United States General Accounting Office

GAO Testimony

Before the Subcommittee on Capital Markets,

Securities and Government Sponsored Enterprises,

Committee on Banking and Financial Services,

House of Representatives

For Release on Delivery

Expected at

10:00 a.m., EDT

on Thursday

July 30, 1998

FEDERAL HOUSING

ENTERPRISES

HUD’s Implementation of

Its Mission Oversight Needs

to Be Strengthened

Statement of Nancy Kingsbury

Assistant Comptroller General

General Government Division

GAO/T-GGD-98-177

Summary 

Federal Housing Enterprises: HUD’s

Implementation of Its Mission Oversight

Needs to Be Strengthened

In a recently issued report, GAO assessed the Department of Housing and

Urban Development’s (HUD) implementation of its housing mission

oversight responsibilities for Fannie Mae and Freddie Mac-(the

enterprises)-the two largest government sponsored enterprises. GAO found

that HUD had adopted a conservative approach to setting housing goals that

require the enterprises to purchase mortgages serving low- and

moderate-income borrowers and those who live in central cities and rural

areas (targeted groups). GAO also identified several weaknesses in HUD’s

enterprise housing mission oversight activities that need to be addressed.

Among its other provisions, the Federal Housing Enterprises Financial

Safety and Soundness Act of 1992 required HUD to develop numeric

housing goals for the enterprises to promote housing opportunities for

targeted groups. In 1995, HUD adopted a conservative approach to setting

the final housing goals for 1996 through 1999 that placed a high priority on

maintaining the enterprises’ financial soundness. HUD’s final housing goals

represented a modest increase in the enterprises’ existing commitment to

targeted mortgage purchases and are not expected to generate significant

financial losses, even during periods of severe economic stress. During

1996 and 1997, both enterprises complied with the housing goals.

GAO also recommended that HUD take the following actions to strengthen

its housing mission oversight:

1. Develop and implement a program to assess the accuracy of the

enterprises’ reported housing goal compliance data.

2. Conduct further research to determine the extent to which the

implementation of the housing goals is promoting housing opportunities.

For example, determine whether the housing goals have provided

mortgage lenders with incentives to lower mortgage interest rates for

targeted groups.

3. Implement a process and obtain the necessary expertise to ensure that

the enterprises’ sophisticated financial activities are consistent with their

housing mission.

Finally, GAO recommended that HUD estimate the costs of its mission

oversight requirements and consider proposing to Congress that the

enterprises bear these costs to help ensure effective oversight.

Page 1 GAO/T-GGD-98-177
Statement 

Federal Housing Enterprises: HUD’s

Implementation of Its Mission Oversight

Needs to Be Strengthened

Mr. Chairman and Members of the Subcommittee:

We are pleased to be here today to discuss the Department of Housing and

Urban Development’s (HUD) housing mission oversight of the two largest

government-sponsored housing enterprises: the Federal National Mortgage

Association and the Federal Home Loan Mortgage Corporation (the

enterprises). HUD has a basic oversight responsibility to ensure that the

enterprises’ mortgage purchase activities serve the credit needs of all

Americans and that the enterprises’ financial activities are consistent with

their housing mission.

In 1992, Congress concluded that HUD’s regulatory framework had not

been effective in ensuring that the enterprises’ activities benefit low- and

moderate-income Americans and those who live in underserved areas,

such as central cities and rural communities (targeted groups).

Consequently, Congress passed the Federal Housing Enterprises Financial

Safety and Soundness Act of 19921

 (the 1992 Act). The 1992 Act required

HUD to develop, implement, and enforce a comprehensive housing mission

regulatory framework established by Congress. Among other provisions,

the 1992 Act directed HUD to set housing goals, which require the

enterprises to meet specified criteria each year for the purchase of

mortgages serving targeted groups.

At your request, we recently issued a report2

 on HUD’s implementation of

its enterprise housing mission oversight responsibilities under the 1992

Act. We concluded that (1) HUD adopted a generally conservative approach

in 1995 to setting the final enterprise housing goals for 1996 through 1999

that placed a high priority on maintaining the enterprises’ financial

soundness, and (2) Fannie Mae and Freddie Mac were in compliance with

the final housing goals in 1996 and 1997, according to data the enterprises

submitted to HUD. We also concluded that there are several weaknesses in

HUD’s mission oversight that need to be addressed. Specifically,

• HUD has not implemented a program to assess the accuracy of the

enterprises’ housing goal-compliance data;

• HUD’s research agenda does not address several issues necessary to fully

understand the extent to which the housing goals promote housing

opportunities; and

1

P.L. 102-550, Title XIII, 106 Stat 3672 (1992).

2

Federal Housing Enterprises: HUD’s Mission Oversight Needs to Be Strengthened (GAO/GGD-98-173,

July 28, 1998).

Page 2 GAO/T-GGD-98-177
Statement 

Federal Housing Enterprises: HUD’s

Implementation of Its Mission Oversight

Needs to Be Strengthened

• HUD has not yet fully implemented a process under its general regulatory

and new mortgage program approval authorities to ensure that the

enterprises’ financial activities are consistent with their housing mission.

Congress Has

Established a

Comprehensive

Enterprise Housing

Mission Regulatory

Framework

Under their federal charters, the enterprises are responsible for serving

the secondary mortgage market credit needs of targeted groups. The

enterprises also receive benefits from their relationship with the federal

government to assist in meeting their housing mission. The most important

of these benefits allows the enterprises to borrow money at lower interest

rates than comparable private corporations. Given their federal charters

and financial benefits, Congress concluded in the 1992 Act that the

enterprises had a responsibility to reach out and meet the credit needs of

targeted groups. Thus, the act directed the HUD Secretary to develop

numeric housing goals for each enterprise in the following three

categories:

• housing for low- and moderate-income3 families;

• housing located in central cities, rural areas, and other underserved areas;

and

• special affordability goals that target mortgage purchases serving

very-low-income and low-income families living in low-income areas.

The 1992 Act also defined HUD’s general regulatory and new mortgage

program4

 approval authorities. HUD has the general regulatory authority to

ensure that the enterprises’ activities are consistent with their housing

mission. HUD also has the authority to review new mortgage programs

proposed by the enterprises to ensure that the programs are consistent

with the enterprises’ charters and not contrary to the public interest.

3

The government defines households whose incomes do not exceed an area’s median family income as

moderate income and households whose incomes do not exceed 80 percent of an area’s median family

income as low income. The government defines households whose income does not exceed 60 percent

of an area’s median family income as very-low income.

4

The 1992 Act defines a “new mortgage program” as being significantly different from programs that

have been approved, or that represent an expansion, in terms of the dollar volume or number of

mortgages or securities involved, of programs previously approved.

Page 3 GAO/T-GGD-98-177
Statement 

Federal Housing Enterprises: HUD’s

Implementation of Its Mission Oversight

Needs to Be Strengthened

HUD’s Approach to

Setting the Final

Enterprise Housing

Goals Was

Conservative

The 1992 Act provided the HUD Secretary with the authority to set the final

housing goals. When setting the final housing goals for 1996 through 1999,

the HUD Secretary adopted a conservative approach that emphasized

protecting the enterprises’ financial soundness. The enterprises are

reportedly in compliance with the goals, but HUD has not taken sufficient

steps to verify the reported data.

HUD Set Conservative

Housing Goals

The 1992 Act established six general, but potentially competing, factors to

guide the HUD Secretary’s decisionmaking process in setting the final

housing goals. In particular, the 1992 Act directed the HUD Secretary to

balance (1) the ability of the enterprises to “lead the [mortgage finance]

industry” in financing the mortgages of targeted groups and (2) the need to

maintain the enterprises’ financial soundness. These factors may be in

competition with one another because requiring the enterprises to

significantly increase their purchases of targeted mortgages could result in

additional credit losses.5

During our work, we found that HUD had adopted a conservative approach

to setting the final housing goal rule that placed a high priority on

maintaining the enterprises’ financial soundness. The following

summarizes our findings:

• HUD defined the term “lead the industry” to mean that the enterprises

should provide technical and financial assistance to mortgage lenders to

encourage additional mortgage lending to targeted borrowers, rather than

adopting alternative definitions that could have required the enterprises to

substantially increase their targeted mortgage purchases; and

• HUD and the Office of Federal Housing Enterprise Oversight (OFHEO)—an

independent HUD office responsible for ensuring the financial soundness of

the enterprises—conducted research that found that the required targeted

mortgage purchases under the final housing goals were modest and would

not materially affect the enterprises’ financial condition.

Table 1 provides HUD’s housing goals for 1996 through 1999. We note that

HUD set the goals below HUD’s estimates of targeted mortgage lending that

was already occurring in the primary mortgage market.

5

Credit losses result from borrower defaults and associated foreclosure expenses.

Page 4 GAO/T-GGD-98-177
Statement 

Federal Housing Enterprises: HUD’s

Implementation of Its Mission Oversight

Needs to Be Strengthened

Table 1: Enterprise Housing Goals for

1996-1999 and HUD’s Estimates of

Primary Market Shares. Percentage goala

Goal category 1996 1997-1999

Estimated

originations in

primary marketb

Low- and moderate-income 40% 42% 48-52%

Underserved areas 21 24 25-28

Special affordability 12 14 20-23

aHUD’s goals are based on the number of dwelling units financed by enterprise-targeted

mortgage purchases as a percentage of the total dwelling units financed through mortgage

purchases. Assuming an enterprise purchased mortgages containing 1 million dwelling units in a

particular year, and that 400,000 of these units qualified under the low- and moderate-income

goal, the enterprise’s goal compliance would be 40 percent (400,000/1,000,000).

bIn 1995, HUD estimated the percentage of dwelling units financed by targeted mortgages

originated by banks, thrifts, and mortgage bankers in the primary mortgage market for each

housing goal.

Source: HUD.

Enterprise Targeted

Mortgage Purchase

Activity Increased

Between 1993 and 1997

According to annual data that Fannie Mae and Freddie Mac provide to HUD,

the enterprises have increased their share of targeted mortgage purchases

since 1993 and were in compliance with the final housing goals in 1996 and

1997 (see table 2). Fannie Mae’s performance under the housing goals has

generally exceeded that of Freddie Mac.

Table 2: Enterprise Mortgage

Purchases Under the Affordable

Mortgage Housing Goals, 1993-1997

Goal Category Enterprise 1993 1994 1995 1996 1997

Low- and

moderate- income

households Fannie Mae 34.1% 45.1% 42.8% 45.1% 45.5%

Freddie Mac 30.0 38.0 39.6 41.3 42.9

Underserved areas Fannie Mae 22.9 29.0 31.2 28.2 29.0

Freddie Mac 21.3 24.2 25.2 25.0 26.3

Special affordable Fannie Mae 10.0 16.7 15.8 17.4 19.1

Freddie Mac 7.2 11.4 13.2 14.2 15.3

Source: HUD.

HUD’s housing goals may have contributed to the enterprises’ reported

increases in targeted mortgage purchases. However, other factors, such as

a generally growing U.S. economy, favorable mortgage interest rates, and a

strong housing market also likely played a role.

Page 5 GAO/T-GGD-98-177
Statement 

Federal Housing Enterprises: HUD’s

Implementation of Its Mission Oversight

Needs to Be Strengthened

HUD Has Not Verified the

Enterprises’ Goal

Compliance Data

HUD has implemented some limited procedures to verify the accuracy of

the enterprises’ reported goal compliance data. However, HUD has not

implemented a program to assess the overall data collection and reporting

process. Given the decentralized nature of the housing goal data and the

resulting potential for error, it may therefore not be possible for HUD at this

time to independently draw conclusions about the accuracy of the data. In

our report,6

 we recommend that HUD—consistent with available

resources—develop and implement a program to assess the accuracy of

the goal compliance data.

HUD’s Research

Agenda Does Not

Address Several

Issues That Are

Essential to

Understanding the

Goals’ Effects

HUD has a basic oversight responsibility to try to determine the extent to

which the housing goals are meeting the intent of the 1992 Act (i.e.,

promoting housing affordability and opportunities for targeted groups).

Such research is essential for HUD to determine the appropriate levels at

which to set the housing goals in the future. HUD has ongoing research to

assess the goals’ effects, but the research agenda does not fully address

several essential issues, such as the goals’ effects on mortgage terms for

targeted groups and the multifamily mortgage finance market.

HUD Research Does Not

Assess Goals’ Effects on

Mortgage Loan Terms

HUD’s reported data on the enterprises’ compliance with the housing goals

are input measures that show the annual volumes of the enterprises’

targeted loan purchases. The reported data do not provide information on

the extent to which the enterprises’ increased purchases are resulting in

increased home ownership and housing opportunities for targeted groups.

Currently, HUD has a variety of research projects—in-house, contract, and

grant—to assess a range of issues that address the impacts of the goals.

For example, in September 1997, HUD awarded 11 research grants totaling

about $400,000 to study the mortgage purchase activities of the

enterprises.

However, HUD’s research agenda does not address the extent to which the

housing goals provide lenders with incentives to make mortgage credit

more affordable to targeted groups. For example, in theory, the additional

liquidity associated with increased enterprise purchases to meet the

housing goals should lower lenders’ costs on qualifying loans, which then

can be passed on in the form of lower mortgage interest rates. We

recommend in our July 28 report that HUD include in its research agenda

6

GAO/GGD-98-173, July 28, 1998.

Page 6 GAO/T-GGD-98-177
Statement 

Federal Housing Enterprises: HUD’s

Implementation of Its Mission Oversight

Needs to Be Strengthened

the effect of the housing goals on mortgage interest rates and other loan

terms for targeted groups.

HUD Has Not Adequately

Analyzed Multifamily

Purchase Activities

For an enterprise that is not in compliance with the housing goals, HUD’s

final goal rule may provide regulatory incentives, especially with regard to

multifamily housing, to employ risk-management strategies to help the

enterprise meet or exceed the numeric goals. However, the possible

enhancing effects of these risk-management strategies on housing

opportunities for targeted groups are not clear. Under the rule, the

enterprises are permitted to count multifamily mortgage purchases toward

full compliance with the goals where the mortgage originator—such as a

bank or thrift—is required to cover most or all estimated future losses that

may occur due to borrower defaults. One reason that the enterprises

employ these risk-management strategies is that multifamily mortgage

purchases are considered riskier than single-family mortgage purchases.

According to HUD, these risk-management strategies encourage the

enterprises to participate in the multifamily mortgage market, promote

liquidity, and are necessary to protect the enterprises’ financial soundness.

However, there is also available information that suggests that the

enterprises’ risk-management strategies involve offsetting trade-offs that

may serve to limit lenders’ incentives to originate affordable multifamily

mortgages. For example, by requiring lenders to retain most or all of the

expected credit risks, the enterprise risk management strategies could

limit the lenders’ willingness to extend mortgage credit. By contrast, when

the enterprises purchase single-family mortgages, they generally relieve

the lenders of the associated credit risks, which has encouraged the

development of a liquid, secondary market for single-family mortgages. We

recommend in our report that HUD conduct further research on enterprise

risk-management strategies and their effects on multifamily mortgage

finance and housing opportunities.

HUD Lacks Focus and

Expertise as a

Financial Regulator

Although HUD’s staff have significant expertise in housing and related

issues, we have identified weaknesses in HUD’s capacity and focus as a

regulator of financial institutions. We note that Congress reached similar

conclusions when it passed the 1992 Act. The fact that HUD’s enterprise

oversight budget is financed through congressional appropriations of

taxpayer dollars rather than assessments on the enterprises may be one

reason for HUD’s lack of focus on financial regulatory issues.

Page 7 GAO/T-GGD-98-177
Statement 

Federal Housing Enterprises: HUD’s

Implementation of Its Mission Oversight

Needs to Be Strengthened

HUD Did Not Act in a

Timely Manner to Monitor

Enterprise Nonmortgage

Investments

In our March 1998 report,7 we found that HUD had not used its general

regulatory authority provided under the 1992 Act until 1997 to ensure that

the enterprises’ nonmortgage investment practices were consistent with

their housing mission. We pointed out that such oversight by HUD is

important because the enterprises have incentives to use the funding

advantage associated with their federal sponsorship to make nonmortgage

investments that may result in arbitrage profits.8

HUD did not act on its general regulatory authority until 1997 when a public

controversy erupted over the fact that Freddie Mac had invested in

long-term Phillip Morris corporate bonds. In 1997, HUD initiated a process

to oversee the enterprises’ nonmortgage investments, which has the

potential to ensure more effective oversight. However, HUD has not yet

fully implemented this process, and we believe it should continue to do so

as expeditiously as possible.

HUD Lacks Expertise in

Financial Products

Since the passage of the 1992 Act, HUD has approved the four enterprise

new mortgage programs that have been proposed. As required by the act,

HUD approved each of these programs within a 45-day deadline. However,

in our March 1998 report, we noted that in 1997 HUD staff who reviewed

Fannie Mae’s Mortgage Protection Plan (MPP) proposal did not have

expertise in the intricacies of the cash value life insurance industry. Such

expertise was important because, under the MPP, Fannie Mae proposed

that it would purchase a cash-value life insurance policy on a first-time

homebuyer after the selected borrower’s residential mortgage was

purchased by Fannie Mae. We recommended that HUD ensure that it has

sufficient expertise—either inhouse or contract—to monitor the

enterprises’ financial activities.

HUD May Lack Adequate

Resources for Effective

Oversight

Unlike other federal regulators that have housing enterprise oversight

responsibilities,9

 such as OFHEO, HUD’s mission oversight expenditures are

funded through congressional appropriations of taxpayer dollars rather

than assessments on the regulated entities. As a result, HUD’s mission

7

Government-Sponsored Enterprises: Federal Oversight Needed for Nonmortgage Investments

(GAO/GGD-98-48, Mar. 11, 1998).

8

We defined the term “arbitrage” to mean that the enterprises use their funding advantage from

government sponsorship to raise funds for making certain nonmortgage investments.

9

OFHEO’s safety and soundness activities—about $15 million in fiscal year 1997—are financed by

assessments on the enterprises. Another federal housing enterprise—the Federal Home Loan Bank

System—pays similar assessments for its housing mission and safety and soundness regulator, the

Federal Housing Finance Board.

Page 8 GAO/T-GGD-98-177
Statement 

Federal Housing Enterprises: HUD’s

Implementation of Its Mission Oversight

Needs to Be Strengthened

oversight responsibilities necessarily compete with and are constrained by

other HUD priorities in a budget environment of declining resources.

In previous reports,10 we have commented that regulatory costs should be

borne by the respective federal housing enterprises to ensure safety and

soundness as well as effective housing mission oversight. For example,

HUD’s capacity to obtain the expertise to monitor the enterprises’ financial

activities may be limited, particularly since HUD’s traditional housing

research focus may continue to command a significant share of the

Department’s available resources. We recommended in our most recent

report11 that HUD collect data on the costs necessary to effectively oversee

the enterprises and propose to Congress that the enterprises be assessed

these costs.

Conclusions The 1992 Act established a comprehensive regulatory framework for HUD

to ensure that the enterprises complied with their housing mission. In

1995, HUD set conservative housing goals that were intended to ensure the

enterprises’ financial soundness, and the enterprises have reportedly

complied with these goals. However, there is little information currently

available on the extent to which the housing goals promote housing

opportunities. We made several recommendations in our recent report to

strengthen HUD’s mission oversight, enhance its resources, and determine

the effects of the housing goals.

Over the years, we have recommended the creation of a single regulator to

be in charge of mission and safety and soundness oversight for the

enterprises and the Federal Home Loan Bank System. Last year, we

completed a report12 on OFHEO’s financial soundness oversight efforts, and

we have just issued a report13 addressing OFHEO’s progress in meeting our

recommendations. Our work on HUD’s mission oversight highlights the

challenges the Department faces in becoming an effective regulator of

financial institutions. OFHEO and HUD are two agencies that generally

operate independently of one another. We believe that this separation

10Government-Sponsored Enterprises: Advantages and Disadvantages of Creating a Single Housing

GSE Regulator (GAO/GGD-97-139, July 9, 1997) and Government-Sponsored Enterprises: A Framework

for Limiting the Government’s Exposure to Risks (GAO/GGD-91-90, May 22, 1991).

11GAO/GGD-98-173, July 28, 1998.

12Federal Housing Enterprises: OFHEO Faces Challenges in Implementing a Comprehensive Oversight

Program (GAO/GGD-98-6, Oct. 22, 1997).

13OFHEO’s Progress in Implementing a Comprehensive Oversight Program for Fannie Mae and Freddie

Mac (GAO/GGD-98-182R, July 29, 1998).

Page 9 GAO/T-GGD-98-177
Statement 

Federal Housing Enterprises: HUD’s

Implementation of Its Mission Oversight

Needs to Be Strengthened

results in a fragmented approach to regulation that does not adequately

consider the relationships between housing mission and financial

soundness objectives, including the potential trade-offs. We also continue

to support the creation of a single regulator for federal housing enterprises

to ensure coherent and effective regulation.

Mr. Chairman, this concludes my statement. My colleagues and I would be

pleased to respond to any comments that you may have.

(233575) Page 10 GAO/T-GGD-98-177
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