Federal Housing Finance Agency: Objectives Needed for the Future of Fannie Mae and Freddie Mac After Conservatorships
Published: 2016-11-17T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In 2008, FHFA used its authority under the Housing and Economic Recovery Act to place Fannie Mae and Freddie Mac into conservatorships out of concern that their deteriorating financial condition threatened the stability of the financial market. Eight years later, the enterprises remain in conservatorships. However, FHFA says the conservatorships were not intended to be permanent. FHFA has issued two strategic plans for its conservatorship of the enterprises, one in 2012 and another in 2014.
GAO was asked to examine FHFA's actions as conservator. This report addresses (1) the extent to which FHFA's goals for the conservatorships have changed and (2) the implications of FHFA's actions for the future of the enterprises and the broader secondary mortgage market.
GAO analyzed and reviewed FHFA's actions as conservator and supporting documents; legislative proposals for housing finance reform; the enterprises' senior preferred stock agreements with Treasury; and GAO, Congressional Budget Office, and FHFA inspector general reports. GAO also interviewed FHFA and Treasury officials and industry stakeholders.
section_title: What GAO Found
paragraphs: The Federal Housing Finance Agency (FHFA) issued a new strategic plan for the conservatorships of Fannie Mae and Freddie Mac (the enterprises) in 2014 with reformulated goals and supporting actions that reflect a shift in priorities and changing market conditions. While the three goals in the 2014 strategic plan are broadly similar to those in the previous plan issued in 2012, FHFA changed the weight and wording of the goals (see table) to align the plan more closely with FHFA's statutory responsibilities. Specifically, compared with the 2012 plan FHFA (1) increased its emphasis on maintaining credit availability and foreclosure prevention options; (2) shifted away from shrinking the enterprises as a way to reduce taxpayer risk (focusing instead on transferring credit risk to private investors, for example); and (3) reduced the scope of the securitization infrastructure being built, such as a new technology platform for securitizing mortgages, to focus on meeting the enterprises' current needs.
In the absence of congressional direction, FHFA's shift in priorities has altered market participants' perceptions and expectations about the enterprises' ongoing role and added to uncertainty about the future structure of the housing finance system. In particular, FHFA halted several actions aimed at reducing the scope of enterprise activities and is seeking to maintain the enterprises in their current state. However, other actions (such as reducing their capital bases to $0 by January 2018) are written into agreements for capital support with the Department of the Treasury (Treasury) and continue to be implemented. In addition, the change in scope for the technology platform for securitization puts less emphasis on reducing barriers facing private entities than previously envisioned, and new initiatives to expand mortgage availability could crowd out market participants. Furthermore, some actions, such as transferring credit risk to private investors, could decrease the likelihood of drawing on Treasury's funding commitment, but others, such as reducing minimum down payments, could increase it. GAO has identified setting clear objectives as a key principle for providing government assistance to private market participants. Because Congress has not established objectives for the future of the enterprises after conservatorships or the federal role in housing finance, FHFA's ability to shift priorities may continue to contribute to market uncertainty.
section_title: What GAO Recommends
paragraphs: Congress should consider legislation that would establish clear objectives and a transition plan to a reformed housing finance system that enables the enterprises to exit conservatorship. FHFA agreed with our overall findings.

section_title: Letter
paragraphs: On September 6, 2008, the Federal Housing Finance Agency (FHFA)  placed the government-sponsored enterprises Fannie Mae and Freddie  Mac (the enterprises) into conservatorships out of concern that their  deteriorating financial condition threatened the stability of financial  markets. At the time, the enterprises guaranteed about $4.5 trillion in  mortgage-backed securities (MBS), on par with their current exposure.  The Department of the Treasury (Treasury) provided substantial capital  support to the enterprises as part of senior preferred stock purchase  agreements, as authorized under the Housing and Economic Recovery  Act (HERA), so that the enterprises could continue to support mortgage  finance through the secondary mortgage market in accordance with their  charters. In doing so, Treasury committed to provide funds to the  enterprises to avoid insolvency. Before receiving Treasury support, the  enterprises’ guarantees had been viewed by the market as being  implicitly backed by the federal government. This market perception  lowered the enterprises’ overall cost of doing business. As of September  2016, Treasury had provided about $187.5 billion in funds as capital  support to the enterprises, with an additional $258.1 billion available to  the enterprises should they need further assistance. In accordance with  the terms of the agreements with Treasury, the enterprises had declared  and paid dividends to Treasury totaling about $250.5 billion through  September 2016.
Congress did not provide direction on reforming the enterprises when it  granted conservatorship authority to FHFA. Although the  conservatorships have lasted more than 8 years, FHFA has said that the  conservatorships were not intended to be permanent.
You asked us to examine FHFA’s actions as conservator of the  enterprises and the effects of its actions on the future of the enterprises  and the secondary mortgage market. This report addresses (1) how  FHFA’s goals for the conservatorships have changed over time and what  actions FHFA has taken to further these goals, and (2) the implications of  FHFA’s actions for the future of the enterprises and the broader  secondary mortgage market.
To address our first objective, we reviewed relevant statutory provisions  to understand FHFA’s authorities and responsibilities. We analyzed  FHFA’s 2012 and 2014 strategic plans for the conservatorships to identify  key differences in the goals FHFA established and any changes to the  actions to be taken to further these goals. We also reviewed FHFA’s  annual scorecards for the enterprises for 2012–2016 along with various  progress reports FHFA issued related to the scorecards and specific  initiatives for additional information about the actions FHFA was taking or  planned to take. We reviewed public statements from the current FHFA  Director and interviewed FHFA officials about the goals and actions to  understand the rationale for differences we identified. We also reviewed  the enterprises’ senior preferred stock purchase agreements with  Treasury and interviewed Treasury officials to understand Treasury’s role  and input into FHFA’s decisions and actions.
For our second objective, we reviewed documentation from FHFA, the  enterprises, industry stakeholders, the Congressional Budget Office  (CBO), the FHFA Inspector General, and our prior reports. In particular,  we reviewed CBO’s 2014 report on transitioning to alternative structures  for housing finance. We compared legislative proposals for reforming the  housing finance system introduced from 2014 through 2016 with the  alternative structures CBO outlined and with FHFA’s actions as  conservator to assess whether FHFA’s actions appeared to be necessary  to transition to alternative structures included in the various proposals.
Additionally, we reviewed the enterprises’ senior preferred stock purchase  agreements with Treasury and the results of their annual stress tests for  2014 through 2016 to identify potential implications of FHFA’s actions on  the enterprises’ future structures and potential draws on Treasury’s  capital commitment. We also interviewed FHFA officials and industry  stakeholders and reviewed industry stakeholders’ comment letters to  FHFA on a number of proposed and completed actions to understand the  potential implications of these actions on the enterprises and the broader  secondary market. Industry stakeholders we interviewed included  members of an industry advisory group formed by the enterprises to  provide feedback and share information on efforts to build a common  securitization platform—the American Bankers Association, Mortgage  Bankers Association, Securities Industry and Financial Markets  Association, and Structured Finance Industry Group—as well as several  members of the Association of Institutional Investors.
We conducted this performance audit from May 2016 to November 2016  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.
subsections: section_title: Background
subsections: section_title: The Enterprises
paragraphs: Congress chartered Fannie Mae and Freddie Mac as for-profit,  shareholder-owned corporations in 1968 and 1989, respectively. They  share a primary mission, which is to enhance the liquidity, stability, and  affordability of mortgage credit. To accomplish this goal, the enterprises  purchase conventional mortgages that meet their underwriting standards,  known as conforming mortgages, from primary mortgage lenders such as  banks or savings associations. Mortgage lenders sell mortgages to  transfer risk (especially interest rate risk in the case of fixed-rate  mortgages) or increase liquidity. They can use the proceeds from selling  mortgages to the enterprises to originate additional mortgages, or they  may exchange a pool of mortgages for enterprise-backed MBS, which  they can keep or sell. The enterprises package mortgages they purchase  into MBS, which are sold to investors in the secondary mortgage market.  In exchange for a fee (the guarantee fee), the enterprises guarantee the  timely payment of interest and principal on MBS that they issue. These  fees are typically incorporated into the interest rates charged to  borrowers. The charter requirements for providing assistance to the  secondary mortgage markets specify that those markets are to include  mortgages on residences for low- and moderate-income families and  require the enterprises to support mortgage financing in underserved  areas.
section_title: FHFA’s Authorities and the Conservatorships of the Enterprises
paragraphs: HERA established FHFA as an independent agency responsible for the  safety and soundness and housing mission oversight of the enterprises.  FHFA took over the oversight of the enterprises from the Office of Federal  Housing Enterprise Oversight, formerly an independent entity within the  Department of Housing and Urban Development (HUD). FHFA has a  statutory responsibility to ensure that the enterprises operate in a safe  and sound manner and that the operations and activities of each  regulated entity foster liquid, efficient, competitive, and resilient national  housing finance markets. Additionally, the Emergency Economic  Stabilization Act of 2008 directed FHFA and other agencies to implement  plans seeking to maximize assistance for homeowners and encourage  mortgage servicers to take advantage of available programs to minimize  foreclosures.
HERA authorized the Director of FHFA to appoint FHFA as conservator  or receiver for the enterprises for the purpose of reorganizing,  rehabilitating, or winding up their affairs. As conservator, FHFA was  authorized to take such action as may be necessary to put the regulated  entity in a sound and solvent condition, as well as such action as may be  appropriate to carry on the business of the regulated entity and to  preserve and conserve the assets and property of the regulated entity.  Upon placing the enterprises into conservatorships, FHFA succeeded by  operation of law to the authority of the enterprises’ management, boards  of directors, and shareholders during the period of the conservatorships.  However, according to FHFA, it does not manage every aspect of the  enterprises’ operations. Instead, FHFA reconstituted the enterprises’  boards of directors in 2008 and charged them with overseeing  management’s day-to-day operation of the enterprises, subject to FHFA  review and approval on certain matters. Fannie Mae and Freddie Mac  retain their government charters and continue to operate legally as  business corporations.
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. Most recently, under the current  Director, whose term began in January 2014, FHFA issued an updated  strategic plan in May 2014 that reformulated its three strategic goals.
Using its authority provided in HERA, Treasury provides capital support to  the enterprises while in conservatorships through senior preferred stock  purchase agreements. Under these agreements, Treasury committed to  provide up to $445.6 billion in assistance to the enterprises, of which the  enterprises have drawn $187.5 billion to date. In exchange, the  enterprises pay quarterly dividends to Treasury. Under the current terms  of the agreements as amended, Fannie Mae and Freddie Mac must pay  to Treasury as dividends all of their quarterly positive net worth amount (if  any) over a specified capital reserve amount upon declaration of  dividends. However, the agreements reduce this capital reserve amount  to zero in January 2018.
section_title: Proposals to Reform the Housing Finance System
paragraphs: From 2008 through 2013, the federal government directly or indirectly  supported over three-quarters of the value of new mortgage originations  in the single-family housing market. Mortgages with federal support  include those backed by the enterprises as well as mortgages insured by  the Federal Housing Administration (FHA), which has experienced  substantial growth in its insurance portfolio and significant financial  difficulties. In light of developments concerning the enterprises and FHA,  in 2013 we identified the role played by the federal government in the  housing finance system as a high-risk area for the government.
Subsequently, Congress considered a number of legislative proposals to  make significant changes to the housing finance system. 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, H.R. 2767—were  reported out of committee during the 113th Congress (January 2013– January 2015), but no further action was taken.
section_title: Enterprises’ Share of First- Lien Mortgage Originations
paragraphs: From 2003 to 2006, the enterprises saw the share of total first-lien  mortgage originations they securitized into MBS decline from 51 percent  to 32 percent (see fig. 1). This decrease coincided with the rapid  expansion of nonprime lending and private-label MBS. However, there  have been very few new issuances of private-label MBS since 2007. As  that segment of the market virtually disappeared, the enterprises’ market  share increased to a high of 65 percent of total originations in 2008 (even  as the dollar volume of originations they securitized decreased from  2007) and remained nearly at that level for several years. Meanwhile, the  share of first-lien mortgage originations that banks held in their portfolios  generally decreased, from 34 percent in 2002 to a low of 12 percent in  2009. However, the percentage of loans held in banks’ portfolios  increased from less than 20 percent in 2013 to more than 30 percent in  2014, where it remained through the first half of 2016. Simultaneously,  the percentage of loan originations that the enterprises packaged into  MBS and guaranteed dropped from 62 percent in 2013 to less than 50  percent in 2014, and fell further to 43 percent during the first half of 2016.
section_title: FHFA’s Reformulated Goals for the Conservatorships and Its Supporting Actions Reflect a Shift in Priorities and Changing Market Conditions
paragraphs: While the three goals FHFA outlined in its 2014 strategic plan for the  conservatorships are similar to those in the previous 2012 plan in a  number of ways, there are key differences that reflect a shift in priorities  for the conservatorships and changing market conditions. Whereas in the  2012 plan FHFA stated that its goals were aimed at establishing a  foundation for a new housing finance system in the future, FHFA stated  that the 2014 plan and goals emphasize overseeing and managing the  enterprises in their current state in accordance with statutory mandates.  This shift in priorities is evident in the goals’ relative importance as  indicated by the weight given to each goal, as well as changes to the  wording of the three goals between the 2012 and 2014 strategic plans  (see table 1) and the actions FHFA is taking to further these goals. In  addition, the previous strategic plan was produced while the enterprises  were generating losses and the outlook for future losses was highly  uncertain, according to FHFA, but the 2014 plan was issued after a string  of profitable quarters for both enterprises.
subsections: section_title: FHFA Increased Its Emphasis on Maintaining Credit Availability and Foreclosure Prevention Options to Align with Statutory Responsibilities
paragraphs: In the 2014 plan, FHFA indicated it was placing greater emphasis on its  goal for maintaining credit availability and foreclosure prevention options  (Maintain goal). FHFA increased the weight given to this goal in its annual  scorecards for the enterprises, from 20 percent in 2012 and 2013 to 40  percent in 2014 through 2016. Additionally, FHFA changed the wording of  the Maintain goal from “maintain foreclosure prevention activities and  credit availability for new and refinanced mortgages” to “maintain, in a  safe and sound manner, foreclosure prevention activities and credit  availability for new and refinanced mortgages to foster liquid, efficient,  competitive, and resilient national housing finance markets.” The new  wording more closely aligns the goal with FHFA’s responsibilities outlined  in statute and Congress’s stated purpose for the enterprises.
Many of the activities that were identified in the 2012 plan under the  Maintain goal continue to be stressed in the 2014 plan. These activities  include the following:
Representations and warranties framework. FHFA and the  enterprises undertook a multiyear effort to develop a new framework  governing representations and warranties—the assurances lenders  provide that mortgage loans sold to the enterprises comply with the  standards outlined in the enterprises’ selling and servicing guides,  including underwriting and documentation. The objective of the  framework is to enhance transparency and certainty for lenders by  clarifying when a mortgage loan may be subject to repurchase. This  clarity may give lenders more confidence to lend, which helps  maintain borrowers’ access to credit. For example, currently lenders  are eligible for relief from certain representations and warranties when  borrowers make 36 consecutive payments with no more than two  delinquencies of 30 days or less. The enterprises categorized loan  origination and servicing defects and the appropriate remedies  available to address them in the framework and established an  independent dispute resolution program to resolve contested loan- level disputes about repurchase requests. The final piece of the  framework was put in place in February 2016.
Loss mitigation and foreclosure prevention. In an effort to help  borrowers avoid foreclosure, FHFA worked with the enterprises to  align their servicing policies and develop loss mitigation tools that  included loan modifications, streamlined refinance options, and  foreclosure prevention actions including short sales and deeds-in-lieu  of foreclosure. FHFA and the enterprises also made enhancements  to requirements related to foreclosure alternatives, unemployment  forbearance, and rate-reset notifications. For example, the enterprises  announced in June 2014 that mortgage servicers could approve  eligible borrowers for extended unemployment forbearance without  obtaining prior written authorization from the enterprises. Finally, the  enterprises have used sales of nonperforming loans to transfer pools  of severely delinquent loans to new buyers and servicers with the goal  of providing more favorable outcomes for borrowers while also  reducing losses to the enterprises and, therefore, to taxpayers.
In addition, FHFA identified a number of new activities, some of which the  enterprises have begun implementing, that serve to expand its efforts to  maintain credit availability and foreclosure prevention as market  conditions improve, including  lowering the minimum down payment from 5 percent to 3 percent; providing for principal forgiveness for an estimated 30,000 borrowers  in default; issuing proposed rules outlining the enterprises’ duty to serve certain  underserved segments of the market; and  transferring funds to a statutory housing trust fund that will be  distributed through grants made to the states.
FHFA also reframed the enterprises’ actions in multifamily production to  focus on maintaining credit availability rather than on reducing their  market share. Beginning in 2013, FHFA imposed a production cap on  the enterprises’ multifamily business. However, since 2014 FHFA has  allowed the enterprises to exclude from the caps affordable housing  loans, loans to small multifamily properties, and loans to manufactured  housing rental communities. In addition, FHFA increased the 2016  multifamily lending caps for the enterprises from $31 billion to $36.5 billion. The adjustment for 2016 was based on increased estimates of  the overall size of the 2016 multifamily finance market due to continued  high levels of property acquisitions and deliveries of newly constructed  apartment units, as well as record levels of maturing loans that required  refinancing.
section_title: FHFA Shifted Efforts for Reducing Taxpayer Risk Away from Decreasing the Enterprises’ Role
paragraphs: FHFA’s second goal in the 2014 plan, like the corresponding goal in the  2012 plan, is aimed at transferring risk from the enterprises (and  taxpayers) to private investors. However, the two goals are worded  differently due to different approaches to decreasing risk. In 2012, the  goal was to “gradually contract the enterprises’ dominant presence in the  marketplace while simplifying and shrinking their operations” (Contract  goal). The 2014 plan rephrases the goal as to “reduce taxpayer risk  through increasing the role of private capital in the mortgage market”  (Reduce goal) and shifts away from decreasing the enterprises’ role in the  housing market. In addition, FHFA reduced the weight that activities  under the second goal were given in FHFA’s annual scorecards, from 50  percent in 2013 to 30 percent in 2014 through 2016.
As FHFA noted in the 2014 strategic plan, its statutory responsibilities as  conservator do not include making policy decisions on the future of  housing finance reform. FHFA officials told us that the current Director did  not believe that shrinking the enterprises’ dominant presence in the  market was FHFA’s decision to make because Congress had not yet  acted on housing finance reform.
Additionally, FHFA noted that it was concerned about the effects of  shrinking the enterprises’ operations on mortgage market liquidity and the  availability of mortgage credit, which it was seeking to support through its  Maintain goal. In other words, there may have been tension between the  Contract goal and the Maintain goal in the 2012 plan, and shifting risk  from taxpayers to private market participants without contracting the  enterprises’ presence in the market helped eliminate this tension. As a  result, one of the actions outlined in the 2012 plan related to efforts to  contract the enterprises’ role—continued gradual increases in the  enterprises’ guarantee fee pricing—was eliminated. Another action was  reframed: the multifamily production activities that in the 2014 plan focus  on maintaining access to credit and are therefore included in the Maintain  goal, as discussed previously.
In its efforts to support the new focus of the Reduce goal, FHFA has  taken several actions, including the following:
Credit risk transfers. FHFA directed the enterprises to transfer a  portion of the credit risk they face on the mortgages they securitize to  private investors. These transfers of risk can occur either before  (“front-end”) or after (“back-end”) the enterprises purchase mortgages.  The enterprises primarily employed back-end risk transfers in the first  3 years of the initiative (2013–2015), but recently they have been  trying various structures, including some front-end transfers. Under  the debt issuance structure for credit risk transfers (the structure the  enterprises have used most), the enterprises sell debt to investors  and receive payment up front at the time of the sale. The enterprises  repay the debt based on the performance of a reference pool of  mortgages, in which the investor earns a higher return if the  mortgages perform well and a lower return should they perform  poorly. From 2013 through 2015, the enterprises completed 70  transactions that transferred credit risk totaling $30.6 billion on single- family mortgages with an unpaid principal balance of about $838  billion. In June 2016, FHFA issued a request for input on proposals for  the enterprises to adopt a number of front-end credit risk transfer  structures.
Private mortgage insurance standards. FHFA and the enterprises  updated eligibility requirements for private mortgage insurers seeking  to insure loans that are eligible for purchase by the enterprises. These  requirements help to ensure the stability of mortgage insurance  companies that are counterparties of the enterprises, reducing  counterparty risk to the enterprises and, by extension, risk to  taxpayers. Among other things, the requirements establish financial  standards for private mortgage insurers to demonstrate adequate  resources to pay claims and operational standards relating to quality  control processes and performance metrics. The enterprises began  implementing the requirements in the second half of 2015, and all the  revised requirements were effective December 31, 2015.
section_title: FHFA Has Reduced the Scope of the Securitization Infrastructure Being Built, Focusing Instead on Initiatives for the Enterprises
paragraphs: FHFA narrowed the focus of its goal of building a securitization  infrastructure (Build goal) from creating a new secondary mortgage  market infrastructure to primarily addressing the enterprises’ current  operational needs. But FHFA kept the weight assigned to this goal in the  annual scorecards it issued for the enterprises at 30 percent (which is the  weight it was given each year from 2012 through 2016). The reduction in  scope is evident in the changed wording of the goal, from “build a new  infrastructure for the secondary mortgage market” to “build a new single- family securitization infrastructure for use by the enterprises and  adaptable for use by other participants in the secondary market in the  future.”
One example of refining the goal’s scope was discontinuing the effort to  develop a model contractual and disclosure framework. Since 2012, the  enterprises had been working to develop the framework to align the  contracts and data disclosures that supported fully guaranteed MBS  issued by the enterprises and craft a set of uniform contractual terms and  standards for transparency for MBS that carried no or only a partial  federal guarantee and that could be broadly accepted by issuers and  investors. To develop this framework, FHFA was incorporating input it  received in 2012 on a proposal for a standardized pooling and servicing  agreement. According to FHFA, by the end of 2013 the enterprises had  made progress toward developing preliminary recommendations for the  framework. However, the 2014 strategic plan did not mention the  framework. FHFA officials said that the effort to develop the framework  was distracting FHFA from focusing on addressing the enterprises’  securitization infrastructure needs, particularly those related to the  implementation of a Single Security (discussed later). They said  discontinuing the work on the framework was part of a strategy to mitigate  risk through managing the scope of the infrastructure they were building.  Additionally, the officials said that private industry groups commented to  FHFA that such an effort should be left to the private sector.
Despite the change in goal’s scope in the 2014 plan, FHFA is continuing  efforts begun earlier to create a new securitization infrastructure—most  notably, a common securitization platform. The common securitization  platform is a technology and operational platform that will perform many  of the enterprises’ current securitization functions for single-family  mortgages on behalf of the enterprises. FHFA directed the enterprises to  develop a common platform to replace the information technology  platforms at each enterprise that support their securitization activities.  While the common platform is designed to meet the current securitization  activities of the enterprises, it is being built using open architecture and  industry standard software, systems, and data requirements with the goal  of being adaptable for use by other market participants in the future.  According to FHFA officials, focusing first on meeting the known  requirements of the enterprises made the most sense for defining the  scope of the work and managing the project. Nonetheless, they said the  ultimate goal of building an infrastructure that can be used by other  market participants remains an important part of the Build goal and has  informed many decisions FHFA has made.
FHFA expects the platform to be implemented in two releases:  Implementation of the first release is scheduled to occur before the  end of 2016 and should allow Freddie Mac to use the platform to  issue its current single-class securities. In preparation for the first  release, Freddie Mac and Common Securitization Solutions, LLC, a  joint venture of the enterprises that was formed to operate the  platform, successfully completed system-to-system and end-to-end  testing of the functionality of the platform in early 2016.
The second release is scheduled for 2018, when both enterprises  plan to use the platform to issue a Single Security, which FHFA is  developing to replace the different MBS they currently offer. Unlike the  enterprises’ current products, the new securities will have the same  features, and the goal is for the market to treat them as fungible  irrespective of the enterprise that issued them. In addition, the  enterprises will be able to commingle first-level and second-level  securities from either enterprise in the second-level securities they  issue. As of July 2016, FHFA had finalized the features of the Single  Security after soliciting and incorporating input from the public. FHFA  also updated loan-level disclosures and announced that the  enterprises will begin issuing these securities in 2018.
To support the Build goal, FHFA and the enterprises continue to develop  mortgage data standards for the single family loans they purchase  through the Uniform Mortgage Data Program. This program has provided  lenders with common and consistent definitions and specification for  various mortgage data, including appraisal, loan delivery, mortgage loan  application, and closing disclosure information. The enterprises currently  collect standardized appraisal and loan delivery data, and expect to  implement a data collection system for the closing disclosure dataset in  the third quarter of 2017. As part of a new mortgage loan application, the  enterprises released technical requirements and an associated dataset to  electronically capture loan application information to the industry in the  third quarter of 2016. Implementation of the new loan application and  associated dataset is likely to be in the first quarter of 2019, according to  FHFA.
section_title: In the Absence of Congressional Direction, FHFA’s Shift in Priorities Adds to Uncertainty about the Future Structure of the Housing Finance System
subsections: section_title: FHFA Partially Changed Direction on Reducing the Enterprises’ Role in Housing Finance
paragraphs: Prior to 2014, FHFA was taking explicit steps to shrink the enterprises’  role in the secondary market. These actions included gradual increases  in guarantee fees and strict caps on the total amount of multifamily loans  that the enterprises could purchase. As discussed earlier, these actions  were stopped by the current Director and FHFA’s adoption of the 2014  strategic plan. However, other actions that serve to reduce the depth and  breadth of the enterprises’ activities and that are written into the  enterprises’ agreements with Treasury continue. These actions include  reducing retained mortgage portfolios and reducing the enterprises’  capital bases to $0 by January 2018.
FHFA stated that it changed its strategy for the conservatorships and took  actions to maintain the enterprises’ current state and role in the  secondary market in the absence of congressional direction on housing  finance system reform. At the same time, FHFA officials told us that the  strategy was intended to be neutral in terms of the enterprises’ future  structure and left all reform options open. Our analysis comparing FHFA’s  actions with legislative proposals to reform the enterprises’ structure  found that some proposals continue or build upon actions FHFA has  taken, such as the common securitization platform and credit risk  transfers. However, proposals that incorporate the same future structure  for the enterprises do not consistently build upon the same actions. For  example, one legislative proposal that replaces the enterprises with a  single federal agency builds upon FHFA’s credit risk transfer initiative, but  other similar proposals do not explicitly address credit risk transfers. As a  result, FHFA’s actions are not necessary to transitioning to the particular  structures in any of these proposals, such as a single governmental  agency or fully privatized companies. In addition, we found that the  same actions were included in multiple proposals that envisioned different  future structures for the enterprises.
Industry stakeholders generally said that FHFA’s recent actions have not  advanced or constrained any of the future structures for the enterprises  outlined in legislative proposals. Representatives from two industry  associations told us that FHFA’s recent actions have been neutral as to  the future structure. However, other industry stakeholders who are  members of a third industry association noted that FHFA had taken steps  prior to 2014 to harmonize the enterprises’ policies, procedures, and  products, some of which continued after the publication of the 2014 plan,  such as the development of a Single Security and the common  securitization platform. Taking these steps could facilitate (but would not  require) merging the enterprises into a single entity. But whether that  single entity would be a government agency, government corporation, or  private entity was unclear to these stakeholders. Officials from another  industry association said that instead the enterprises could be  recapitalized as competitors to one another but that it was unclear how  they would be able to balance competing against each other with working  together to ensure the common securitization platform works well.
section_title: FHFA’s Change in Priorities Puts Less Emphasis on Addressing Barriers to Entry into the Secondary Mortgage Market, Adding to Uncertainty
paragraphs: As outlined in the 2012 strategic plan, FHFA set out to address a number  of barriers to entry into the secondary mortgage market. By creating a  common securitization platform using open architecture, a model pooling  and servicing agreement (which evolved into the contractual and  disclosure framework discussed previously), and standardized mortgage  data, along with contracting the enterprises’ presence through increased  guarantee fees, FHFA sought to make entry into the secondary market  easier for private entities. However, over time most of these actions were  scoped down or eliminated, resulting in a reduced emphasis on  addressing barriers. Some industry stakeholders said that FHFA’s shift in  direction sent mixed messages to market participants and increased  uncertainty about the role private entities should be playing in the  secondary mortgage market.
For example, some industry stakeholders we spoke with perceived a  technological barrier to entry into the secondary mortgage market. The shift in the Build goal from 2012 to 2014 related to the common  securitization platform does not clearly address this barrier as it is less  clear whether private entities will be able to use the platform. According to  FHFA officials, many decisions remain to be made about whether, when,  and for what purposes private entities will be able to use the platform,  which adds to uncertainty.
As another example, FHFA and the enterprises began developing a  contractual and disclosure framework but decided to halt the effort in  2014. The framework had the potential to help address some of the  governance issues that some industry stakeholders said were holding  back the secondary mortgage market’s private-label MBS. These  governance issues include a lack of alignment of interests among parties  to a securitization transaction and processes for holding servicers for the  underlying mortgages accountable for their performance. Some industry  stakeholders we spoke to said that completing the framework, while  potentially helpful in addressing some issues, would have been unlikely to  fully address the barriers that continue to prevent the private-label MBS  market from growing. According to FHFA officials, the private sector has  worked on developing its own framework, and this effort is ongoing.
Further, changes to FHFA’s Maintain goal from the 2012 plan to the 2014  plan have expanded the enterprises’ reach to put them in competition with  other market participants. Rather than addressing barriers to entry for  private entities, these actions may enhance rather than lessen the  enterprises’ existing advantages, which serve as barriers to entry and add  to market participants’ uncertainty about their role in the market relative to  the enterprises. For example, allowing down payments as low as 3  percent expands the market segments the enterprises serve. According  to an industry stakeholder, doing so could push other market participants  out of these segments because the enterprises have built-in  advantages—such as lower cost of funding and a government  guarantee—that may make their products more attractive. Another  stakeholder said the proposed rule on the enterprises’ duty to serve  underserved markets, could also increase the enterprises’ competition  with private entities, depending on future decisions.
Increases in guarantee fees that occurred in the first few years of the  conservatorship began to address the barrier posed by the enterprises’  pricing advantage. According to the Urban Institute, other options for  lenders, such as holding certain loans in portfolio, made more financial  sense as the cost of selling loans to the enterprises increased.  However, not continuing the increases as envisioned in the 2012 plan  under the Contract goal could make these options less attractive than  selling to the enterprises, according to an industry stakeholder. As a  result, lenders may focus on making loans that can be sold to the  enterprises and place less emphasis on reaching segments of the  population that do not qualify for those loans. On the other hand, lower  guarantee fees keep mortgages affordable, which has been the aim of the  Maintain goal in both the 2012 and 2014 plans.
In addition, the Reduce goal includes developing new front-end credit risk  transfers to increase the amount of risk borne by private entities. Some  industry stakeholders expressed concern that possible options for front- end credit risk transfer transactions could increase barriers to entry for  mortgage originators, depending on how the transactions are structured.  FHFA officials noted that they would be reviewing comments on how to  structure these front-end transactions after the close of the comment  period on October 13, 2016.
section_title: Whether FHFA’s Actions Reduce the Likelihood of Drawing on Treasury’s Capital Commitment Is Uncertain
paragraphs: FHFA has taken some actions that could increase the likelihood of  drawing on Treasury’s capital commitment under the agreements as well  as other actions that could have the opposite effect, and the net effect of  these actions is uncertain. Some of FHFA’s newer actions supporting the  2014 plan could increase credit risk and therefore the likelihood of  needing further assistance from Treasury. For example, one industry  stakeholder said allowing the enterprises to purchase riskier mortgages,  such as those with a 3 percent down payment and expanding the  enterprises’ service to certain underserved segments of the market, could  increase the likelihood of a draw on Treasury under the agreements.  However, the underwriting requirements for these mortgages and the fees  the enterprises collect help offset the increased risk. In addition, FHFA  officials noted that these actions currently represent a small portion of the  enterprises’ business and therefore would have a minimal impact on the  likelihood of drawing on Treasury’s funding commitment.
Several actions FHFA is taking, such as credit risk transfers and the  Single Security, would reduce the likelihood of needing additional  Treasury support, according to FHFA. These and other actions, including  private mortgage insurer standards, the representations and warranties  framework, and loss mitigation and foreclosure prevention activities,  reduce credit risk or counterparty risk to the enterprises. While FHFA  has directed the enterprises to engage in a growing set of credit risk  transfers including front-end transfers, such as deeper mortgage  insurance, the enterprises (as of 2016) have mostly conducted back-end  risk transfers. With back-end transfers, the enterprises hold the credit  risk until they complete the credit risk transfer transactions. In front-end  transactions, private entities agree to take on a portion of the credit risk  before or at the same time the loans are delivered to the enterprises.  FHFA has stated that the enterprises need to issue a large enough  volume of transactions to ensure a liquid market for credit risk transfer  products. But FHFA has also stated that the enterprises need to avoid an  excess supply of any particular product to the market that, for example,  causes investors to abandon the market because the value of their  existing holdings is reduced. Some industry stakeholders we spoke with  noted that the enterprises have not been particularly attuned to investor  demand when determining the timing, volume, and pricing of credit risk  transfer transactions. As a result, investors’ demand for credit risk transfer  transactions may not meet the volume offered, and the enterprises could  find themselves retaining more risk than planned.
The enterprises’ results from their annual stress tests have improved  each year since 2014 (see fig. 2). Although linking the changes in  results to specific actions they and FHFA have taken is difficult, these  results suggest that draws from Treasury due to negative economic  conditions are less likely than they were several years ago. FHFA officials  stated that loss mitigation actions, sales of illiquid assets from retained  portfolios, and better credit quality in newer loans all contribute to the  improved results, along with improved market factors such as house price  appreciation. According to FHFA, credit risk transfers would also have an  impact on the stress test results, even though the overall effect has been  small given that the program is in the relatively early stages. However,  the stress tests show that both enterprises would still need capital support  from Treasury under a severely adverse economic scenario. As noted  earlier, in January 2018 the enterprises’ capital reserve amount will fall to  $0 as required by the agreements with Treasury, meaning any quarterly  losses—including those due to market fluctuations and not necessarily to  economic conditions—will require additional draws from Treasury under  the agreements.
section_title: Congress Has Not Defined Objectives for Concluding the Conservatorships That Would Address Uncertainty
paragraphs: In the 8 years since the enterprises were placed in conservatorships,  Congress has not enacted legislation that establishes objectives for  concluding the conservatorships and the future structure of the  enterprises. One of the long-standing principles we have identified that  should serve as a guide for providing government assistance to private  market participants is setting clear objectives. In this case, clarity on  issues related to comprehensive housing finance system reform is  needed in order for the enterprises to exit conservatorship. According to  FHFA, setting objectives for the conclusion of the conservatorships  should be left to Congress. In a 2014 report, we outlined a framework  consisting of nine elements that Congress could use to assess or craft  proposals as it considers changes to the housing finance system. These  elements are  clearly defined and prioritized housing finance system goals; policies and mechanisms that are aligned with goals and other adherence to an appropriate financial regulatory framework; government entities that have capacity to manage risks; protections for mortgage borrowers and reductions in barriers to protection for mortgage securities investors;  consideration of cyclical nature of housing finance and impact of  housing finance on financial stability;  recognition and control of fiscal exposure and mitigation of moral  hazard; and emphasis on implications of the transition.
As noted earlier, the 113th Congress considered a number of proposals  for reforming the housing finance system, but none were enacted. Other  proposals have been introduced in the 114th Congress but have not yet  been passed by either the Senate or the House of Representatives (see  app. I). These include the Financial Regulatory Improvement Act of 2015,  S. 1484; Mortgage Finance Act of 2015, S. 495; Housing Finance  Restructuring Act of 2016, H.R. 4913; and Partnership to Strengthen  Homeownership Act of 2015, H.R. 1491. Given the unknown duration of  the conservatorships, without Congress providing explicit direction for the  future of the enterprises, a change in leadership at FHFA could again shift  priorities for the conservatorships and set the enterprises on a new path  with another vision for their role and future structure. Such changes in  direction could send mixed messages to market participants and add to  existing uncertainty.
section_title: Conclusions
paragraphs: Eight years after entering conservatorship, the enterprises’ futures remain  uncertain and billions of taxpayer dollars remain at risk. Although FHFA  has established goals for the conservatorships, its goals have been  somewhat in tension with each other. In addition, the actions taken by  FHFA to implement its goals have lacked a consistent direction over time,  and FHFA has not clarified how to balance different priorities. As we have  previously found, the federal government should set clear goals and  objectives when providing financial assistance to private market  participants. However, Congress has yet to establish objectives for the  future of the enterprises after conservatorship or the future federal role in  housing finance. Without Congress providing explicit direction for the  future of the enterprises, the conservatorships will continue. Prolonged  conservatorships and a change in leadership at FHFA could again shift  priorities for the conservatorships, which in turn could send mixed  messages and create uncertainties for market participants and hinder the  development of the broader secondary mortgage market. By setting a  clear direction for the future of the housing finance system, Congress  would enable FHFA to use the conservatorships of the enterprises to  facilitate the transition to a new structure.
section_title: Matter for Congressional Consideration
paragraphs: To reduce uncertainty and provide FHFA sufficient direction for carrying  out its responsibilities as conservator of the enterprises, Congress should  consider legislation that establishes objectives for the future federal role  in housing finance, including the structure of the enterprises, and a  transition plan to a reformed housing finance system that enables the  enterprises to exit conservatorship.
section_title: Agency Comments
paragraphs: We requested comments on a draft of this product from FHFA, Treasury,  and the previous FHFA Acting Director. The Acting Deputy Director of the  Division of Conservatorship provided us with oral comments, stating that  FHFA agreed with our overall findings. He also provided some technical  clarifications, which we incorporated as appropriate. The previous FHFA  Acting Director also provided us with technical comments in an e-mail,  which we incorporated as appropriate. Treasury did not provide  comments.
We are sending copies of this report to the appropriate congressional  committees, the Director of FHFA, and the Secretary of the Treasury. In  addition, the report is available at no charge on the GAO website at  http://www.gao.gov.
If you or your staffs have any questions about this report, please contact  me at (202) 512-8678 or evansl@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. GAO staff who made major contributions to this report  are listed in appendix II.
section_title: Appendix I: Legislative Proposals Introduced in Congress that Address the Role of Fannie Mae and Freddie Mac in the Housing Finance System—March 2013 to July 2016
paragraphs: This appendix discusses the legislative proposals that were introduced in  the United States Senate and the House of Representatives between  March 2013 and July 2016 that addressed the future structure of Fannie  Mae and Freddie Mac and the secondary mortgage market.
section_title: Appendix II: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Karen Tremba (Assistant  Director), Don Brown (Analyst-in-Charge), Giselle Cubillos-Moraga,  Rachel DeMarcus, Davis Judson, Risto Laboski, Marc Molino, Jennifer  Schwartz, Mathew Scirè (retired), Tyler Spunaugle, and Jessica Walker  made significant contributions to this report.