United States General Accounting Office

GAO Testimony

Before Subcommittee on Capital Markets, Securities and

Government Sponsored Enterprises, House Committee on

Banking and Financial Services, and Subcommittee on

Government Management, Information and Technology,

House Committee on Government Reform and Oversight

For Release on Delivery

Expected at

2:00 p.m. EDT

on Wednesday

July 16, 1997

GSEs

Recent Trends and Policy

Statement of James L. Bothwell

Chief Economist

GAO/T-OCE/GGD-97-76

Mr. Chairmen and Members of the Committees:

We are pleased to be here today to discuss the large and growing role of

government-sponsored enterprises (GSEs) in the nation’s credit markets.

As you are aware, Congress originally created GSEs to enhance the credit

available to homebuyers, farmers, students and colleges. Congress

established GSEs as federally chartered, but privately owned and operated

corporations, limited their activities to certain economic sectors deemed

worthy of public support, and gave them certain advantages to help

accomplish their public purposes.1

 Today, the outstanding volume of

federally assisted GSE credit is large and rapidly increasing. As shown in

Figure 1, Appendix I, the volume of GSE credit more than doubled between

1990 and 1996, from $874 billion to almost $1.8 trillion, and is now almost

double the outstanding amount of credit made available through all federal

direct loan and federal loan guarantee programs combined. As shown in

Figure 2, Appendix I, GSE credit has also steadily increased as a percentage

of the total net credit outstanding in our economy,2

 from less than

2 percent in 1970 to over 12 percent in 1996. By contrast, the share of total

net credit accounted for by federal direct and guaranteed loans has

declined substantially over this period from almost 13 percent in 1970 to

less than 7 percent in 1996.

As shown in Figure 3, Appendix I, 95 percent of total outstanding GSE

credit in 1996 was housing related, with the remaining 5 percent going for

agricultural and educational purposes. In recent years, housing has also

been the only sector where GSE credit has been growing as a percentage of

the total available credit outstanding. In particular, as shown in Figure 4,

Appendix I, the two largest housing GSEs, Fannie Mae and Freddie Mac,

have increased their share of total residential mortgage debt from

23 percent in 1990 to over 37 percent in 1996.3

 By contrast, as shown in

Figure 5, Appendix I, the share of farm credit supplied by the Farm Credit

System, the largest agricultural GSE, actually declined between 1985 and

1995. And Congress passed legislation

1

Appendix II provides more details on the creation and operations of each of the major GSEs.

Appendix III provides a list of related GAO products.

2

Total net credit outstanding in the economy includes debt owed by all domestic sectors except

financial intermediaries, which are omitted to avoid double counting.

3

Specifically, of the $3.0 trillion in outstanding mortgage debt at the end of fiscal year 1990,

12.5 percent was in Fannie Mae’s portfolio or its guaranteed mortgage pools, while 10.7 percent was in

Freddie Mac’s portfolio or mortgage pools. By the end of fiscal year 1996, Fannie Mae’s share of the

$4.1 trillion in outstanding mortgage debt had increased to 22.5 percent, while Freddie Mac’s share had

risen somewhat less, but still by a substantial amount, to 14.6 percent. During this period, the share of

total outstanding mortgage credit supplied by the Federal Home Loan Bank System actually declined

from 3.9 percent to 3.7 percent.

Page 1 GAO/T-OCE/GGD-97-76
in 1996 that allowed the two education GSEs — Sallie Mae and Connie

Lee — to end their government sponsorship and become fully private

corporations.

While the legal powers, organizational structures, and operating styles of

GSEs differ, they have several common characteristics. For example, each

GSE was chartered by Congress to help achieve a particular public purpose,

each is privately owned and operated, and each operates under certain

restrictions and obligations which would not apply to a completely private

corporation. Each GSE was also given certain explicit advantages —such as

exemptions from state and local corporate income taxes, lines of credit

with the Treasury Department, or exemptions from SEC registration

requirements and fees — to help achieve its public purpose. The most

important benefit that GSEs receive from their government sponsored

status, however, is an implicit one stemming from investors’ perceptions

that the federal government would not allow a GSE to default on its

obligations. Although GSE obligations are not obligations of the United

States Government, the lower perceived risk of holding GSE obligations

allows GSEs to borrow at rates lower than comparably creditworthy private

corporations that do not enjoy federal sponsorship. In our recent

statement on the potential impacts of privatizing Fannie Mae and Freddie

Mac, we estimated that this funding advantage saved the two GSEs from

about $2 billion to $8 billion in 1995.4

Because of their federal sponsorship, GSEs also involve significant risks

and potential costs to taxpayers, including the risk that taxpayers could be

potentially liable for a GSE’s obligations if it were to get into financial

difficulty. In 1987, Congress did in fact authorize $4 billion in financial

assistance to the Farm Credit System when it experienced financial stress.5

 Limited financial and regulatory relief was also provided to Fannie Mae

when it suffered losses of $277 million between 1981 and 1984.6

The special nature of GSEs, and the potential taxpayer exposure to large,

rapidly increasing GSE financial obligations, raises several important policy

issues, including the adequacy of GSE regulation, the potential for

expansion of GSE activities, and potential ways to limit GSE exposures. Over

the past few years, we have performed several major evaluations of the

4

Housing Enterprises: Potential Impacts of Severing Government Sponsorship, GAO/T-GGD-96-134,

June 12, 1996.

5

Farm Credit System: Repayment of Federal Assistance and Competitive Position, GAO/GGD-94-39,

March 10, 1994.

6

Housing Enterprises: Potential Impacts of Severing Government Sponsorship, GAO/GGD-96-120,

May 13, 1996.

Page 2 GAO/T-OCE/GGD-97-76
effectiveness of the various GSE regulators.7

 Based on our reviews, we

developed the following five criteria for an effective GSE regulator:

• objectivity and arm’s length status from the GSE,

• prominence in government,

• consistency in regulation of similar markets,

• separation of primary and secondary market regulation, and

• economy and efficiency.

Although Congress has enacted some recent legislative changes to

strengthen and improve regulatory oversight of GSEs, our work has shown

that none of the three housing GSE regulators — the Office of Federal

Housing Enterprise Oversight (OFHEO), the Department of Housing and

Urban Development (HUD), nor the Federal Housing Finance Board

(FHFB)— meets all five of our criteria. In 1993 we recommended that OFHEO

and the FHFB be merged to better meet these criteria and our ongoing work

continues to support merging the housing GSE regulators and making one

agency responsible for both GSE safety and soundness and mission

compliance.

Based on our work, we have also developed several criteria that

policymakers could use to evaluate proposals to expand the types of

products or services that existing GSEs currently offer.8

 Under these

criteria, any new GSE product or service should:

• add value and be consistent with the GSE’s public mission,

• be properly priced to reflect risk,

• be within the GSE’s area of expertise, and

• avoid competing with products and services offered by fully private

companies or member institutions.

Because GSEs have been given the advantages of federal sponsorship to

achieve particular public purposes, we believe that any proposals to

7

Government-Sponsored Enterprises: A Framework for Limiting the Government’s Exposure to Risks,

GAO/GGD-91-90, May 22, 1991; Government-Sponsored Enterprises: The Government’s Exposure to

Risks, GAO/GGD-90-97, Aug. 15, 1990; FHLBank System: Reforms Needed to Promote Its Safety,

Soundness, and Effectiveness, GAO/T-GGD-95-244, Sept. 27, 1995; Government-Sponsored Enterprises:

Development of the Federal Housing Enterprise Financial Regulator, GAO/GGD-95-123, May 30, 1995;

Farm Credit System: Farm Credit Administration Effectively Addresses Identified Problems,

GAO/GGD-94-14, Jan. 7, 1994; Federal Home Loan Bank System: Reforms Needed to Promote Its

Safety, Soundness, and Effectiveness, GAO/GGD-94-38, Dec. 8, 1993; Improved Regulatory Structure

and Minimum Capital Standards are Needed for Government-Sponsored Enterprises,

GAO/T-GGD-91-41, June 11, 1991.

8

See, in particular, Federal Home Loan Bank System: Reforms Needed to Promote Its Safety,

Soundness, and Effectiveness, GAO/GGD-94-38, Dec. 8, 1993.

Page 3 GAO/T-OCE/GGD-97-76
significantly expand their existing activities should be required to meet

these, or similarly rigorous, criteria before they are approved.

Finally, we have also done work addressing ways that Congress might

limit the taxpayers’ potential exposure to GSE obligations. One obvious

way to do this is to end their federal sponsorship. As I mentioned at the

beginning of my statement, Congress passed legislation last year that

would make two of the GSEs — Sallie Mae and Connie Lee — fully private

entities. In 1996, we, along with the Treasury Department, HUD, and the

Congressional Budget Office, produced reports that analyzed the potential

impacts of privatizing the two largest GSEs — Fannie Mae and Freddie

Mac.9

 While taking such action could eliminate taxpayers’ risk exposure to

these GSEs, it would also have major impacts on housing finance markets,

including a likely increase in mortgage interest rates for certain borrowers.

Our report also discussed some more limited policy options that would

reduce the level of taxpayers’ risk exposure to these two GSEs, such as

imposing “user fees” or greater restrictions on their housing finance

activities. As with privatization, however, each of the options that we

presented had benefits, risks, and trade-offs that would need to be

considered and weighed carefully.

Mr. Chairmen, this concludes my prepared statement, and we would be

happy to respond to any questions that you or other members of the

committees may have.

9

Housing Enterprises: Potential Impacts of Severing Government Sponsorship, GAO/GGD-96-120,

May 13, 1996; Assessing the Public Costs and Benefits of Fannie Mae and Freddie Mac, Congressional

Budget Office, May 1996; Government Sponsorship of the Federal National Mortgage Association and

the Federal Home Loan Mortgage Corporation, United States Department of the Treasury, July 11,

1996; Studies on Privatizing Fannie Mae and Freddie Mac, May 1996, and Privatization of Fannie Mae

and Freddie Mac: Desirability and Feasibility, July 1996, United States Department of Housing and

Urban Development.

Page 4 GAO/T-OCE/GGD-97-76
Page 5 GAO/T-OCE/GGD-97-76
Appendix I 

Rapid Growth in GSE Credit

Figure 1

Federal Loans & Guarantees & GSE Credit: 1990-1996

In Billions of Dollars

0

500

1,000

1,500

2,000

Fiscal Year

GSE Credit

Guaranteed Loans

Direct Loans

90 91 92 93 94 95 96

874 988 1,129 1,282 1,533 1,548 1,771

611 701 680 666 668 693 775

162 160 156 151 155 160 165

Billions of $

Source: U.S. Budget with GAO adjustment for Sallie Mae’s holdings of guaranteed loans.

Page 6 GAO/T-OCE/GGD-97-76
Appendix I 

Federal Loans & Guarantees & GSE Credit: 1970-1996

As a Percent of Total Credit Outstanding

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5

10

15

20

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3.7 3.4 4.3 3.8 1.5 1.1

9.2 8.8 7.8 6.1 5.9 5.6

1.8 2.3 3.9 5.5 8.0 12.1

Percent

GSE Credit Affects Rising 

Share of Total U.S. Credit

Figure 2

Source: U.S. Budget & Federal Reserve Board

Page 7 GAO/T-OCE/GGD-97-76
Appendix I 

GSE Credit by Sector FY 96

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95.0%

3.2%

1.8%

Housing Gets Largest 

Share of GSE Credit

Housing

Education

Agriculture

Total: $1.8 trillion

Figure 3

Source: U.S. Budget, FY 1998

Page 8 GAO/T-OCE/GGD-97-76
Appendix I 

GSE Share of Mortgage Credit

is Rising

Figure 4

Mortgage Lending Shares: FY 1990 & FY 1996

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17.4%

12.5%

10.7%

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55.5%

FY 1990

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14.8%

22.5%

14.6%

3.7%

44.4%

FY 1996

FHA/VA

Fannie 

Mae

Freddie 

Mac

FHLBS

Other

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Mae

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Total: $3.0 

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Total: $4.1 

trillion

Source: U.S. Budget & Federal Reserve Bulletin

Page 9 GAO/T-OCE/GGD-97-76
Appendix I 

GSE Share of Farm Credit is 

Declining

Farm Credit Shares: 1985 & 1995

Banks

FCS

USDA Loans

Other

1985

Banks

FCS

USDA Loans Other

1995

12.0%

29.0%

23.0%

36.0%

39.0%

7.0%

30.0%

24.0%

Figure 5

Source: U.S. Budget, FY 1998

Page 10 GAO/T-OCE/GGD-97-76
Appendix II 

Housing GSEs The two major housing GSEs—Fannie Mae and Freddie Mac—were both

created to improve the operations and efficiency of the housing credit

markets. Although they were created in different circumstances and have

operated differently, their charters and methods of operations have

become much more similar.

Fannie Mae was first created in 1938 as a government-held association to

buy FHA, and later VA and conventional, loans from originators, primarily

mortgage banks, with funds raised by selling bonds. The initial goals of the

program were to support the development of a national mortgage market

and to improve liquidity through the creation of a resale market for

mortgage loans. In the 1950s, Congress began the process of shifting

Fannie Mae to private ownership. This was to be accomplished by

requiring each mortgage seller to purchase a certain amount of common

stock based on the amount of loans it sold to Fannie Mae, which would

allow the gradual retirement of preferred stock owned by the Treasury

Department.

The Housing and Urban Development Act of 1968 completed the

transformation of Fannie Mae into a government-sponsored enterprise.

The act separated Fannie Mae into two separate components. One

component, Ginnie Mae, remained in HUD to provide support to FHA, VA,

and special assistance programs. The other part was the

government-sponsored, privately owned, for-profit Federal National

Mortgage Association, which was to be concerned exclusively with

attracting funding into residential mortgages. To accomplish this purpose,

Fannie Mae used funds raised by selling bonds to purchase mortgage loans

from originators and held them in its own portfolio.

Congress chartered Freddie Mac in 1970 in reaction to the loss of deposits

in the savings and loan industry that was curtailing that industry’s ability

to fund and originate home mortgages. Its creation ensured that the

savings and loan industry had access to funds to continue to fund

mortgages. In comparison to Fannie Mae, Freddie Mac did not hold

mortgages in its portfolio, but created mortgage-backed securities (MBS)

and sold them to investors. However, Freddie Mac guaranteed timely

interest and principal payments on these securities.

In the early 1980s, Fannie Mae and Freddie Mac experienced different

financial results as short-term interest rates increased. Because Fannie

Mae was funding the mortgages in its portfolio with short-term debt, sharp

short term rate increases meant that the interest earned on the old

Page 11 GAO/T-OCE/GGD-97-76
Appendix II 

mortgages in its portfolio was less than interest expenses on the newly

issued debt. As a result, Fannie Mae experienced total losses of about

$277 million between 1981 and 1984. In response to Fannie Mae’s financial

problems, the federal government provided limited tax relief and

regulatory forbearance in the form of relaxed capital requirements.

Freddie Mac’s different method of operations meant that investors, and

not Freddie Mac, bore the risks of changing interest rates. To avoid future

losses from interest rate changes, Fannie Mae partially adopted Freddie

Mac’s strategy of issuing MBS and shifting the interest rate risk to investors.

The activities of Fannie Mae and Freddie Mac have largely converged. The

effect of the Housing and Community Development Act of 1992, along with

the GSE-related provisions in the Financial Institutions Reform, Recovery,

and Enforcement Act of 1989 (FIRREA), was to make the charters of Fannie

Mae and Freddie Mac substantially the same. Both GSEs attempt to smooth

the availability of mortgage funds across time and regions and promote

liquidity in the secondary mortgage market. In addition to their traditional

goal of improving the functioning of capital markets, the charters of both

enterprises now include distributional goals. Both Fannie Mae and Freddie

Mac have the additional purpose of providing access to mortgage finance

for low-income families and underserved areas. A primary difference

between the two GSEs continues to be Fannie Mae’s relatively greater use

of debt-financing to hold mortgages in its own portfolio, although Freddie

Mac has increased its portfolio investment share in recent years.

The Federal Home Loan Bank System is the third housing-related GSE. It

was established in 1932 to extend mortgage credit by making loans, called

advances, to its member institutions, who in turn lend to homebuyers for

mortgages. The System consists of 12 federally chartered, privately owned

FHLBanks that raises funds by issuing consolidated debt securities in the

capital market. The advances are secured by home mortgage loans or such

other collateral as U.S. Treasury securities. These advances help member

institutions, originally limited to thrifts, by enhancing liquidity and

providing access to national capital markets.

With the evolution of national mortgage markets and the contraction of

the thrift industry, the original justifications for the Federal Home Loan

Bank System to support housing credit and the thrift industry have

diminished. Rather than phase down its activities, Congress allowed the

Federal Home Loan Bank System to expand its membership pool to

include commercial banks, which now comprise 65 percent of the

members.

Page 12 GAO/T-OCE/GGD-97-76
Appendix II 

Agricultural GSEs The largest of the two agriculture GSEs, the Farm Credit System (FCS),

raises money through bond sales and makes loans directly to farmers. FCS

lends this money to the farming sector through a network of

member-owned cooperatives with the purpose of ensuring a stable supply

of credit to agriculture. Established in 1916, FCS became insolvent in the

mid-1980s when inadequate interest-rate risk management and falling land

prices depressed the value of collateral behind FCS credit and created large

losses for the institution. This necessitated a federal bailout through the

FCS Financial Assistance Corporation (FAC), which injected funds into FCS

by issuing $1.261 billion in bonds.

Unlike direct loans and FCS loans, the other agricultural GSE—Farmer

Mac—operates by promoting a secondary market for agricultural loans.

Farmer Mac was created in 1987 by the same legislation that provided for

the FCS bailout. Its purpose was to create and oversee a secondary market

for, and to guarantee securities based on, farm real estate loans. However,

unlike the GSEs in the housing sector, Farmer Mac was not able to

establish a growing niche in farm credit markets by guaranteeing farm

securities. As a result of the decline in Farmer Mac’s capital base, the

Farm Credit System Reform Act of 1996 expanded its powers. The 1996

Act transformed Farmer Mac from just a guarantor of securities formed

from loan pools into a direct purchaser of mortgages in order to form

pools to securitize. The expanded powers make it more attractive for

banks to participate in Farmer Mac and permit Farmer Mac to act as a

pooler. While the new powers are intended to boost Farmer Mac’s

revenues, it is too early to tell how this will affect Farmer Mac’s role in

agricultural credit. However, as a direct purchaser of loans with no

required subordination, this increased role does have the potential to

expose Farmer Mac to greater credit risk than on guaranteed pools, which

require loan originators or other entities outside the pool to hold a

10-percent subordinated interest in pooled loans.

Education GSEs The federal government created two GSEs to increase the availability of

credit in the educational sector. The largest one, Sallie Mae, was created in

1972 as a for-profit, shareholder-owned corporation. Sallie Mae purchases

insured student loans from eligible lenders and makes secured loans to

lenders. It now holds about one-third of all outstanding guaranteed student

loans. In 1996 Congress passed legislation establishing a process for

restructuring Sallie Mae and ultimately terminating its federal government

sponsorship.

Page 13 GAO/T-OCE/GGD-97-76
Appendix II 

The second education GSE, Connie Lee, was created in 1986 to insure and

reinsure the financing of postsecondary education facilities. Connie Lee’s

financial condition has been strong, particularly since 1991, when it

obtained the “triple-A” credit rating necessary to engage in the financial

guaranty business as a direct writer of insurance. Legislation passed in

1996 privatized Connie Lee by repealing the corporation’s enabling

legislation and requiring the federal government to sell, and Connie Lee to

purchase, the corporation’s federally owned stock during fiscal year 1997.

Page 14 GAO/T-OCE/GGD-97-76
Appendix II 

Page 15 GAO/T-OCE/GGD-97-76
Appendix III 

Related GAO Products

Housing Enterprises: Investment, Authority, Polices, and Practices,

GAO/GGD-97-137R, June 27, 1997.

Housing Enterprises: Potential Impacts of Severing Government

Sponsorship, GAO/T-GGD-96-134, June 12, 1996.

Housing Enterprises: Potential Impacts of Severing Government

Sponsorship, GAO/GGD-96-120, May 13, 1996.

GAO views on the “Federal Home Loan Bank System Modernization Act of

1995”, Letter from James L. Bothwell, Director, Financial Institutions and

Markets Issues, GAO, to the Honorable James A. Leach, Chairman,

Committee on Banking and Financial Services, U.S. House of

Representatives, Oct. 11, 1995.

FHLBank System: Reforms Needed to Promote Its Safety, Soundness, and

Effectiveness, GAO/T-GGD-95-244, Sept. 27, 1995.

Housing Finance: Improving the Federal Home Loan Bank System’s

Affordable Housing Program, GAO/RCED-95-82, June 9, 1995.

Government-Sponsored Enterprises: Development of the Federal Housing

Enterprise Financial Regulator, GAO/GGD-95-123, May 30, 1995.

Farm Credit System: Repayment of Federal Assistance and Competitive

Position, GAO/GGD-94-39, March 10, 1994.

Farm Credit System: Farm Credit Administration Effectively Addresses

Identified Problems, GAO/GGD-94-14, Jan. 7, 1994.

Federal Home Loan Bank System: Reforms Needed to Promote Its Safety,

Soundness, and Effectiveness, GAO/GGD-94-38, Dec. 8, 1993.

Improved Regulatory Structure and Minimum Capital Standards are

Needed for Government-Sponsored Enterprises, GAO/T-GGD-91-41, June 11,

1991.

Government-Sponsored Enterprises: A Framework for Limiting the

Government’s Exposure to Risks, GAO/GGD-91-90, May 22, 1991.

Government-Sponsored Enterprises: The Government’s Exposure to

Risks, GAO/GGD-90-97, Aug. 15, 1990.

(972628) Page 16 GAO/T-OCE/GGD-97-76
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