find out why cbo was ranked one of the best places to work in the federal government
December 22, 2010
Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs)privately owned financial institutions that were chartered by the Congress four decades ago to fulfill a public mission: to provide a stable source of funding for residential mortgages across the country, including loans on housing for low- and moderate-income families. Fannie Mae and Freddie Mac have carried out those responsibilities by purchasing mortgages that meet certain standards from banks and other originators, and have financed those purchases by creating mortgage-backed securities (MBSs) and selling them to investors, or by issuing debt to fund mortgages and MBSs held in their portfolios. Those activities take place in the secondary mortgage market, which channels funds to borrowers by facilitating the resale of mortgages and mortgage-backed securities (MBSs).
The nationwide collapse of house prices and sharp rise in mortgage defaults threatened both the ability of the secondary mortgage market to continue functioning and the solvency of Fannie Mae and Freddie Mac; in September 2008 the federal government assumed control of those institutions. Now operating under federal conservatorship, Fannie Mae and Freddie Mac continue to play a central role in the secondary mortgage market: Last year the GSEs guaranteed three-quarters of new residential mortgages originated in the United States, and they hold or guarantee nearly 50 percent of the outstanding residential mortgage debt.
The cost to taxpayers of taking over Fannie Mae and Freddie Mac, and the structural weaknesses that contributed to the institutions financial problems, have prompted policymakers to consider various alternatives for the governments future role in the secondary (resale) market for residential mortgages. To provide a context for those options, CBO has prepared a study entitled Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market. That study examines the rationales that are often cited for federal involvement in the secondary mortgage market, the problems with Fannie Mae and Freddie Mac that existed before the recent financial crisis, and alternative approaches for the future of the secondary mortgage market.
Federal policies that affect the secondary mortgage market generally have two aims: helping to ensure a stable supply of financing for residential mortgages nationwide and providing assistance for mortgages on housing for low- and moderate-income families. Many of the governments efforts in pursuit of those goals operate by increasing the liquidity of mortgages and mortgage-backed securities. Ensuring that mortgage products can be readily bought and sold helps to broaden and stabilize the base of investors in the secondary market, which in turn modestly reduces the interest costs that mortgage borrowers face, particularly during periods of financial stress. However, federal support for the secondary mortgage market also entails costsincluding the transfer of risk from investors to taxpayers, a weakening of incentives to control risk, and encouragement to overinvest in housingwhich must be weighed against the potential benefits.
The model under which the two government-sponsored enterprises operated before federal conservatorship had major structural weaknesses. Those weaknesses included an implicit federal guarantee, which led to a concentration of market power in the two GSEs, risks to the stability of the larger financial system, and a lack of openness about costs and risks to the government. Weak regulation and goals for financing affordable housing allowed greater risk taking and may have contributed to those shortcomings. Furthermore, the policies directed at making housing more affordable appear to have provided only limited benefits to borrowers. Finally, an intrinsic tension existed in charging private companies with a public mission; the GSEs, their regulators, and policymakers struggled to find a balance among the competing goals of maximizing profits for shareholders, maintaining the entities safety and soundness, and fulfilling the entities public mission.
CBO examined a wide range of alternatives for the future structure of the secondary market that include:
- A hybrid public/private model in which the government would help ensure a steady supply of mortgage financing by providing explicit guarantees on privately issued mortgages or MBSs that met certain qualifications;
- A fully public model in which a wholly federal entity would guarantee qualifying mortgages or MBSs; or
- A fully private model in which there would be no special federal backing for the secondary mortgage market.
Those alternatives for the future of the secondary market involve different choices about whether the federal government should continue to guarantee payment on certain types of mortgages or MBSs and, if so, what the scope, structure, and pricing of those guarantees should be. The proposals also involve choices about support for affordable housing and the competitive structure and regulation of the secondary market. This study examines the trade-offs involved in making those key design choices and evaluates the strengths and weaknesses of the three broad approaches for the future of the secondary mortgage market.
CBOs analysis focuses primarily on the long-term strengths and weaknesses of the alternative approaches, not on the transition from the status quo to a new model. Transitional issuessuch as what to do with the existing portfolios and obligations of Fannie Mae and Freddie Macare important in their own right, but they are largely separate from the questions about the long-term future of the secondary mortgage market that are examined. However, if changes were made in the next few years, care would need to be taken not to disrupt the housing and mortgage markets further. Those markets remain fragile: The sharp decline in housing prices has left many homeowners owing more on their mortgages than their homes are worth, foreclosure rates are still high, and obtaining a mortgage continues to be difficult for many households.
This study was written by Deborah Lucas and David Torregrosa of CBOs Financial Analysis Division.