic development activities. Pub. L.
                                 No. 110-289 § 1131, 122 Stat. at 2723. The fee generally would be a number of basis
                                 points on conforming loans.
                                 113
                                       GAO-09-782.




                                 Page 60                                                    GAO-19-239 Housing Finance
                         believe that the goals improved access to credit for minority and low- to
                         moderate-income borrowers. Regardless of their position on the
                         affordable housing goals, we found that proposals with a federal
                         guarantee generally would require market participants to serve all eligible
                         borrowers in all markets to receive the guarantee.

                         Thirteen proposals also recommend policies that would promote small
                         lender access to the market, such as maintaining the enterprises’ cash
                         windows or creating a similar structure in their successors. Through the
                         cash windows, lenders can sell individual loans directly to the enterprises
                         and retain servicing rights. According to the Center for Responsible
                         Lending, keeping loan servicing within community-based financial
                         institutions often results in better loan performance and customer service
                         outcomes. 114 One former HUD official we interviewed stated that minority
                         communities are often served by smaller lenders and these lenders need
                         the cash window as a way to continue making affordable loans. Ten
                         experts in our panels—including housing advocates, primary and
                         secondary market participants, and researchers—said that reform plans
                         should give fair treatment to all lenders, regardless of size. 115

Market Cyclicality and   Nine of 14 reform proposals fully meet the element relating to
Financial Stability      consideration of the cyclical nature of the housing finance market and its
                         impact on financial stability. We previously reported that the housing
                         finance market is characterized by cyclical fluctuations and its market
                         cycles may pose risks to overall financial and economic stability because
                         housing is a significant part of the economy. 116 The five proposals that do
                         not fully meet this element do not address how the reformed system
                         would attempt to mitigate market cycles. We previously reported that
                         financial regulatory action or inaction can exacerbate housing finance
                         cycles, and thus reform proposals should consider the potential impact of
                         new regulations on market cyclicality. 117


                         114
                           Principles for Housing Finance Reform, Senate Committee on Banking, Housing, and
                                           th
                         Urban Affairs, 115 Cong. (June 29, 2017); statement of Michael D. Calhoun, President,
                         Center for Responsible Lending.
                         115
                            Before the financial crisis, the enterprises provided lenders that sold large volumes of
                         loans with discounted guarantee fees, but FHFA took steps to reduce these differences
                         under conservatorship.
                         116
                               GAO-15-131.
                         117
                               GAO-15-131.




                         Page 61                                                        GAO-19-239 Housing Finance
                         To mitigate market cycles, the nine proposals that meet this element
                         generally include policies that would allow the regulator to adjust
                         regulations based on market cycles. In one proposal, the regulator would
                         establish risk-based capital requirements for the enterprises or successor
                         entities and could adjust the requirements temporarily based on market
                         cycles. One proposal that would create a government corporation also
                         would allow the corporation to maintain a small portfolio to manage
                         distressed loans.


Some Proposals Do Not    Eight of the proposals we reviewed do not have clearly defined goals and
Have Clearly Defined     seven do not fully consider other entities in the housing finance system—
                         two key elements in our housing finance reform framework.
Goals or a System-Wide
Focus
Clearly Defined Goals    Eight of 14 proposals we reviewed do not have clearly defined goals for
                         the housing finance system, including four legislative proposals.
                         Additionally, none of the proposals prioritize their goals. Among the six
                         proposals with clearly defined goals, we identified some common goals,
                         such as minimizing the risk of taxpayer-funded bailouts, supporting
                         market liquidity, and maintaining a level playing field for lenders of all
                         sizes. We also identified different goals among the proposals, reflecting
                         differences in reform models. For example, proposals similar to the
                         multiple-guarantor model explicitly include market competition as a goal,
                         while a proposal for reconstituting the enterprises includes stable
                         transition as a goal.

                         As we reported in 2015, clearly defined and prioritized goals are a key
                         element to consider when assessing changes to the housing finance
                         system. Clear goals help guide agencies’ activities and establish
                         accountability. 118 Experts with whom we spoke also emphasized the
                         importance of clearly defined goals in housing finance reform proposals.
                         For example, one researcher said it would be difficult to discuss any
                         necessary policy changes until the government clearly articulated goals
                         for its role in the housing finance system.

                         Furthermore, prioritizing goals can help guide agencies’ actions and
                         provide clarity to market participants, particularly if there are conflicting


                         118
                               GAO-15-131.




                         Page 62                                                GAO-19-239 Housing Finance
                    goals. 119 For example, three proposals we reviewed include the goals of
                    both minimizing risks to taxpayers and promoting affordable
                    homeownership, but there is a trade-off between these goals—promoting
                    homeownership may mean encouraging lending to riskier borrowers.

                    As of early January 2019, Congress had not enacted legislation that
                    establishes clear and prioritized objectives for the future federal role in
                    housing finance. The lack of such goals in many of the proposals we
                    reviewed raises questions as to whether the proposals that Congress
                    may consider in the future will give adequate attention to these critical
                    elements of housing finance reform.

                    Without clearly defined and prioritized goals, agencies’ housing finance
                    activities may lack focus and consistency. We previously reported that
                    because Congress did not provide clearly defined and prioritized goals to
                    FHFA for conservatorship, each FHFA director has been able to shift
                    agency priorities within statutory requirements. 120 For instance, the first
                    FHFA director raised guarantee fees to encourage the return of private
                    capital to the MBS market, while the next director stopped the increase
                    out of concern for its effect on credit availability. Additionally, we reported
                    that FHFA’s shifting priorities for conservatorship contributed to
                    uncertainty among market participants. 121 Therefore, by identifying a
                    primary objective for housing finance reform, Congress would be better
                    positioned to determine appropriate steps and policies and provide clarity
                    to market participants.

System-Wide Focus   Seven of 14 proposals we reviewed—including proposed legislation—do
                    not consider if and how they would affect other federal entities in the
                    housing finance system, such as FHA and Ginnie Mae. 122 The proposals
                    that consider other federal entities include policies to help them manage
                    the effects of reform and ensure agencies’ policies are consistent with
                    overarching goals. For example, proposals that would expand Ginnie
                    Mae’s guarantee to include the enterprises’ market also recommend that
                    119
                          GAO-15-131 and GAO-17-92.
                    120
                          GAO-15-131.
                    121
                          GAO-17-92.
                    122
                       GAO-15-131. This section addresses our element “Policies and Mechanisms That Are
                    Aligned with Goals and Other Economic Policies.” We narrowed the focus of this element
                    to specifically focus on the extent to which proposals had a system-wide approach after
                    observing that a number of proposals focus solely on the enterprises.




                    Page 63                                                     GAO-19-239 Housing Finance
Ginnie Mae become an independent agency to better manage its
expanded role. Another proposal with the broad goal of reducing the
federal role in the mortgage market by terminating the enterprises also
aims to manage fiscal exposure through FHA by increasing its capital
reserve ratio from 2 to 4 percent. Finally, one proposal with a goal of
promoting market liquidity recommends that FHA should become an
independent agency to buttress its countercyclical role (that is, its ability
to provide credit availability across market cycles).

We previously reported that aligning policies and mechanisms with goals
is a key element of housing finance reform, and that reform should have a
comprehensive approach that considers all relevant entities. 123 A
comprehensive approach would help to promote consistency,
transparency, and reduce unnecessary overlap and duplication between
the enterprises and other federal entities.

As of early January 2019, Congress had not enacted legislation with a
system-wide approach to housing finance reform that considers the
enterprises and other federal entities. The lack of a comprehensive
approach in half of the proposals we reviewed highlights the need for
policymakers to consider these key elements when reforming the housing
finance system.

Housing finance reform that does not consider all federal entities or
participants may not account for how changes in the enterprises’ activities
could affect risk exposure of other federal entities. 124 For example, CBO
reported that transitioning to a fully private market likely would lead to
large increases in the volumes of loans insured by FHA. 125 Industry
experts with whom we spoke—including stakeholders from the primary
and secondary markets, researchers, and former agency officials—also
stated that any reforms to the enterprises must consider FHA too. Thus,
considering the impacts of potential reforms on other federal entities
would help ensure consistency and avoid unintended consequences.




123
      GAO-15-131.
124
      GAO-15-131.
125
   Congressional Budget Office, Transitioning to Alternative Structures for Housing
Finance: An Update.




Page 64                                                       GAO-19-239 Housing Finance
                  The enterprises have remained in conservatorship since 2008 (over 10
Conclusions       years), perpetuating uncertainty about their future and the federal role in
                  the housing finance market. Determining those future roles and the
                  enterprises’ structures has become both more urgent and more
                  challenging as federal fiscal exposures have grown and new risks
                  emerged in the housing finance markets (such as the growing role of
                  nonbank lenders and servicers). Congress and industry stakeholders
                  have introduced a number of proposals to reform the housing finance
                  system, including addressing the prolonged conservatorship of the
                  enterprises, but several proposals lack clearly defined and prioritized
                  goals or do not consider all relevant federal entities in the housing finance
                  system. By incorporating these key elements in future reform efforts,
                  Congress could facilitate a more focused and comprehensive transition to
                  a new housing finance system. Moreover, reform efforts that are both
                  focused and comprehensive could allow market participants to confidently
                  engage in long-term planning and help increase private-sector
                  participation in the markets.


                  Congress should consider legislation for the future federal role in housing
Matter for        finance that addresses the structure of the enterprises, establishes clear,
Congressional     specific, and prioritized goals and considers all relevant federal entities,
                  such as FHA and Ginnie Mae. (Matter for Consideration 1)
Consideration
                  We provided a draft of this report to FHFA, Treasury, and HUD for review
Agency Comments   and comment. FHFA provided a technical comment that we incorporated.
                  We also received technical comments from HUD and Treasury on
                  sections of the draft report, which we incorporated as appropriate. Further
                  comments on the full draft report from HUD and Treasury were not
                  available due to the partial government shutdown.




                  Page 65                                             GAO-19-239 Housing Finance
We are sending copies of this report to the appropriate congressional
committees and FHFA, Treasury, and HUD. This report will also be
available at no charge on our website at http://www.gao.gov.

Should you or your staff have questions concerning this report, please
contact me at (202) 512-8678 or garciadiazd@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. Key contributors to this report are listed in
appendix III.




Daniel Garcia-Diaz
Director, Financial Markets and Community Investment




Page 66                                              GAO-19-239 Housing Finance
Appendix I: Objectives, Scope, and
              Appendix I: Objectives, Scope, and
              Methodology



Methodology

              Our objectives in this report were to examine (1) recent developments in
              the housing and financial markets that could affect the safety and
              soundness of Fannie Mae and Freddie Mac, two government-sponsored
              enterprises (enterprises); 1 (2) risks and challenges that the ongoing
              conservatorships pose to the status and operations of the enterprises and
              other aspects of the housing finance system, and (3) housing finance
              reform options that have been proposed and their relative strengths and
              limitations.

              To examine trends in the housing market and assess related risks, we
              reviewed and analyzed data that we considered relevant to various
              aspects of risk and developments in the housing market. Specifically, we
              reviewed and analyzed:

              •   house prices from the Federal Housing Finance Agency (FHFA) and
                  Standard and Poor’s (a financial services company);
              •   mortgage delinquency rates from FHFA; the Board of Governors of
                  the Federal Reserve System (Federal Reserve); the Bureau of
                  Consumer Financial Protection, also known as the Consumer
                  Financial Protection Bureau (CFPB); and Inside Mortgage Finance (a
                  housing market data provider);
              •   mortgage origination and securitization data from Inside Mortgage
                  Finance, FHFA, the Mortgage Bankers Association, and the Securities
                  Industry and Financial Markets Association; and
              •   measures of underwriting standards from Fannie Mae, Freddie Mac,
                  the Department of Housing and Urban Development (HUD), and the
                  Senior Loan Officer Opinion Survey on Bank Lending Practices
                  (conducted by the Federal Reserve).

              We adjusted house prices for inflation using the Bureau of Labor
              Statistics’ Consumer Price Index and mortgage origination and
              securitization volume using the Bureau of Economic Analysis’s Implicit
              Price Deflator for gross domestic product to make dollar amounts
              reflective of real 2017 dollars.

              To further inform our assessment of these developments and risks, we
              reviewed prior GAO work on these issues. Specifically, we reviewed prior

              1
               We did not include the Federal Home Loan Bank System (also a government-sponsored
              enterprise) in our review because we specifically focused on Fannie Mae and Freddie
              Mac, and recent developments affecting their safety and soundness.




              Page 67                                                  GAO-19-239 Housing Finance
Appendix I: Objectives, Scope, and
Methodology




GAO work that identified and analyzed key national housing market
indicators, including house prices and loan performance, since the 2007–
2009 financial crisis. 2

To examine risks and challenges that conservatorship poses to the status
of the enterprises and other aspects of the housing finance system, we
reviewed FHFA reports and Fannie Mae and Freddie Mac financial
statements. Specifically, we reviewed progress reports and program
updates from FHFA regarding its credit risk transfer and foreclosure
prevention actions, and reviewed FHFA’s scorecard progress and other
FHFA reports (such as the 2017 Report to Congress), strategic plans,
and FHFA Office of Inspector General reports. For financial information
on Fannie Mae and Freddie Mac, we reviewed filings with the Securities
and Exchange Commission, quarterly financial supplements, and reports
from credit rating agencies. We also reviewed selected academic
literature that reported on risks and challenges identified in these sources
and the potential effectiveness of risk-mitigation efforts. We also reviewed
our prior work on the enterprises’ instability during the financial crisis. 3

We took a number of steps to assess the reliability of the data, including
interviewing agency officials; corroborating trends across data from
multiple sources that we analyzed for these two objectives; reviewing
related documentation; and reviewing relevant, prior GAO work. We used
data that had been collected for prior GAO reports and reviewed the data
reliability assessments that had been completed for those reports to
determine if the data were reliable for our purposes. Based on these
actions, we determined the data were sufficiently reliable to report on
recent trends in the housing market and developments under the
conservatorships of the enterprises.

To address our third objective, we reviewed 14 proposals proposed by
Congress, federal agencies, industry groups, or think tanks for reforming
the single-family housing finance system. We selected proposals for
review based on the following criteria:


2
 See GAO, Housing Finance System: A Framework for Assessing Potential Changes,
GAO-15-131 (Washington, D.C.: Oct. 7, 2014); and GAO, Mortgage Reforms: Actions
Needed to Help Assess Effects of New Regulations, GAO-15-185 (Washington, D.C.:
June 25, 2015).
3
 See GAO, Fannie Mae and Freddie Mac: Analysis of Options for Revising the Housing
Enterprises’ Long-term Structures, GAO-09-782 (Washington, D.C.: Sept. 10, 2009).




Page 68                                                  GAO-19-239 Housing Finance
Appendix I: Objectives, Scope, and
Methodology




•      Time frame: We selected proposals that were released from 2014
       through 2018.
•      Source of proposal: We selected proposals from the following
       sources: (1) Congress (either proposed legislation or discussion drafts
       by members), (2) federal agencies, and (3) industry groups or think
       tanks (limited to those that were discussed in congressional hearings).
       We excluded some proposed legislation that only would modify
       certain aspects of the conservatorships of the enterprises and did not
       contain broader reforms. For example, three proposed legislative acts
       would have amended the terms of the senior preferred stock purchase
       agreements but did not address other aspects of housing finance and
       thus we excluded them from our review. We also excluded documents
       that outlined principles and objectives for reform but did not include
       specific policies, such as reform principles documents that some
       industry and advocacy groups released.

We used elements of GAO’s framework for assessing potential changes
to the housing finance system to analyze the content and assess the
potential strengths and limitations of the reform proposals. 4 For each
element, we defined a series of responses to determine if the proposal
fully, partially, or did not meet the element and provided examples of
relevant policies for each element. Generally, a proposal fully met an
element if it described specific policies and programs relevant to that
element, partially met an element if it the element was addressed but the
proposal did not describe specific policies or programs relevant to it, or
did not meet an element if it did not address it at all. We also gathered
descriptive information on the policies and programs on which the
proposals relied.

We used the information we collected from the proposals to determine the
potential strengths and limitations of the proposals. We generally
considered a proposal’s strengths to be the elements it fully met and its
limitations to be elements that were partially met or not met. We did not
make an individual, overall determination about each proposal, but
instead examined whether each proposal fully considered key elements
of housing finance reform. For example, a proposal could have useful
ideas for reform but had yet to consider some key elements. Using this
information, we used the number of proposals that fully met each element
to determine which elements were most frequently met. We noted which

4
    See GAO-15-131.




Page 69                                               GAO-19-239 Housing Finance
Appendix I: Objectives, Scope, and
Methodology




elements were met least often to determine the gaps in the reform
proposals as a whole. We also grouped the individual proposals into the
different reform models. We determined the main reform models and their
potential strengths and weaknesses based on our review of the
proposals, prior GAO reports, Congressional Budget Office reports,
industry stakeholder reports, and information we obtained during panels
and interviews we conducted.

To address all three objectives, we convened four, 2-hour panels of
experts and stakeholders representing (1) mortgage originators and
insurers, (2) securitizers and investors, (3) consumer and affordable
housing advocates, and (4) researchers. We selected the experts and
stakeholders based on the extent to which they developed reform
proposals, testified before Congress on housing finance reform, or had
participated in prior GAO studies of housing finance issues. Each panel
had from three to five participants. In cases in which key experts or
stakeholders could not attend our discussion panels, we interviewed them
separately. We also interviewed officials at FHFA, HUD, and the
Department of the Treasury.

We conducted this performance audit from March 2018 to January 2019
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.




Page 70                                          GAO-19-239 Housing Finance
Appendix II: Housing Finance Reform
              Appendix II: Housing Finance Reform
              Proposals Reviewed



Proposals Reviewed

              For this report, we reviewed the following housing finance reform
              proposals released between 2014 and September 2018 (see appendix I
              for more information about how we selected the proposals):

              Legislative Proposals

              Bipartisan Housing Finance Reform Act of 2018 (discussion draft).
              Released by House Financial Services Chairman Jeb Hensarling,
              Representative John Delaney, and Representative Jim Hines on
              September 6, 2018.

              Housing Finance Reform and Taxpayer Protection Act of 2014 (S. 1217).
              Released by Senate Banking Committee Chairman Tim Johnson and
              Ranking Member Michael Crapo on March 16, 2014.

              Housing Opportunities Move the Economy (HOME) Forward Act of 2014
              (discussion draft). Released by House Financial Services Committee
              Ranking Member Maxine Waters on March 27, 2014.

              Mortgage Finance Act of 2015 (S. 495). Introduced by Sen. Johnny
              Isakson on February 12, 2015.

              Partnership to Strengthen Homeownership Act of 2014 (H.R. 5055).
              Introduced by Representative John Delaney on July 10, 2014.

              Protecting American Taxpayers and Homeowners Act of 2018 (H.R.
              6746). Introduced by House Financial Services Chairman Jeb Hensarling
              on September 7, 2018 (originally introduced on July 22, 2013).

              Proposals from Other Sources

              Bright, Michael, and Ed DeMarco. Toward a New Secondary Mortgage
              Market. Washington, D.C.: Milken Institute, September 2016.

              Federal Housing Finance Agency. Perspectives on Housing Finance
              Reform. Washington, D.C.: January 2018.

              Independent Community Bankers of America. ICBA Principles for GSE
              Reform and a Way Forward. Washington, D.C.: 2017.

              Moelis & Company LLC. Blueprint for Restoring Safety and Soundness to
              the GSEs. June 2017.



              Page 71                                          GAO-19-239 Housing Finance
Appendix II: Housing Finance Reform
Proposals Reviewed




Mortgage Bankers Association. GSE Reform: Creating a Sustainable,
More Vibrant Secondary Market. Washington, D.C.: April 2017.

National Association of Home Builders. Why Housing Matters: A
Comprehensive Framework for Reforming the Housing Finance System.
Washington, D.C.: September 2015.

Office of Management and Budget. Delivering Government Solutions in
the 21st Century: Reform Plan and Reorganization Recommendations.
Washington, D.C.: June 2018.

Parrott, Jim, Lewis Ranieri, Gene Spalding, Mark Zandi, and Barry Zigas.
A More Promising Road to GSE Reform. Washington, D.C.: Urban
Institute, March 2016.




Page 72                                          GAO-19-239 Housing Finance
Appendix III: GAO Contact and Staff
                   Appendix III: GAO Contact and Staff
                   Acknowledgements



Acknowledgements


                   Daniel Garcia-Diaz, 202-512-8678, or GarciaDiazD@gao.gov
GAO Contact
                   In addition to the contact named above, Karen Tremba (Assistant
Staff              Director), Tarek Mahmassani (Analyst in Charge), Miranda Berry, M’Baye
Acknowledgements   Diagne, Michael Hoffman, Risto Laboski, Melanie Magnotto, Marc Molino,
                   Matthew Rabe, Barbara Roesmann, Jessica Sandler, and Andrew
                   Stavisky made significant contributions to this report.




(102706)
                   Page 73                                        GAO-19-239 Housing Finance
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