Since I took a look at Fannie Mae and Freddie Mac for The American Interest late last year, the future of both agencies has remained uncharted by Congress. My piece offered a brief history of the Depression-era birth of Fannie Mae and its younger thrift-inspired sibling, Freddie Mac. For much of that history, these government-sponsored enterprises, or GSEs, were the key buyers and sellers of residential mortgage investments in an era of few market participants. The GSEs were needed because an earlier form of government support to housing finance—primarily FHA mortgage insurance or VA loan guarantees—was insufficient by itself to ensure the smooth functioning of a secondary mortgage market in residential loans. There was need for an intermediary that could buy and sell residential mortgage investments. The GSEs played that role.Until 1968, Fannie Mae operated within the U.S. Department of Housing and Urban Development (HUD) and predecessor agencies. A legislative change in 1968 removed Fannie Mae from direct Federal control to allow it to conduct operations as a profit-seeking, congressionally chartered corporation. Freddie Mac received a similar legislative authorization a few years later, chartered initially to buy and sell home loans originated by thrifts. Unlike private companies, Fannie Mae and Freddie Mac were able to engage in business with a credit line drawn from the U.S. Treasury. This mixed structure gave rise to the term “government sponsored enterprise.” As my original piece explored in greater depth, mission creep and missteps by the GSEs did not occur with any regularity until passage of The Federal Housing Enterprises Financial Safety and Soundness Act of 1992. Mismanagement combined with insufficient capital and too many liabilities turned the GSEs into a financial accident waiting to happen.1 Then the housing bubble burst. The GSEs didn’t have the capital to absorb the losses associated with skyrocketing loan delinquencies and plunging values in their mortgage investments, but it was not until the summer of 2008 that Congress enacted legislation that could respond to a potential insolvency of the GSEs. A few weeks later, the GSEs became subject to a conservatorship authorized by the new legislation. The Federal Housing Finance Agency (FHFA), the regulator of the GSEs, served as conservator. At the start of the conservatorship on September 6, 2008, the combined amount of debt and guaranteed mortgage-backed securities of the GSEs was $5.4 trillion— the same amount of all publicly held debt of the United States, according to the FHFA. The conservatorship that started in 2008 remains in effect for each GSE, with a U.S. Treasury credit line available to cover operations as needed. At the end of 2009, the U.S. Treasury was compelled to remove any cap on its extension of credit to the GSEs to ensure that operations, as approved by FHFA, could continue. The most recent estimate by FHFA of Federal support of the GSEs exceeds $180 billion, with more than $150 billion paid to fund GSE operations. In a recent written strategic plan delivered to Congress for the GSEs, FHFA conceded that the losses of the GSEs are of such magnitude that the GSEs cannot repay taxpayers “in any foreseeable scenario.” Given the dismal chance of recovery of Federal payments made to the GSEs during the conservatorship, the economic substance of the “credit” extended to the GSEs by the U.S. Treasury looks more like an off-budget outlay of funds. Evidently, the House of Representatives agrees with this characterization: H.R. 3581, passed by the House in February 2012, requires Federal outlays to the GSEs to be included in any presidential or congressional budget. H.R. 3581 has been referred to the Senate Committee on the Budget for consideration. H.R. 3581 is one of the few congressional reactions to the now three-year GSE conservatorship. There have also been other missed legislative opportunities during this period. Congress enacted Dodd-Frank to prevent another financial crisis like the one in 2008; included in that goal was preventing the failure of key financial institutions. But despite the fact that the GSEs are at the heart of U.S. residential mortgage lending and caused one of the costliest financial failures born by the taxpayers to date, Dodd-Frank made no provisions for resolution of GSE conservatorship, whether through a liquidation plan or otherwise. The GSEs were also conspicuously absent from a $25 billion settlement announced by the Federal Government and 49 State Attorneys General in February 2012 with major U.S. residential mortgage lenders. The settlement responds, in part, to certain abusive practices in residential lending. The GSEs were reported to have engaged in comparable abusive practices but were not subject to the terms of the settlement because they were not parties to the settlement. Of the Federal agencies, only the SEC has brought suit against certain former GSE officials for understating to investors the level of high-risk subprime mortgages purchased by the GSEs before the housing bubble burst. It appears that the Federal Government is just now catching up to an accurate accounting of the risky mortgage investments of the GSEs—a key contributor to their failure. A topic of active debate in recent months has been whether Wall Street was the primary source of risky mortgage lending (through subprime and alt-A lending); or whether the affordable housing produced by the GSEs, as required by the 1992 Act, was the largest component of risky mortgage lending in the run-up to the financial crisis. So large was the dollar volume of the risky GSE mortgages by some estimates that it is argued to have been the major driver of the housing bubble.2 With private residential mortgage markets still in recovery at this point in time, FHFA estimates that the source for about three of every four residential mortgage originations continues to be the GSEs. The other key Federal housing vehicle is Federal Housing Administration-insured mortgage financing securitized as mortgage-backed securities guaranteed by the Government National Mortgage Association (Ginnie Mae). Both FHA and Ginnie Mae conduct operations within HUD and provide insurance or guarantees, as applicable, that carry the full faith and credit of the United States. Most FHA single-family insurance programs have been self-funded from mortgage insurance premiums paid by borrowers since the passage of the National Housing Act in 1934.3 FHA’s mortgage origination niche for decades has been low down payment loans subject to low mortgage limits— a sliver of the residential mortgage market, most often occupied by first-time home buyers. Until legislative changes in 2008, the maximum FHA loan limit for a single-family residential property in a low-cost area was 48 percent of the conventional or “conforming” loan limit of the GSEs. For a high-cost area, the maximum FHA loan limit was 87 percent of the conforming loan limit. As a result of the 2008 changes, the FHA maximum limit in a low-cost area was moved up to 65 percent of the conforming loan limit. But the most important change in 2008 was made to the FHA maximum loan limit in a high-cost area. This maximum loan limit jumped to 175 percent of the conforming loan limit, subject to a maximum of $729,750. This limit was scheduled to drop to $625,500 (generally 150 percent of the conforming loan limit) for FHA and the GSEs on October 1, 2011. However, late in 2011, Congress restored the $729,500 maximum loan limit only for FHA. As Congress expanded the role of FHA single-family origination to cover a larger share of the residential mortgage market in the aftermath of the housing bubble, FHA insurance fund reserves have thinned due to increases in loan defaults and lender claims for FHA insurance benefits. To the extent permitted by Congress, FHA responds like any other insurance company when claims are higher than expected: It raises premiums to cover unexpected losses. FHA has raised mortgage insurance premiums more than once over the past several months to cover increased losses. The GSEs, now in competition with FHA for originations, lack a credit or budgetary constraint comparable to FHA. Perhaps this is why Congress has taken the small step of permitting higher maximum loan limits in high-cost areas solely for FHA mortgages, to support a fragile housing market. Given the increased risk of default for higher loan balance loans, FHA has implemented a special mortgage insurance premium increase for loans that exceed $625,500. In providing a written strategic plan to Congress for a “story that needs an ending”, FHFA identified three goals as conservator of the GSEs:
- building a new infrastructure for the secondary mortgage market;
- gradually contracting GSE operations to reduce the dominant presence of each GSE;
- maintaining foreclosure prevention activities and mortgage credit availability.
This three-pronged approach is a sensible plan to steer the GSEs through conservatorship and is consistent with a one-year-old report from the U.S. Treasury on GSE policy options. At the present, the only missing ingredient is the legislative will to budget the Federal outlays needed to implement these three goals, as well as legislative amendments to provide FHFA the authority it needs to scale back GSE operations when appropriate and liquidate GSE portfolios when favorable pricing is available in the capital markets. For example, to reduce the number of GSE originations as housing fundamentals improve, Congress could delegate to FHFA the authority to lower the maximum loan limits for the GSEs based upon specified criteria. The start-up of certain portfolio liquidation activities by FHFA also might be advisable at this point in time; some mortgage investments owned by the GSEs consist of FHA or other agency investments that could be sold at high prices in the current low interest rate environment. FHFA could initiate auction procedures now even if it is still years away from liquidating the vast majority of GSE assets.After more than three years of conservatorship and billions of dollars spent outside the Federal budget on the GSEs, it is time for Congress to stop ignoring the GSEs. They are the unresolved casualty of the financial crisis. It is time for Congress to authorize the winding down of the GSEs, however slow and painful a process this may be. 1For an in-depth look at the people and events that were at the root of the GSE financial collapse, Gretchen Morgenson and Joshua Rosner have written the book Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon. 2For example, see the dissenting statement of Peter J. Wallison in the Financial Crisis Inquiry Report produced by the U.S. Financial Crisis Inquiry Commission. 3Ginnie Mae’s guarantee program typically is profitable for the Federal government, because its timely payment guarantee is provided for mortgages already insured or guaranteed under another Federal program.