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Federal Mortgage Brokering

September 27, 2018
Since the Great Recession in 2008, the federal government has taken conservatorship of two major home mortgage providers, Freddie Mac and Fannie Mae. In order to reestablish market stability, these two firms were converted from wholly private entities into government-sponsored enterprises (GSEs) under the conservatorship of the Federal Housing Administration (FHA). In return for being under public stewardship, the GSEs are required to make annual contributions to the Housing Trust Fund and Capital Magnet Fund to support FHA activities and offset costs for things like affordable housing mandates.[1]

Freddie Mac and Fannie Mae were originally exempt from these payments in 2008, but in 2015 the FHA reversed this action, arguing that they were finally in good enough financial health to make these contributions. Since 2015, the two GSEs have made a combined $498 million in contributions into the two funds and have sold a combined $187 billion of “senior preferred stock” to the Treasury which have paid dividends of over $279 billion to date.[2] With the backing of the federal government, these GSEs have dominated private mortgage providers and aggregators and, with the support of the FHA, they have collectively steered the housing market and broadened their portfolios. Proponents of free enterprise have generally been skeptical of this growth in the GSEs’ purview, but policy discussions on the future of the FHA and the housing market broadly have to grapple with the tradeoffs between fostering broad homeownership rates and protecting against a repeat of the 2008 housing bubble.

Skeptics of the FHA’s expanded role in the housing market point out that GSEs have inflated their role in setting the direction of the housing market because they are backed by government fiat. Even national organizations within the housing sector like the Mortgage Bankers Association have called for the Federal Housing Finance Agency, a branch of the FHA, to increase transparency in its decision-making and to limit its activities to those of public interest. They claim that the FHFA manage the entire housing market through the GSEs and push private sector investors toward the margins in the housing market. Since the 1990s, but increasingly after taking hold of Freddie Mac and Fannie Mae in 2008, the FHA has pushed outward from its traditional role in the secondary housing market, and has begun to operate in the primary housing market as well.[3] Mortgage loans originated in the primary market, usually by a private bank or credit union for a small fee. In the secondary market, mortgage aggregators purchase mortgages from originators and aggregate them into mortgage-backed securities (MBS), which reduce the individual risk of each individual mortgage. GSEs like Freddie Mac and Fannie Mae have traditionally dominated the secondary mortgage market as a way of guaranteeing their payout, but now they are making expansionary efforts in the primary market as well. This expansion, stemming from the 1990s, includes programs like the FHA’s affordable housing mandates, public-private partnerships on primary, and the easing of regulations on maximum loan-to-value and debt-to-income limits on primary loans, all of which interfere with private lenders in the market.[4]

Image: Real Home Price Index, 1975-2015, Source: Urban InstituteImage: Real Home Price Index, 1975-2015, Source: Urban Institute

The preferred status of Freddie Mac and Fannie Mae under the conservatorship of the federal government has allowed the two to compete in a quasi-market where, in competing with one another in both the primary and secondary loans market, they are incentivized to take on risky mortgages insured by taxpayer dollars. Freddie Mac announced on April 2018 that it would disperse more mortgages with a down-payment of only 3% in order to compete with the low rates of both Fannie Mae and the FHA itself. Altogether, because the two GSEs and the FHA comprise of roughly 80% of mortgage guarantees, this spurs a tradeoff between the positive effects of allowing more Americans access to mortgage loans, and the rise of home prices due to increased borrowing at low down payments. Based on data compiled by the American Enterprise Institute, home prices have risen 28% since 2012 after having rebounded from the skyrocketed prices before the Great Recession in 2008.[5]

Image: Conforming Loan Limit Heat Map, Source: Federal Housing Finance AgencyImage: Conforming Loan Limit Heat Map, Source: Federal Housing Finance Agency

Moreover, this access to easy loans for high-risk borrowers was a major factor in fueling the same sort of housing bubble in 2008 that caused the entire market to crash. Ten years after the Great Recession, the same housing arms race is occurring, albeit the actors are under conservatorship of the federal government and the guarantee of taxpayer dollars. Policy solutions to troubleshoot a potential repeated housing bubble tend to favor measures that reinstate a former policy of the FHA that required at least 5% down on 30-year mortgages sponsored by the federal government, and 3.5% down on private mortgages.[6] These reforms seek to protect both American taxpayers who carry the risk for insuring GSE mortgage-backed securities and the private homebuyer who is able to garner artificially-guaranteed loans from GSEs at sub-market rates.

Image: Only 1 in 10 GSE dollars went to buyers of more modest homes, Source: National Council of State Housing AgenciesImage: Only 1 in 10 GSE dollars went to buyers of more modest homes, Source: National Council of State Housing Agencies

Another policy proposal to curb the burgeoning power of the FHA lies within the congressional authority to limit the credit value of conforming loans, or loans that the FHA is able to purchase in order to aggregate in the secondary housing market.[7] GSEs are restricted to purchasing loans from private lenders under a maximum loan limit that is defined by Congress and itemized to an annual housing price index by the FHA. The standard maximum loan limit is $453,100, though it can extend over $680,000 in the most expensive markets like New York City and San Francisco.[8] Between Freddie Mac and Fannie Mae, approximately 16% of their aggregated loan value go to well-off, first-time buyers with credit scores in the misd-700s that seek loans for homes over $250,000. Similarly, 26% of loans go to repeat homebuyers, 7% go toward purchasing second homes, and a full 30% of GSE loans go toward refinancing existing mortgages. Thus, only 6.5% of GSE spending on loan purchases goes toward the targeted populations that the FHA is meant to serve and, according to proponents of reform, the vast majority goes toward homebuyers who would be served well by private mortgage originators.

Given the expansion of the federal government’s involvement in mortgage markets, much of congressional and academic solutions to the FHA’s mission to “Stabilize credit markets in times of economic disruption” and “Operate with a high degree of public and fiscal responsibility” involves drawing back the FHA’s own influence in the market and renewing a focus on protecting low-income and first-time homebuyers like it was formed to do. While FHA mortgage guarantees ultimately encourage lenders to offer loans to first-time and low-income homebuyers who are seen as risky to insure, it is still the fiduciary duty of the FHA to protect the American housing market from another housing bubble before government-sponsored enterprises become ‘too big to fail.’

 

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  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Penn Wharton Public Policy Initiative’s strategies, recommendations, or opinions.

 

References

  [1]http://www.crs.gov/Reports/IF10851?source=search&guid=b96757867bca4323985dceb214d97186&index=6

  [2]http://www.crs.gov/Reports/IF10851?source=search&guid=b96757867bca4323985dceb214d97186&index=6

  [3]http://www.aei.org/publication/fhfa-needs-to-curb-fannie-and-freddies-insatiable-appetites/

  [4]http://www.aei.org/publication/fhfa-needs-to-curb-fannie-and-freddies-insatiable-appetites/

  [5]http://www.aei.org/publication/the-government-creates-another-housing-bubble/

  [6]http://www.aei.org/publication/the-government-creates-another-housing-bubble/

  [7]https://www.fhfa.gov/DataTools/Downloads/pages/conforming-loan-limits.aspx

  [8]https://www.ncsha.org/wp-content/uploads/2018/03/NCSHA-Pinto-Legislative-Conference-03.05.18.pdf

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