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

Since 2008, the federal government has greatly increased its role in financially supporting housing markets. In September 2008, FHFA placed Fannie Mae and Freddie Mac under conservatorship, which created an explicit fiscal exposure for the federal government. As of October 2018, the dollar amounts of their outstanding MBS have grown by more than $800 billion since the end of 2008.

Since 2013, GAO has designated the federal role in housing finance as a high-risk area. GAO examines (1) recent housing market developments, (2) risks and challenges posed by the current federal role, including ongoing conservatorship, and (3) housing finance reform proposals and their strengths and limitations.

To address these issues, GAO reviewed housing finance data; FHFA and enterprise reports; and 14 housing finance reform proposals introduced in Congress or proposed by industry stakeholders since 2014. GAO also convened panels with housing finance experts and stakeholders (including consumer advocates, mortgage originators, insurers, and investors), who developed reform proposals, testified before Congress, or participated in prior GAO studies.

Federal support of the housing finance market remains significant even though the market has largely recovered since the 2007–2009 financial crisis. While down from the peak in 2009, in 2017, the federal government directly or indirectly guaranteed about 70 percent of single-family mortgage originations.

The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)—two government-sponsored enterprises (enterprises) that purchase and securitize mortgages into mortgage-backed securities (MBS)—securitized and guaranteed about 46 percent of mortgage originations in 2017.

In 2017, federal programs, such as those offered by the Federal Housing Administration (FHA), insured about 25 percent of mortgage originations.

Together, the enterprises and the Government National Mortgage Association (Ginnie Mae)—a federally owned corporation that guarantees MBS backed by federally insured mortgages—have issued or guaranteed 95 percent or more of all MBS issued annually since 2008 (see figure).

However, recent market trends pose risks to these entities and the housing finance system. For example, mortgage lending standards have loosened slightly in recent years, which could increase the risk of borrower default—especially in a recession or downturn in the housing market—and losses to federal entities. Nonbanks have increased their presence in mortgage lending and servicing, which involves collecting monthly mortgage payments, among other duties. For instance, the share of nonbank originations of FHA-insured mortgages increased from 56 percent in fiscal year 2010 to 86 percent in 2017. The share of nonbank servicers of mortgages in enterprise MBS also grew from 25 percent in 2014 to 38 percent as of the third quarter of 2018. While nonbank lenders and servicers have helped provide access to mortgage credit, they are not subject to federal safety and soundness regulations.

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.

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.

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.

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.

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. 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. 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,  and market-related issues. In prior work, we developed a framework to  help assess potential changes to the housing finance system. 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;  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.

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. 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  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.

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).

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.

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. 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.

Federal Participation in the Housing Finance System

The federal government participates in the primary and secondary  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.

Congress chartered Fannie Mae and Freddie Mac as for-profit,  shareholder-owned corporations in 1968 and 1989, respectively. 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.

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.

HERA established authorities for providing capital support to the  enterprises and established FHFA as an independent regulatory agency  for the enterprises. HERA also authorized the Director of FHFA to  appoint FHFA as a conservator or receiver for the enterprises. 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.

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 Finance System and Our Framework for Considering Reform Proposals

Since the 2007–2009 financial crisis, Congress has taken steps to  improve regulation and consumer protection related to the housing  finance system. For example, to address challenges related to limitations  on mortgage information, HERA requires FHFA to collect market data.  The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd- Frank Act) created CFPB, which has undertaken a number of consumer  protection initiatives related to mortgage lending and servicing. 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  and think tanks also have published reform proposals. 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. 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).

Government Continues Significant Support of Housing Market but Recent Trends Present Risks to Enterprises and Others

The housing market has recovered since the financial crisis, with  significant federal support. Indicators of recovery include rising house  prices and declining mortgage delinquency rates. However, the federal  government has continued to support the housing market with guarantees  on more than two-thirds of new mortgages each year since 2008, either  through government-insured originations or by guaranteeing timely  payment to investors on mortgage loans purchased and securitized by  the enterprises. The government also has continued to play a very  substantial role in the secondary market, guaranteeing around 95 percent  or more of all MBS issued annually since 2008. But recent trends—some  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 Benefited from Housing Recovery but Government Still Supports a Majority of Mortgages

Several indicators demonstrate that the housing market has recovered  since the financial crisis of 2007–2009. For example, real national  average house prices have consistently risen each year since 2012 (see  fig. 2). The rise in house prices also has been complemented by  consistent economic growth, declining unemployment, and low mortgage  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.

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  for mortgages insured by FHA are higher on average than those  purchased by the enterprises but generally have followed similar trends.

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  since 2008. 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. 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. Federally insured and prime conforming  mortgages represented 80 percent or more of originations every year  since 2008.

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). 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. 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. 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.

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). Conversely, private-label MBS issuance since 2008 has  been minimal, as many private-label issuers left the market and nonprime  originations declined.

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  the enterprises. 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. 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 Housing Market May Present Risks and Challenges

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

Underwriting Standards and Borrower Credit Risk

Indicators of borrower credit risk and surveys of loan officers indicate a  loosening of underwriting standards in recent years. More specifically,  indicators of borrower credit risk for mortgages the enterprises purchased  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. 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. 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. The higher the loan- to-value ratio when a loan is originated, the less equity borrowers will  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. Additionally, house price valuation—measured by the price-to- rent ratio—has increased substantially since 2012 to levels last seen in  2004. 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.

Average credit scores for enterprise-purchased loans rose significantly  from their pre-crisis lows and remained historically high through 2012 but  have since slightly declined (see fig. 8). 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.

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.  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.  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.

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.

Our review found that the increased role of nonbank mortgage lenders  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.

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  frequent trading of mortgage servicing rights than banks. 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.

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  business with the enterprises. 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. 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.

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. 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.

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. 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. 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.

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. 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  areas, raising concerns about affordability. 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. 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.

Enterprises Have Expanded or Plan to Expand Activities That Could Present Challenges for Other Market Participants

Fannie Mae and Freddie Mac have taken actions in recent years that  could further increase the scope of their activities and present challenges  or barriers to entry for other market participants.

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  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.

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. The platform will support  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. (We discuss recent proposals to  reform the housing finance system in detail later in this report.)

FHFA Has Taken Actions to Reduce the Enterprises’ Exposure, but Risks, Uncertainty, and Challenges Remain FHFA Has Taken Actions to Reduce the Enterprises’ Risk Exposure

FHFA-directed actions (including retained mortgage portfolio reductions,  credit risk transfer, and foreclosure prevention) have improved the  condition of the enterprises by mitigating some of the enterprises’  exposures to potential losses.

Continued Treasury Support Presents an Ongoing Federal Fiscal Exposure

Treasury’s remaining funding commitment through the senior preferred  stock purchase agreements leaves taxpayers exposed to risk, especially  in the event of adverse market or other external conditions and  considering the recent growth in the enterprises’ guarantee business.  Total MBS outstanding guaranteed by the enterprises and held by  external investors has increased each year since 2012. As of the end of  2017, the enterprises’ combined MBS outstanding held by external  investors peaked at $4.8 trillion (see fig. 12).

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  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. In return, the enterprises  must pay to Treasury as dividends all of their quarterly positive net worth  amount (if any) over $3 billion. 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. As of the end of September 2018, the enterprises had  cumulatively returned $285.8 billion to Treasury through senior preferred  stock agreement dividend payments. 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 Conservatorships Leaves Future Role of Enterprises Uncertain and Presents Challenges

The extended duration of the conservatorships continues to create  uncertainty about the goals and future role of the enterprises. We  previously reported that FHFA’s priorities can shift, sometimes due to  changes in leadership. For example, FHFA initially outlined its  understanding of its conservatorship obligations and how it planned to  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. 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  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.

Reform Proposals We Reviewed Aim to Manage Fiscal Exposure, but Some Do Not Have Clear Goals or a System- Wide Approach

We assessed 14 proposals for housing finance reform against our  framework to assess potential changes to the housing finance system.  The framework consists of nine elements we determined to be critically  important, such as recognition and control of federal fiscal exposure,  protections for investors and borrowers, and clear goals (see the  Background for more information). We found that the proposals  generally aim to manage fiscal exposure—the risk the housing finance  system poses to the federal government and taxpayers—but only six  have clear goals and only seven consider other federal housing finance  entities, such as FHA or Ginnie Mae, in addition to the enterprises.

Each Type of Reform Proposal Has Strengths and Limitations

Reform proposals we reviewed generally fit into four different models: (1)  reconstituted enterprises, (2) multiple guarantor, (3) government  corporation, or (4) privatization (termination of the enterprises). Based on  our review of the proposals, relevant literature, and expert interviews,  each model has potential strengths and limitations.

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.

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. 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. 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. If the enterprises  were recapitalized without sufficient safeguards, shareholders again  might have incentive to take on excessive risk.

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. 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. 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.

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.

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. 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).

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  competition also could encourage innovation in the secondary market.  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. 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.

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 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.

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. 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. 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.

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. In  contrast, a government corporation would not be motivated by profit and  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.

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.

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 Some Key Reform Elements

The 14 proposals we reviewed generally meet the following elements of  our housing finance reform framework: recognizing and controlling federal  fiscal exposure, protecting mortgage investors, adhering to an appropriate  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. Legislative proposals and those from other sources  generally address these elements in similar ways.

Fiscal Exposure and Government Guarantee

Every reform proposal we reviewed attempts to recognize and control  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  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. However, according to CBO, the initial increases in  capital requirements could increase mortgage interest rates.

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 Securities Investors

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

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. 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 Regulatory Framework

Twelve of 14 proposals emphasize an appropriate regulatory framework  with federal regulators that have the capacity to manage risk.  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  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.

Emphasis on the Implications of the Transition

Eleven of the 14 proposals we reviewed fully consider the implications of  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. 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 do not address what would happen to the enterprises’ current assets,  human capital, and intellectual property.

Protecting Mortgage Borrowers and Addressing Barriers to the Mortgage Market

Nine of 14 reform proposals explicitly address protections for mortgage  borrowers. The relevant policy mechanisms to protect mortgage  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. 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. However, affordable housing and consumer advocates we  interviewed stated that they want to maintain the goals because they  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. 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.

Market Cyclicality and Financial Stability

Nine of 14 reform proposals fully meet the element relating to  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. 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.

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 Have Clearly Defined Goals or a System-Wide Focus

Eight of the proposals we reviewed do not have clearly defined goals and  seven do not fully consider other entities in the housing finance system— two key elements in our housing finance reform framework.

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. 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  goals. 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. 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. 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.

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. 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  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. 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. 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. 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.

The enterprises have remained in conservatorship since 2008 (over 10  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  finance that addresses the structure of the enterprises, establishes clear,  specific, and prioritized goals and considers all relevant federal entities,  such as FHA and Ginnie Mae. (Matter for Consideration 1)

We provided a draft of this report to FHFA, Treasury, and HUD for review  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.

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.

Appendix I: Objectives, Scope, and 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); (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  GAO work that identified and analyzed key national housing market  indicators, including house prices and loan performance, since the 2007– 2009 financial crisis.

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.

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:

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. 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  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.

Appendix II: Housing Finance Reform 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):  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).

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.

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.

Appendix III: GAO Contact and Staff Acknowledgements

In addition to the contact named above, Karen Tremba (Assistant  Director), Tarek Mahmassani (Analyst in Charge), Miranda Berry, M’Baye  Diagne, Michael Hoffman, Risto Laboski, Melanie Magnotto, Marc Molino,  Matthew Rabe, Barbara Roesmann, Jessica Sandler, and Andrew  Stavisky made significant contributions to this report.

Fannie Mae and Freddie Mac issue mortgage-backed securities, which let lenders use investor cash for mortgage loans. When people default on the mortgages backing these securities—as many did in the 2007–2009 financial crisis—these issuers can take a hit.

So, in 2008, the federal government took control of Fannie Mae and Freddie Mac—leaving taxpayers on the hook for any potential losses.

This led to several housing finance reform proposals. Of the 14 proposals we reviewed, some lacked clear goals or didn't consider other federal players in the housing finance market—which we think Congress should consider including.