Housing Finance System: A Framework for Assessing Potential Changes
Released: 2014-10-07T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: Housing finance played a major role in the 2007-2009 financial crisis, and the housing sector continues to show considerable strains. The federal government's role in the single-family housing finance system has also grown substantially. As a result, policymakers and others have made proposals to change the system. To help policymakers assess various proposals and consider ways to make it more effective and efficient, this report (1) describes market developments since 2000 that have led to changes in the federal government's role in the single-family housing finance system; (2) analyzes whether and how these market developments have challenged the housing finance system; and (3) presents an evaluation framework for assessing potential changes to the system.

GAO reviewed literature on housing finance and housing market developments as well as prior GAO reports presenting frameworks for reform in the financial sector and criteria for improving government performance. GAO also met with officials from a number of federal agencies. Based on the literature review and interviews, GAO developed a draft framework that it shared with seven discussion groups composed of government officials, experts from academia and research organizations, and interested parties such as consumer advocates and industry representatives. The discussants provided input on market developments and the framework.

section_title: What GAO Found
paragraphs: Developments in the single-family housing finance market from 2000-2013 led to changes in the federal government's role in the housing finance system and ultimately to a significant increase in that role. For example,

Before the 2007-2009 financial crisis, the market share of nonprime mortgages—loans often made to borrowers with high-risk characteristics and funded by mortgage backed securities (MBS) issued by private institutions without a federal guarantee (private-label MBS)—grew but fell dramatically during the crisis.

As this market segment grew the share of new mortgage originations (refinances and purchase loans) insured by federal entities—the Federal Housing Administration and the Departments of Veterans Affairs and Agriculture—fell from 11 percent in 2000 to less than 3 percent of the value of new originations in 2006 but, with the onset of the crisis, the market share of these mortgages rose as high as 25 percent before declining to 20 percent of the market in 2013.

The market share of new mortgages backing MBS guaranteed by Fannie Mae and Freddie Mac (the enterprises) fell from 36 percent in 2000 to 27 percent in 2006 but stood at 61 percent in 2013.

In 2008, when the enterprises' weakened financial condition led to their being placed into conservatorship, the federal government's support for them became explicit .

In 2013 the federal government was providing support either directly or indirectly for 81 percent of the value of all new mortgages. In addition, during the crisis, the Federal Reserve System and the Department of the Treasury began purchasing MBS issued by the enterprises. The Federal Reserve System began reducing these purchases in January 2014, and Treasury completed the sale of its MBS investments in fiscal year 2012.

Developments in mortgage markets since 2000 have challenged the housing finance system and revealed or led to weaknesses in that system including misaligned incentives, an overall lack of reliable information or transparency, and excessive risk taking. For example

Originators' and private-label securitizers' incentives were not aligned with those of borrowers and investors, because originators and private-label securitizers generally did not retain credit risk.

Some borrowers lacked reliable and relevant information to adequately understand the risks of mortgage products because originators were not required to share certain information.

A loosening of underwriting standards prior to the financial crisis likely led to excessive risk taking by borrowers.

Limitations in federal oversight of housing market participants exacerbated these weaknesses, though Congress has taken some steps designed to address these limitations. The Federal Housing Finance Agency and Bureau of Consumer Financial Protection (known as the Consumer Financial Protection Bureau) were

created to address regulatory gaps, including oversight of the enterprises and consumer protection. These agencies have taken steps designed to oversee the enterprises, protect consumers, and provide better information to the public. However, representatives of market participants said that they faced uncertainties because some regulations had not been implemented, and Congress was considering further changes to the system.

In light of the substantial increase in federal support of the single-family housing finance system and weaknesses revealed during and after the financial crisis, some experts believe the U.S. housing finance system warrants reform. In addition, GAO has identified the federal role in housing finance as a high risk area. GAO is providing a framework to help assess proposed changes in the housing finance system. This framework is comprised of nine elements (see table), and certain characteristics—transparency, accountability, aligned incentives, and efficiency and effectiveness—need to be addressed throughout the elements. Applying the elements of this framework should help reveal the relative strengths and weaknesses of any proposal for change and identify what are likely to be significant trade-offs among competing goals and policies. Similarly, the framework could be used to craft new proposals. Finally, the framework should help policymakers understand the risks associated with transitioning to a new housing finance system.

section_title: Letter
paragraphs: Housing finance played a major role in the 2007-2009 financial crisis, and  the housing sector, which is an important part of the overall U.S.  economy, continues to show considerable strains. In the years since the  crisis began, mortgages supported by the federal government, directly or  indirectly, have accounted for over three-quarters of the value of new  originations in the single family housing market. Mortgages receiving  support included loans guaranteed or insured by the Federal Housing  Administration (FHA) and the U.S. Departments of Veterans Affairs (VA)  and Agriculture (USDA) and those securitized by Fannie Mae and Freddie  Mac (the enterprises), which guarantee the timely payment of principal  and interest on those mortgage-backed securities (MBS). The federal  government also provides support for mortgages through Ginnie Mae,  which guarantees the timely payment of principal and interest of MBS  supported by pools of loans insured by FHA, VA, and USDA. Recognizing  the large role played by the federal government in the housing finance  market and continuing challenges that were not addressed by the Dodd- Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank  Act), we have placed the housing finance system on our high-risk list. In  part, as a result of concerns about the government’s role in housing  finance, many proposals have been introduced, both in Congress and  elsewhere, to change the single-family housing finance system.

To help policymakers assess various proposals for changing the single- family housing finance system and consider ways in which the system  could be made more effective and efficient, we prepared this report under  the authority of the Comptroller General. Specifically, this report (1)  describes market developments since 2000 that have led to changes in  the federal government’s role in single-family housing finance; (2)  analyzes whether and how these market developments have challenged  the housing finance system; and (3) presents an evaluation framework for  assessing potential changes to the housing finance system.

To meet these objectives, we reviewed literature, including prior GAO  reports, on housing finance and housing market developments, as well as  prior GAO reports presenting frameworks for reform in the financial sector  and reports that contain criteria for improving government performance.  We also met with officials from the Bureau of Consumer Financial  Protection known as the Consumer Financial Protection Bureau (CFPB),  Federal Deposit Insurance Corporation (FDIC), Federal Housing Finance  Agency (FHFA), Board of Governors of the Federal Reserve System  (Federal Reserve), Office of the Comptroller of the Currency (OCC),  Securities and Exchange Commission (SEC), and Departments of  Housing and Urban Development (HUD), Treasury (Treasury), USDA,  and VA. Based on our literature review and meetings with officials, we  developed a draft framework, which we shared with seven discussion  groups to gather input on market developments and the framework. The  groups were comprised of government officials, experts from academia  and research organizations, and other relevant parties, such as consumer  advocates and industry representatives. The experts and interested  parties were chosen because they had made reform proposals, written or  testified before Congress on housing finance reform issues, or been  recommended by government officials. We also reviewed proposals for  changing the housing finance system including legislative proposals and  those made by groups that participated in our discussion groups. We  used examples from these proposals to show how the framework  elements can be used to assess potential changes. See appendix I for  more information on the scope and methodology for this report.

We conducted this performance audit from August 2013 to October 2014  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
paragraphs: The U.S. markets for single-family housing finance are complex and have  numerous public and private participants. The housing finance markets  include a primary market, in which lenders make loans to borrowers, and  a secondary market, in which mortgage loans are purchased from lenders  and packaged into securities that are sold to investors. Thus, a single  mortgage is often owned or held by many different parties before the  mortgage terminates. Figure 1 provides an overview of the lifecycle of a  mortgage. The federal government participates in the primary and  secondary mortgage markets as both an actor and a regulator, to  promote home ownership and stabilize housing markets. The federal  government also regulates certain aspects of mortgage servicing.
subsections: section_title: The Primary Mortgage Market Connects Borrowers and Lenders
paragraphs: When individuals purchase residential real property with borrowed funds,  they usually enter into a contractual agreement, typically called a  promissory note, in which they agree, among other things, to make  principal and interest payments to the originating lender for a period of  time. To secure their debt, lenders obtain a lien on the underlying  property as collateral against borrower default, which grants the holder of  the lien the right to seize, and usually sell, the property should the  borrower fail to pay. In other words, what may be commonly referred to  as a mortgage consists of both a promissory note evidencing the debt to  be paid by the borrower and the lien or security interest in the underlying  property, which generally is provided for in a deed of trust or a mortgage  document. Equity is a homeowner’s financial interest in a property, or the  difference between the value of a property and the amount owed on the  mortgage. Borrowers may make an initial down payment as a means of  building equity. Home equity can increase over time if the mortgage  balance is paid down or the value of the home appreciates. Borrowers  who owe more on their mortgages than their properties are worth  (negative equity) are commonly referred to as “underwater.”

In the primary market, lenders originate mortgages for borrowers to  purchase homes, refinance existing mortgages, or to extend loans or  lines of credit to borrowers based on the amount of equity the borrower  has accumulated (called home equity loans or home equity lines of credit,  known as HELOCs). Mortgages vary in terms of the interest rates  charged and terms of the loan. Prime mortgages have the most  competitive interest rates and terms and have generally been reserved for  borrowers with strong credit histories and the ability to make required  down payments. Nonprime mortgages include subprime and Alt-A loans,  which have higher interest rates and fees than prime loans. Historically,  subprime mortgages have been offered to borrowers who do not qualify  for a prime loan, while Alt-A loans have been offered to borrowers who  have some higher-risk characteristics, such as limited documentation of  income or assets. However, prior to the financial crisis some borrowers  who qualified for prime mortgages also were steered toward nonprime  loans. Borrowers may be eligible for federally insured or guaranteed  mortgages, which have interest rates that are similar to those of prime  loans, but require borrowers to pay insurance premiums (FHA) or  guaranty fees (USDA and VA). Some borrowers who do not qualify for  prime loans, such as those unable to meet down payment or credit history  requirements, may qualify for these loans. The most common mortgage  length is 30 years, but mortgages can have shorter or longer terms in  some cases. Borrowers with equity in their homes can refinance their  mortgages (pay off the current loan early by taking out a new mortgage  loan) in order to lower their interest rate, change the length of their  mortgage, or get more favorable terms. However, some lenders charge a  prepayment penalty if a mortgage is paid off early. If the equity in the  home has increased since the loan was originated, homeowners may be  able to take out a loan larger than the principal balance, sometimes called  a cash-out refinance mortgage. Figure 2 provides additional information  about mortgage originations.

Mortgage originators offer a range of loan products to borrowers in the  primary market, but most mortgages fall into one of two categories:

Fixed-rate mortgage loan—the interest rate does not change over the  life of the loan. Fixed-rate loans generally have fully amortizing  payment schedules, where equal monthly payments pay off the full  principal balance over the term of the loan.

Adjustable-rate mortgage loan (ARM)—the interest rate changes  periodically over the life of the loan based on changes in a specified  index. Initial interest rates are generally lower on these mortgages  than for fixed-rate loans but can rise or fall over the course of the  term. Typically, an ARM’s interest rate will adjust at agreed-upon  intervals, adjustments to the interest rate will be based on a specific  index rate, and the adjusted rate will fall within a maximum and  minimum range. Prior to the financial crisis, the nonprime market  began to offer a number of nontraditional products with adjustable  rates that had previously been available only in the prime market. For  example, the interest rates on hybrid ARM loans are fixed during an  initial period and then become adjustable for the remaining term of the  loan. Another type of loan, payment-option ARM loans, allowed  borrowers to defer payment of the principal or the accrued interest,  meaning that the balance of the loan could increase over time.

Mortgages create a number of risks for market participants including:

Credit risk is the risk that a borrower will default on the mortgage by  failing to make timely payments. Credit risk can vary based on  borrower characteristics and the terms of the mortgage. For example,  the lower the down payment made by a borrower relative to the value  of the house, the higher the credit risk associated with the loan.  Interest-rate risk is the risk that an increase in interest rates will  reduce the value of a loan. For example, if a mortgage lender is  funded by short-term deposits, and interest rates rise, the cost of the  lender’s funds increase. If the lender had previously made a long-term  fixed-rate mortgage at a lower rate, the difference between the  interest the lender receives from the mortgage payments and the  interest the lender pays its depositors decreases. Fixed-rate loans  have greater interest rate risk for lenders than ARMs.

Prepayment risk is the risk that mortgage borrowers will pay off the  principal of the loan before the term of the mortgage ends.  Prepayment of some or all of the principal balance reduces or  eliminates future interest payments, and requires lenders to relend or  reinvest the principal that was prepaid. Prepayment may be a result of  borrowers refinancing when interest rates decrease, and in these  cases, the lender may have only lower-interest options for lending or  investing the funds.

Mortgage lenders evaluate the creditworthiness of potential borrowers  (called underwriting), and make mortgage loans using funds raised from  deposits, securitization, and other sources. Borrowers generally access  mortgage lenders through three major channels—mortgage brokers, loan  correspondents, and retail lenders. Lenders, such as credit unions,  banks, and thrifts, can fund their mortgages with deposits, but also may  receive funding from the secondary market, discussed in greater detail  later in this report, and the Federal Home Loan Bank (FHLBank) System.  The FHLBank System is a government-sponsored enterprise that  consists of 12 FHLBanks and the Office of Finance, the FHLBanks’ fiscal  agent. Each FHLBank is cooperatively owned by member financial  institutions, typically commercial banks and thrifts. The FHLBanks borrow  funds by issuing debt securities in capital markets and provide low-cost,  long- and short-term advances (loans) to member institutions, which use  the loans to fund mortgages and maintain liquidity for their operations.  Member institutions provide the FHLBanks with mortgages or other  qualifying loans and securities, as collateral for the advances. If a  member institution fails, the FHLBank generally gets repaid before many  other creditors; depending on the agreement, the FHLBank may be able  to draw on the majority of the financial institution’s assets in addition to  the collateral provided for the advances for repayment.

Private financial institutions and the federal government facilitate  mortgage lending by insuring mortgages that meet certain criteria against  default or guaranteeing lenders payment of principal and interest.  Generally, lenders require borrowers to purchase private mortgage  insurance when the initial loan-to-value (LTV) ratio of the mortgage (the  amount of the mortgage loan divided by the value of the home) exceeds  80 percent. The enterprises require that loans they purchase with LTV  ratios in excess of 80 percent have a credit enhancement mechanism,  such as private mortgage insurance. Generally, loans with higher LTV  ratios have a greater risk of default and may experience greater loss  severity in the event of a default. FHA operates the largest federal  mortgage insurance program, which is backed by the full faith and credit  of the federal government. FHA insures the full value of mortgages made  by private lenders for borrowers making down payments of at least 3.5  percent. The purpose of FHA’s mortgage insurance is to encourage  lenders to make mortgages available to borrowers, including those who  would not otherwise qualify, such as low-income and first-time  homebuyers. Congress has set limits on the size of loans eligible for FHA  insurance, and these limits have varied over time. For example, when the  recent financial crisis and economic recession set in and other segments  of the mortgage market contracted, Congress increased the loan amounts  eligible for FHA insurance. In 2014, FHA’s mortgage limits for single- family houses ranged from the national standard of $271,050, to  $625,500 for other higher cost areas, and to $938,250 for certain areas  outside of the 48 contiguous states such as Alaska, Hawaii, and Guam.  Borrowers pay up-front and ongoing insurance premiums that go to FHA’s  Mutual Mortgage Insurance Fund to cover the estimated long-term costs  of the program. In fiscal year 2013, FHA reported that it insured more  than 1.3 million new mortgages representing approximately $240 billion in  mortgage insurance coverage on forward mortgages. This brought the  total loans insured to more than 7.8 million, and FHA reported that its total  amortized insurance-in-force on mortgages at the end of fiscal year 2013  was $1.09 trillion.

The federal government also administers two other mortgage insurance  programs, through VA and USDA. The VA Home Loan Guaranty program  provides financial incentives for private lenders to offer eligible  servicemembers and veterans of the U.S. armed forces mortgages with  certain favorable terms, such as not requiring a down payment or private  mortgage insurance. Depending on the size of the loan, VA guarantees  between 25 and 50 percent of the mortgage loan in the event that a  borrower defaults, providing lenders with protection against some of the  losses that may be associated with making these loans. Most veterans  receiving guaranteed loans pay a funding fee of up to 3.3 percent of the  loan amount, but the program also receives funding through federal  appropriations. As of September 30, 2013, the outstanding principal of  VA’s guaranteed loans was $339 billion, but VA had only guaranteed $89  billion of that amount. USDA administers the Section 502 Guaranteed  Rural Housing Loan Program, which is designed to serve rural residents  who have low or moderate incomes and are able to afford mortgage  payments but are unable to obtain adequate housing through  conventional financing, by guaranteeing loans made by commercial  lenders. In 2013, the principal of new loans supported by USDA  guarantees was $22.3 billion and the outstanding principal of all  guaranteed loans was $89.7 billion.

Borrowers can also take advantage of tax exclusions and deductions  (including the mortgage interest deduction) to facilitate the purchase of a  home. Because of the total dollar amounts provided, these tax  expenditures represent a major element of the federal government’s role  in the markets for housing finance. The most significant of these tax  expenditures is the deduction for mortgage interest, through which  taxpayers who itemize deductions may deduct the interest they pay on  loans secured by qualified homes—either their primary residence or their  primary residence and a second home. Generally, taxable income may  be reduced by the amount of interest paid on first and second mortgages  of up to $1 million, plus home equity indebtedness of up to $100,000.

The mortgage interest deduction has been estimated to result in $67.8  billion in forgone tax revenue in 2014.

The federal government has established regulatory standards, which are  enforced by federal regulators, for mortgage lending in the primary  market. CFPB and the federal banking regulators are involved in the  examination and enforcement of these regulatory requirements.  Significant examples of federal statutes in the mortgage market include:

The Truth in Lending Act (TILA), which was designed to provide  consumers with accurate information about the cost of credit.  Among other things, TILA requires lenders to disclose information  about the terms of loans—including the amount financed, the finance  charge, and the annual percentage rate—that can help borrowers  understand the overall costs of their loans. The Dodd-Frank Act  reformed mortgage lending by amending TILA to include, among  other things, provisions affecting (i) underwriting (for example, the  ability of borrowers to repay their loans); (ii) servicing; (iii) loan  originator compensation; and (iv) escrows and appraisals.

The Real Estate Settlement Procedures Act of 1974 (RESPA), which  was enacted to provide more effective advance disclosure regarding  mortgage loan settlement costs to homebuyers and sellers, requires  lenders to provide consumers with certain disclosures during the  mortgage application and closing transaction. These disclosures  previously included a Good Faith Estimate form given within three  days after a mortgage application is received and a uniform  settlement statement given at the loan closing. Regulations  implementing RESPA were revised in 2008. The Dodd-Frank Act  also made significant changes to RESPA, including transferring  rulemaking authority for RESPA from HUD to CFPB and requiring  CFPB to issue rules to integrate the disclosures required by TILA and  RESPA.

section_title: The Secondary Market Provides Liquidity and Reduces Risk for Mortgage Lenders
paragraphs: In the secondary market, institutions purchase loans from primary market  originators and then either hold the loans in their own portfolios or bundle  the loans into MBS that are sold to investors. Mortgage originators may  sell their loans to transfer risk (especially interest rate risk in the case of  fixed-rate mortgages) or to increase liquidity. When loans are sold, they  are generally packaged together into pools and held in trusts pursuant to  terms and conditions set out in an underlying pooling and servicing  agreement. Pools of loans are the assets backing securities that are  issued and sold to investors, who are entitled to the cash flow generated  by loans in the trust. The terms of the contracts defining the rights  associated with MBS typically include representations and warranties  about the mortgage loans that have been securitized. The investors  assume the interest rate, prepayment, and credit risk associated with the  loans (to the extent that credit losses are not covered by mortgage  insurance or guarantees of MBS). The enterprises are the two largest  participants in the secondary market. Other participants include Ginnie  Mae (a federal agency within HUD that guarantees the timely payment of  principal and interest on MBS backed by government-insured mortgages),  issuers of Ginnie Mae-backed MBS, issuers of private label MBS, and  investors. (Fig. 3 provides an overview of mortgage securitization in the  secondary mortgage market.)

The enterprises are congressionally chartered, for-profit, shareholder- owned companies that have been under federal conservatorship since  2008. Generally the enterprises purchase mortgage loans that meet  certain criteria for size, features, and underwriting standards known as  “conforming” loans. However, prior to the crisis, the enterprises  purchased a large volume of loans that did not meet these standards.  After purchasing mortgages, the enterprises create MBS and guarantee  investors in these securities that they will receive timely payments of  principal and interest. These bonds have generally paid a lower rate of  interest than corporate bonds that posed comparable risks, in part,  because investors generally believed that these bonds had an implicit  guarantee by the federal government. Prior to being placed into  conservatorship in 2008, the enterprises raised capital through the  issuance of common and preferred stock. In conjunction with the  conservatorships, Treasury entered into agreements to provide capital  support to the enterprises to enable them to continue to provide liquidity  and stability to the mortgage market. As of March 31, 2014, Treasury had  outlays of $187.5 billion to the enterprises through purchases of senior  preferred stock. Through its Senior Preferred Stock Purchase  Agreements, Treasury collects dividend payments from the enterprises,  which have reported paying $202.9 billion in dividend payments from  2008 through March 31, 2014.

Private institutions are also involved in the creation of MBS. These  institutions, primarily investment banks, purchase mortgages that do not  conform to the enterprises’ purchase requirements because the  mortgages are too large or do not meet specified underwriting criteria,  and loans that are federally insured. Securities issued by these  institutions that are backed by loans that do not meet the enterprises’ loan  limits or quality standards are called “private-label securities.” Such loans  may include subprime and Alt-A mortgages. Other securities issued by  approved private financial institutions are backed by government- guaranteed mortgages, such as those insured by FHA, and Ginnie Mae  guarantees the timely payment of principal and interest of these MBS.

Ginnie Mae’s guarantee is explicitly backed by the full faith and credit of  the federal government.

MBS issued by the enterprises or guaranteed by Ginnie Mae trade in  different segments of the secondary market from private-label securities.  MBS issued by the enterprises or guaranteed by Ginnie Mae are typically  purchased by investors through the to-be-announced (TBA) market. A  TBA trade is a forward contract in which the specific mortgages in the  MBS that are being purchased are not known until 2 days before the  trade is settled. TBA trades allow the enterprises and issuers of Ginnie  Mae guaranteed securities to provide lenders with the sale price at which  they will purchase conforming and government guaranteed loans, prior to  the mortgages being originated. This allows mortgage lenders essentially  to sell the loans they intend to fund even before the loans are closed. In  turn this allows lenders to lock in the mortgage rate for the borrower  before the loan is finalized. Private-label MBS are traded in the “specified  pool” segment of the secondary market, where the exact securities to be  delivered are known at the inception of the trade. Investors in MBS  include financial institutions, pension funds, and other institutional  investors, such as insurance companies and managers of other complex  structured finance products known as collateralized debt obligations  (CDO), which consist of MBS and other securities.

The federal government regulates the enterprises and private issuers of  MBS are subject to federal securities laws and regulations. FHFA was  created by the Housing and Economic Recovery Act of 2008 (HERA) to  supervise and regulate the enterprises and the FHLBank System. FHFA  is an independent agency that took over the oversight of the enterprises  from the Office of Federal Housing Enterprise Oversight, formerly an  independent entity within 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.  FHFA is managing the conservatorship of the enterprises. FHFA also  took over the responsibilities of the Federal Housing Finance Board that  oversaw the FHLBanks. Private issuers of MBS must either file a  registration statement that meets SEC’s disclosure requirements or rely  on an exemption from registration. Securities issued by the enterprises or  guaranteed by Ginnie Mae are exempt from these registration  requirements. Ginnie Mae has processes in place to oversee issuers of  securities eligible for Ginnie Mae guarantees that include approval,  monitoring, and enforcement. The Dodd-Frank Act also created new  requirements for issuers of MBS related to conflicts of interest, credit risk  retention, disclosures and reporting, reviews of underlying assets, and  representations and warranties. SEC has proposed or finalized rules  addressing these areas, jointly with other agencies when directed by the  act.

section_title: Mortgage Servicers Manage Loans After Origination
paragraphs: After they are originated, mortgages are serviced until they are either paid  in full or closed as a result of nonpayment. Servicing can involve sending  borrowers monthly account statements and tax documents, answering  customer service inquiries, collecting monthly mortgage payments,  maintaining escrow accounts for property taxes and hazard insurance,  and forwarding proper payments to the mortgage owners. Figure 4  provides an overview of the mortgage servicing process. In the event that  a borrowers becomes delinquent on their loan payments, servicers may  initiate a workout option to allow the borrower to stay in the home or  conduct a foreclosure to obtain the proceeds from the foreclosure sale on  behalf of the owners of the loans. In some cases, the servicer is the same  institution that originated the loan. However, servicers may change over  the life of the mortgage, as servicers sell servicing rights to other  institutions. Third-party mortgage servicers, which can be mortgage  finance companies or commercial banks that are also originators, earn a  fee for acting as the servicing agent on behalf of the owner of a loan. If a  mortgage originator sells its loans to an institution that will securitize  them, another financial institution or other entity is usually appointed as  the servicer to manage payment collections and other activities  associated with these loans.

The duties of servicers are specified through several means. The  enterprises specify in servicing guidelines what they expect of servicers  for loans backing their MBS. Also, servicing requirements for some  government-backed loans are specified by the federal agencies backing  the mortgages. Finally, as part of private-label securitizations, investors  and servicers enter into pooling and servicing agreements that specify  what investors expect of servicers. These pooling and servicing  agreements can vary widely, but may mirror the servicing guidelines  issued by the enterprises. However, there is no standard pooling and  servicing agreement that is used for all private-label MBS. CFPB, which  was created by the Dodd-Frank Act, has primary enforcement authority to  assess compliance with mortgage servicing rules under TILA and RESPA  with regard to large depository institutions and credit unions and their  affiliates. FDIC, the Federal Reserve, National Credit Union  Administration, and OCC are responsible for enforcing the mortgage  servicing rules under TILA with respect to depository institutions and  credit unions that have $10 billion or less in assets. The Federal Trade  Commission and CFPB generally both have enforcement authority over  nondepository institutions for mortgage servicing rules under TILA.

section_title: Mortgages Terminate When They Are Paid in Full or After They Go into Default
paragraphs: Generally, mortgages terminate when borrowers pay off their mortgage  debt or after borrowers default on their loans (see fig. 5). Borrowers can  pay off the mortgage debt by making payments of principal and interest or  by refinancing the mortgage for a new loan, usually with lower interest  rates. Generally, if a borrower fails to make a payment for 90 days,  mortgage loans go into default. When a borrower defaults on a mortgage  loan, the mortgage note holder is entitled to pursue foreclosure for the  property, obtain title to the property, and sell it on behalf of the mortgage  owner to repay the loan. However, under CFPB rules issued in 2013,  servicers, with limited exceptions, cannot initiate a foreclosure until a  borrower is more than 120 days delinquent. Once the borrower is in  default, the servicer must decide whether to pursue a home retention  workout or other foreclosure alternative or to initiate foreclosure. Home  retention workouts include loan modifications, through which temporary or  permanent changes are made to the terms of the existing loan  agreement, either by capitalizing the past due amounts, reducing the  interest rate, extending the loan term, reducing the total amount of the  loan through principal forgiveness or forbearance, or a combination of  these actions. Foreclosure alternatives include short sales, in which a  house is sold through a real estate agent or other means rather than  through foreclosure, even if the proceeds of the sale are less than what  the borrower still owes on the mortgage. Mortgage holders may agree to  accept the proceeds of a short sale and may waive any deficiency. Under  a deed-in-lieu of foreclosure, the homeowner voluntarily conveys the  interest in the home to the lender to satisfy a loan that is in default as an  alternative to foreclosure proceedings. Mortgage holders may opt to  accept ownership of the property in place of the money owed on the  mortgage and may waive any deficiency. Deeds-in-lieu will generally not  be accepted by a mortgage holder if there are other liens on the property,  as foreclosure may be necessary for the mortgage holder to gain clear  title.

section_title: Market Developments since 2000 Have Changed the Government’s Role in Housing Finance
paragraphs: Since 2000, home prices have fluctuated dramatically, in part reflecting  developments in the underlying housing finance market such as the  growth of nonprime mortgages. These developments led to changes in  the government’s role throughout the period and ultimately to a significant  increase in that role. In 2000, the federal government directly supported  about $118 billion (11 percent) of the estimated value of new mortgage  originations for home purchase and mortgage refinancing through  government-insured or -guaranteed loans in the primary market. In that  same year, the enterprises supported about $376 billion (36 percent), of  the estimated value of new mortgage originations through their  guarantees on MBS they issued. These roles declined in the years just  prior to the 2007-2009 financial crisis when government-insured or - guaranteed mortgages made up about 3 percent of the market and those  supporting enterprise MBS about 27 percent. During the crisis, the  government’s role in supporting mortgage originations expanded and has  remained relatively high. The share of the primary market insured or  guaranteed by the federal government grew and the share of mortgages  backing MBS securitized by the enterprises also grew, reaching highs in  2009 of about 25 and 67 percent, respectively. As mentioned earlier in  this report, the federal government also placed the enterprises into  conservatorship in 2008. As a result, by 2009, mortgages supported by  the federal government, directly or indirectly, reached a peak of about  $1.7 trillion (93 percent) of the total value of new originations. By 2013,  the market share of those mortgages supported by the federal  government had dropped to 81 percent—about 20 percent guaranteed or  insured directly by the government and about 61 percent backing  enterprise MBS. However, the percentage of loans supported by the  federal government was still well above the 47 percent of the value of  new mortgage originations supported by government-guaranteed or - insured loans and those backing enterprise MBS in 2000. In addition, in  response to the financial crisis, the Federal Reserve has provided  additional support for the mortgage market by becoming one of the  largest purchasers of enterprise MBS.
subsections: section_title: Home Prices and Homeownership Rates Fluctuated since 2000
paragraphs: Nationally, U.S. home prices nearly doubled between January 2000 and  their peak in April 2006 (see fig. 6). However, price changes varied  across local markets. For example, home prices rose by more than 174  percent in the Los Angeles metropolitan area and by 27 percent in the  Detroit metropolitan from 2000 to their respective peaks in 2006 and  2005, according to data from the S&P/Case-Shiller Home Price Indexes.  The volume of home sales rose rapidly during this period as overall  homeownership rose and many people purchased homes other than their  primary residences, some for investment purposes. Researchers and  others have noted that the increases in house prices prior to the financial  crisis may have reflected an asset bubble. Beginning in May 2006,  however, prices began falling, and across the country tumbled by nearly  33 percent from peak to trough. Prices fell even further in some areas  such as the Los Angeles metropolitan area, which experienced a 42  percent decline from peak to trough. National average home prices began  rising in 2011 and continued rising through 2013, bolstered by low interest  rates and housing inventories as well as improving economic factors.

The homeownership rate generally increased between 2000 and 2004 but  has fallen steadily since the financial crisis due to fewer potential  homeowners entering the market and an increase in home foreclosures.  In the fourth quarter of 2000 the homeownership rate was 67.5 percent.  The rate peaked in the fourth quarter of 2004 at 69.2 percent and has  fallen steadily since. As of the end of 2013, the homeownership rate was  65.2 percent. According to The State of the Nation’s Housing 2013, the  declines in homeownership rates have been more pronounced among  certain groups, in particular, families with children and within the African- American and Hispanic communities.

Home prices and homeownership rates are influenced, in part, by  demographic and economic trends. According to some housing market  experts, some of the demographic and economic trends influencing the  housing market in 2013 include later household formation, stagnant  incomes, and changes in the demand for rental housing. However, an  FDIC official noted that the timing of household formation and demand for  rental housing may be the result of changes in the for-sale market.  Experts also suggest that longer demographic trends, such as increases  in the proportion of the population that is 65 or over and those classified  as minorities, may affect homeownership rates in the future. For example,  minorities will make up an increasing share of young households but face  greater constraints than other groups due to lower income and wealth.  As a result, demand for first homes may decrease. A former Chairman of  the Federal Reserve also noted in 2012 that some potential minority  borrowers also may face discrimination either because lenders  discriminate against minority neighborhoods or charge minorities higher  loan prices than they would comparable nonminority borrowers. Other  factors such as high unemployment and student loan debt could also  have an impact on the housing market and homeownership. The U.S.  average unemployment rate rose to over 9 percent in 2009 and 2010  before beginning to decline; in 2013, the average unemployment rate was  7.4 percent. The percentage of students with student debt as well as the  average size of that debt has increased over the period since 2003,  potentially making it more difficult for younger borrowers to qualify for a  mortgage loan or afford to own a home.

section_title: Developments in the Primary Market since 2000 Have Affected the Government’s Role in Housing Finance
paragraphs: Changes in home prices and changes in the housing finance market have  affected the government’s role in housing finance. Changes in the primary  market generally fell into three time periods: 2000-2003, 2004-2006, and  2007 and thereafter (see fig. 7). In the first period, a period of low interest  rates, prime mortgages made up the vast majority of all mortgages.  However, in the second period the market share of nonprime mortgages  increased dramatically to a peak of 34 percent of all mortgage  originations in 2006, including purchases and refinancing. The value and  market share of mortgages insured or guaranteed by the U.S.  government also fell during this period, largely due to the availability of  nonprime mortgages. Specifically, the share of government-insured or - guaranteed mortgages—those directly supported by the government—fell  from 11 percent in 2000 to less than 3 percent of the value of all new  mortgage originations in 2006. From 2008 through 2013, average total  originations declined to around $1.7 trillion per year from more than $2.7  trillion per year on average between 2000 and 2006. However, prime and  government insured or -guaranteed mortgages have dominated the  market since 2008. In 2013, prime mortgages accounted for 76 percent of  the value of all mortgage originations and government-insured mortgages  for 20 percent of the value of all mortgage originations.

In addition to changes in the market shares of mortgage products, the  overall size of the mortgage market and the division between loans for  new mortgages and those that were refinancing existing mortgages  shifted between 2000 and 2013. Early in the period, the overall value of  mortgages rose because, from 2000 through 2003, many homeowners  refinanced their existing mortgages to take advantage of falling mortgage  rates (see fig. 8). As the decline in mortgage rates slowed, and then  began to rise, refinances declined and purchase loans for new homes  grew as a percentage of the value of all originations. After 2007, the  overall value and number of mortgage originations declined. To  encourage spending, the Federal Reserve lowered interest rates, which in  turn lowered mortgage rates and spurred refinancing activity. In 2013,  refinancing volumes decreased as mortgage rates rose. However,  refinances continued to represent the majority of origination activity,  accounting for about 43 percent of the value of FHA originations and  about 71 percent of the value of originations securitized by the  enterprises in 2013.

Before the financial crisis, many borrowers withdrew equity from their  homes. HELOCs, which draw down the home’s equity when borrower’s  use them, were popular (see fig. 7), and some borrowers refinanced with  cash-out refinance mortgages with which they converted increased equity  into cash by taking out a loan larger than the remaining loan balance.  Data from Freddie Mac for a sample of loans retained in their portfolio  show that between 2004 and 2007, homeowners cashed out  approximately $966 billion in home equity and that in 2006, cash-out  refinances accounted for nearly 30 percent of all refinances in Freddie  Mac’s portfolio. At the same time, many new nonprime mortgages had  features that made it more difficult to accumulate home equity and to  refinance with new loans.

The years from 2008 through 2011 were the first in which aggregate  home mortgage debt exceeded home equity since the data were first  collected in 1945 (see fig. 9). During this period a significant number of  homeowners found themselves underwater on their mortgages—in a  situation in which they owed more than the home was worth—because of  the substantial decline in home prices and trailing declines in mortgage  debt. The fall in mortgage debt since 2009 has been attributed to defaults  on existing mortgage loans by financially distressed borrowers,  consumers generally paying down debt, and tightened lending standards  that contributed to a decline in home purchases and less accumulation of  debt. As of December 2011, national home equity (the difference  between aggregate home value and mortgage debt owned by  homeowners) was approximately $3.7 trillion less than total home  mortgage debt. In 2013 home equity rose past home mortgage debt  again, and, as of the end of 2013, aggregate home equity exceeded  aggregate home mortgage debt by approximately $655 billion.

The financial crisis resulted in increased mortgage defaults and  foreclosures. From 1979 until 2007, mortgage performance had been  relatively stable and the rates of default and foreclosure inventory—the  percentage of total mortgage loans in foreclosure—were below 1 or 2  percent, respectively (see fig. 10). But after the financial crisis, the rates  of default and foreclosure rose to historic levels—defaults peaked at 5  percent of mortgages at the end of 2009 and the foreclosure inventory  peaked at 4.6 percent of mortgages in the first quarter of 2010—before  beginning to decline. While defaults and foreclosures have declined, more  than 1.15 million homes were in foreclosure at the end of 2013, according  to data from the Mortgage Bankers Association.

Although the government’s role in the primary market had declined  between 2004 and 2006, reaching a low of less than 3 percent of  originations in 2006, the 2007-2009 financial crisis and the accompanying  rapid increase in foreclosures reversed this trend. The government took  steps to mitigate the effect of the economic downturn and increase  access to mortgage credit by increasing loan limits for FHA-insured  mortgages and mortgage loans eligible for securitization by the  enterprises. Considering only new mortgage originations, the share of  mortgages that were federally insured grew relative to those that were  privately insured or uninsured from 2007 to 2009 (see fig. 11). By 2009,  over 85 percent of all new insured mortgages were insured by FHA or  guaranteed by VA and USDA. In an effort to help troubled homeowners  and stem the increase in foreclosures, the government also introduced  several emergency programs, including the Home Affordable Modification  Program. As of November 2013, about 1.3 million borrowers had  entered into a permanent loan modification through this program, and, to  increase participation, the program deadline has been extended through  December 2016. As of the end of 2013, defaults and foreclosure rates  were continuing to improve, but many homeowners continued to be at risk  for foreclosure, and government-guaranteed and -insured mortgages and  mortgages eligible for securitization by the enterprises continued to be the  primary options for borrowers.

section_title: Developments in the Secondary Market Have Also Affected the Government’s Role in Housing Finance
paragraphs: Until 2009 the securitization rate of mortgage originations generally had  been increasing. Over the period from 2000 through 2013, the rate began  at 50 percent in 2000, peaked at 84 percent in 2009, and ended at 79  percent in 2013 (see fig. 12).

Over that same period, FHLBank advances, which can be an alternative  to securitizations as a source of liquidity for mortgage originations, also  varied. According to the FHLBanks’ financial statements, advances,  which had been rising prior to the financial crisis, rose by over 35 percent  between 2006 and 2007 and continued to rise into 2008, reaching an end  of year value of about $929 billion. Since the crisis, advances have  generally declined to levels consistent with those in the early 2000s. At  the end of 2013 advances were almost $500 billion. According to the  Council of Federal Home Loan Banks, outstanding advances rose during  the crisis to meet liquidity needs. However, since the height of the  economic crisis, advances have declined as reduced loan demand and  excess liquidity have reduced members' need for advances.

The rapid expansion of nonprime lending and private-label MBS  contributed to the increase in securitization between 2000 and 2009 (see  fig. 13). Specifically, the market share of private-label MBS, which  typically pool jumbo and nonprime mortgages, grew rapidly from 2004 to  2006. During this time, the market share of the enterprises’ MBS, which  pool eligible prime mortgages, and MBS guaranteed by Ginnie Mae  decreased. However, there have been almost no new issuances of  private-label MBS since the onset of the financial crisis. As illustrated in  figure 13, since 2008, the market shares of the enterprises, which were in  conservatorship, and Ginnie Mae have increased. Thus, the government  supported almost all of the value of new MBS securities issued in 2008  and continued to do so through 2013.

The increasing reliance on securitization that began around 1980, the  rapid increase and subsequent decline in private-label securities that  reasserted the market dominance of the enterprises and Ginnie Mae, and  the change in the status of the enterprises combined to increase the  government’s role in the secondary market. The percentage of the  secondary market controlled by Ginnie Mae and the enterprises has  grown since the onset of the crisis, in part, because Congress increased  loan limits for FHA-insured loans and loans eligible for enterprise  securitization. The government’s role has also changed as a result of  placing the enterprises into conservatorship in 2008. The Senior  Preferred Stock Purchase Agreements, which provide capital support  from the Treasury to the enterprises, are the federal government’s single  largest risk exposure remaining from its emergency actions to assist the  financial sector after the financial crisis. Given the government  investment in the enterprises and variations in the secondary market over  the period, the government supported almost all of the value of new MBS  issued in 2013. Because of this support, the government indirectly  supports the mortgages backing the MBS. In response to the financial  crisis, the Federal Reserve and Treasury have provided additional  support for the mortgage market by purchasing MBS issued by the  enterprises and those that have Ginnie Mae guarantees. As of the end  of 2013, the Federal Reserve, which was one of the largest purchasers of  enterprise and Ginnie Mae MBS, held approximately $1.5 trillion of these  securities, but announced in January 2014 that it planned to decrease  purchases due to improvements in the economy. Treasury had  completed the sale of its MBS investments in fiscal year 2012.

section_title: Market Developments since 2000 Have Challenged the Single-Family Housing Finance System
paragraphs: Market developments since 2000 have challenged the single-family  housing finance system and revealed some key weaknesses in that  system, including misaligned incentives, an overall lack of reliable  information or transparency, and excessive risk taking. These  developments are evident throughout the phases of the mortgage  lifecycle—origination, securitization, and mortgage servicing.
subsections: section_title: Key Weaknesses in the Housing Finance System Have Been Revealed since 2000
paragraphs: Some market developments that occurred prior to the financial crisis may  have contributed directly to it, revealing weaknesses in the housing  finance system. However, some weaknesses—in particular those related  to mortgage servicing—were revealed only after the onset of the crisis  when mortgage defaults and foreclosures rose. These interrelated  weaknesses include misaligned incentives, lack of information or  transparency, and excessive risk taking (See table 1).

section_title: Developments in the Mortgage Origination Process Revealed Many Weaknesses
paragraphs: A number of developments in the mortgage origination process for home  purchases and mortgage refinancing may have contributed to the housing  bubble and, therefore, to the financial crisis. These market developments  challenged the housing finance system and revealed weaknesses in that  system. For example, prior to the financial crisis:

Originators’ incentives were not aligned with the long-term interests of  borrowers because originators did not retain credit risk. Mortgage  originators lowered underwriting standards, enabling less-qualified  borrowers to access mortgage credit. These changes included  reducing or eliminating requirements for documentation of borrowers’  incomes and assets. Originators lowered underwriting standards, in  part to respond to demand for new mortgage originations in the  secondary market. In addition, originators and brokers may have  focused on increasing loan volume in the short-term, and thereby their  fees, rather than originating loans more suitable for borrowers.

Similarly, with the ability to pass on credit risk and compensation  structures that rewarded them in the short term, mortgage originators  offered nonprime mortgages that included high-risk features. Features  of nonprime mortgages, such as loans with high LTV ratios and  interest-only payments, have been found to increase the likelihood of  default. However, during periods of rapid house price appreciation,  such as that experienced during the housing bubble, these risks were  mitigated. Some mortgage originators may have steered borrowers  who were qualified for less risky products to these nonprime  mortgages. Some mortgage brokers received yield spread premiums  (bonuses or extra compensation) for referring borrowers to high- interest loans. Some consumer advocates have noted that  compensating brokers this way may have resulted in some borrowers  receiving loans with higher interest rates and fees. These mortgages  were not in the best interest of some borrowers.

Many borrowers may have lacked information or may not have fully  understood the risks associated with the features of nonprime loans.

Prior to the crisis, because mortgage originators were not required to  disclose completely all of the features of nonprime loans, some  mortgage originators may not have disclosed some high-risk features,  contributing to borrowers assuming excessive risk. For example,  borrowers may have agreed to such loans without understanding the  potential for substantial increases in monthly payments. A Treasury  official noted that many lenders expected that these loans would be  refinanced and fees would be paid for by extracting expected  increases in equity before the loans got into trouble.

Borrowers took on excessive risk, and when house prices fell,  foreclosures rose and homeowners, communities, the housing  market, and the overall economy experienced adverse effects. The  Financial Crisis Inquiry Commission Report suggested that the  relatively inexpensive mortgage credit available during the housing  bubble and expectations that home prices would continue to rise may  have caused borrowers to take on more debt than they would have  otherwise. Some borrowers may have taken on excessive risk by  investing in homes they planned to sell for a profit or by withdrawing  equity from their homes.

Developments in the mortgage market prior to the financial crisis also  revealed gaps in the financial regulatory system. As we have previously  found, the activities of nonbank mortgage lenders were generally subject  to little or no direct oversight by federal regulators. We also found that  nonbank mortgage lenders played a substantial role in the nonprime  mortgage market and contributed to a dramatic loosening in underwriting  standards leading up to the crisis. Although these lenders were subject to  certain federal consumer protection and fair lending laws, they generally  have not been subject to the same routine monitoring and oversight by  federal agencies that their bank counterparts were. In addition, the  complexity and expanded use of nonprime mortgage products made it  difficult for the current regulatory system to adequately protect individual  consumers and investors.

The financial crisis also resulted in new challenges for FHA. During the  crisis, FHA’s market presence expanded as private sector lenders exited  nonprime markets and tightened credit standards. In response, Congress  increased the limits on the size of mortgages available for FHA insurance  in 2008. With increased demand for FHA-insured mortgages and higher- than-expected insurance claims and losses, FHA has not met its 2  percent statutory minimum capital ratio for its insurance fund since 2009.  In addition, in 2013, FHA needed funding from the Treasury to ensure it  had sufficient resources for all future insurance claims on its existing  portfolio. This funding reflected updated estimates of cash flows into and  out of the fund over the term of the mortgages in its portfolio, rather than  an inability to pay current claims. We have found previously that  tightening underwriting standards, enhancing enforcement powers, and  improving loss mitigation efforts are among options that could help  strengthen FHA’s financial condition. Consistent with recommendations  we made in a 2001 report, we stated in our 2013 high-risk update that  Congress or FHA needed to specify the economic conditions that FHA’s  insurance fund would be expected to withstand without drawing on the  Treasury. We concluded that implementing this prior recommendation  would be an important step not only in addressing FHA’s long-term  financial viability but also in clarifying FHA’s role. The 107th Congress  considered this matter and did not enact legislation. HUD has not  implemented our recommendation, but it has adopted modeling  techniques that can better predict the soundness of the insurance fund.

While national average home prices began to increase in 2011,  challenges to the primary market remain. In particular, after the crisis hit,  mortgage originators tightened underwriting standards, which had  weakened during the crisis, reducing credit availability and limiting  opportunities for some borrowers, and constraints for some borrowers  persist. According to The State of the Nation’s Housing 2013, Ellie Mae  reported that lenders have denied mortgages to many applicants who had  good credit scores but would have been required to purchase mortgage  insurance because their LTVs were above 80 percent. Some government  agencies have also acknowledged constraints facing some creditworthy  borrowers. FHA imposed minimum underwriting standards in September  2010 requiring that new borrowers have a minimum Fair Isaac  Corporation (FICO) credit score of 580 to qualify for its 3.5 percent down  payment program. However, in its May 2014 Blueprint for Access, FHA  expressed concern about credit continuing to be constrained for  borrowers with credit scores between 580 and 680. Similarly, in its  strategic plan for the conservatorship of the enterprises, issued in May  2014, FHFA expressed concern about access for some creditworthy  borrowers. FHFA noted that some originators and private mortgage  insurers require higher minimum credit score requirements than would be  required by the enterprises, resulting in the rejection of many loans that  would otherwise meet enterprise credit standards. The FHFA Director  acknowledged that these higher credit standards were the result of lender  uncertainty about having to repurchase these loans in the future.  Nonetheless, the enterprises reported data in 2014 showing that while  average FICO scores remained higher for acquired mortgages than  before the financial crisis, average origination LTV ratios have steadily  increased or stayed steady since 2009, indicating that opportunities for  borrowers with less equity might be improving.

section_title: The Secondary Market Helped Fuel Nonprime Mortgage Originations and Spread Risks through Complex Products
paragraphs: Increases in demand for private-label MBS, which occurred primarily  between 2004 and 2006, helped fuel the housing bubble and the spike in  nonprime mortgage originations. In addition, complex financial products  such as credit default swaps, which were designed to reduce the risk  associated with MBS for investors, spread risk throughout the financial  markets and contributed to the onset of the financial crisis. Developments  prior to the financial crisis also highlighted similar weaknesses in the  secondary market, such as misaligned incentives, lack of transparent  information, and excessive risk taking. In addition, markets were  challenged by gaps in regulation. For example:

The enterprises’ structures included misaligned incentives and led to  excessive risk taking. We concluded in 2009 that the enterprises’  structures as for-profit corporations with government sponsorship  provided them with incentives to engage in potentially profitable  business practices that were risky and not necessarily supportive of  their public missions. For example, prior to conservatorship, the  enterprises’ retained mortgage portfolios that were complex to  manage and exposed them to losses resulting from changes in  interest rates. Further, the enterprises made substantial investments  in private-label MBS, and the enterprises’ management did not hold  capital commensurate with this additional risk. These investments in  private-label MBS contributed to losses that led to the  conservatorship. In addition, the enterprises had a lower cost of  capital than other for-profit corporations, including private-label MBS  issuers, because market participants assumed that the federal  government would support the enterprises if they experienced  financial distress. This kind of support, referred to as a perceived  implicit guarantee, likely contributed to the enterprises’ taking of  excessive risk.

Similar to the misaligned incentives of lenders and borrowers,  incentives of issuers of private-label MBS and investors were also  misaligned because the former generally did not retain the increased  credit risk associated with lower quality loans. These increased risks  were passed onto investors who may not have been aware that they  were taking on increased risk. A lack of information on the part of  investors likely contributed to their taking on this excessive risk.

Increased competition may have led issuers of MBS to accept lower  quality mortgages for securitization, resulting in higher risk securities.  Historically, the enterprises issued the vast majority of MBS, and we  have found that this led to their underwriting guidelines becoming the  industry standard. Research has suggested that the enterprises were  able to maintain tighter control over underwriting standards for the  loans they purchased because of their market share. The rapid  growth of nonprime mortgage lending and private-label MBS in the  early part of the decade led to increased market competition among  private-label issuers and the enterprises. Competition for market  share led issuers of private-label MBS and the enterprises to relax  underwriting standards and accept riskier mortgages.  Investors may not have understood the risks of MBS, ultimately  leading them to take on excessive risk. Prior to the financial crisis,  investors seeking higher yields invested in private-label MBS because  these securities offered higher returns than other highly rated assets,  such as enterprise MBS. While increased yields over other highly  rated securities should have indicated increased risk, the use of  complex financial instruments such as credit default swaps allowed  investors to transfer the credit risk of these investments, and led to  excessive risk taking. Further, some researchers and industry  representatives have noted the lack of appropriate data made it  difficult for investors to analyze complex private-label securities. In  addition, the common expectation that home prices were expected to  continue to rise further minimized any perceived risks associated with  MBS.

The risks related to private-label MBS also may not have been fully  understood because most of these securities had received investment  grade ratings from independent credit ratings agencies that did not  adequately reflect the risk that these products ultimately posed. We  have found that leading up to the crisis, some investors had come to  rely heavily on these ratings rather than conducting independent  analyses on the quality of assets. Further, we found that although  ratings downgrades for investment grade securities are generally  infrequent, many of the private-label MBS issued with investment  grade ratings were later downgraded. In addition, others have found  that credit-rating agencies used models based, in part, on periods of  relatively strong credit performance and did not consider the  possibility of dramatic declines in home prices. We have also noted  that concerns have been raised over the way in which ratings of some  private-label MBS may have been influenced by compensation  arrangements between the issuers and ratings agencies—that is, the  issuers paid the rating agencies to rate the securities. Prior to the  crisis, investors who viewed ratings agencies as independent  evaluators of securities may not have appreciated the potential impact  on credit ratings posed by apparent conflicts of interest created by the  relationship between private-label MBS issuers and ratings agencies.  Incentives provided to individual employees of the enterprises and  issuers of private-label MBS were often based on short-term results  and were not well-aligned with the longer term interests of the firms  that employed them or investors. Prior to the crisis, some employees  received bonuses based on the volume of MBS issued, which were  not related to the long-term performance of the securities. This gave  these employees the incentive to take on excessive risk, and when  home prices began to fall, firms failed and investors experienced  losses.

We have previously found that there were gaps in the regulatory  system related to the secondary market for private-label MBS and that  market participants and regulators did not fully understand the  complex financial instruments that were intended to transfer risk.  The complexity and expanded use of these products made it difficult  for the regulatory system to oversee risk management at financial  institutions. Many of these institutions, including large commercial and  investment banks, appeared to have underestimated the amount of  risk and potential losses that they could face from creating and  investing in private-label MBS and more complex financial  instruments. For example, among other factors, the variation and  complexity of CDO structures, and the underlying assets they contain,  may explain why institutions—and regulators—did not effectively  monitor and limit the risk that CDOs represented.

section_title: The High Number of Defaults and Foreclosures Revealed Weaknesses in Mortgage Servicing
paragraphs: Mortgage securitization, in general, relies on mortgage servicers to  manage individual mortgages, but the financial crisis revealed the  mortgage servicing industry’s lack of capacity to respond adequately to  the increased number of mortgage defaults and foreclosures. We have  reported previously on challenges in mortgage servicing after the crisis,  such as improper documentation used in foreclosures and the difficulty of  implementing government foreclosure mitigation programs. For  example, we previously found there were pervasive problems with  servicer document preparation and oversight of foreclosure processes.  We also found that servicers faced challenges related to implementing  the government’s first and second lien modification programs and that  investors were concerned about the lack of transparency of modifications.

In addition, the increase in defaults and foreclosures also revealed  misaligned incentives, as well as gaps in regulatory oversight that might  have addressed such weaknesses. For example:

Research suggests that while loan modifications can be in the  financial best interest of investors and borrowers, it can be in the  financial best interest of servicers to foreclose rather than modify  mortgages. Thus incentives for borrowers, investors, and servicers  were not always aligned. While servicers were entitled to  reimbursement of costs related to foreclosures, they may not have  been entitled to the reimbursement of all costs related to pursuing  foreclosure alternatives, creating the incentive for servicers to pursue  foreclosure. Further, servicer reimbursement of costs related to  foreclosures took precedence over investor claims. In addition,  servicers had an incentive to charge borrowers additional fees related  to defaulted loans and, if homeowners lacked the equity to cover  these fees, proceeds for investors would be decreased to cover the  fees.

Similarly, the securitization system created additional misaligned  incentives between servicers and borrowers, and borrowers had little  ability to hold servicers accountable. As CFPB has noted, mortgage  servicers that are hired by the owners of mortgage loans face  competitive pressure to reduce the costs of servicing, and, as a result,  some servicers provided limited customer service. For example,  some servicers did not provide information on fees imposed in  borrowers’ billing statements. Further, servicers earned revenue from  fees assessed on borrowers and, as a result, had an incentive to look  for opportunities to impose fees on borrowers to enhance revenues.  Borrowers generally did not have the ability to change mortgage  servicers, unless they refinanced their mortgages.

Some breaches of representations and warranties in pooling and  servicing agreements may not have been identified because of  mortgage servicers’ potential conflicts of interest. Pooling and  servicing agreements contain representations and warranties that  require originators to repurchase loans from issuers of MBS if the  loans do not meet underwriting requirements or in some cases default  within a certain time period. These representations and warranties are  one mechanism for aligning the incentives of originators, investors,  and servicers. However, in some cases, when servicers and  originators were affiliated, servicers may have had a disincentive to  identify loans that breached representations and warranties because  such loans would need to be repurchased by the affiliated originators.

Although not directly related to the role of servicers, SEC has noted  that transaction agreements typically have not included specific  mechanisms to identify breaches of representations and warranties or  to resolve a question as to whether a breach of the representations  and warranties has occurred. Thus, these contractual agreements  have frequently been ineffective because without access to  documents relating to each pooled asset, it can be difficult for the  trustee, who typically notifies the responsible party of an alleged  breach, to identify a breach. In addition, addressing representation  and warranty breaches can require that a minimum percentage of  investors act together. However, investors have noted that it is difficult  for them to locate other investors so they can jointly exercise their  rights.  Industry representatives and researchers have noted that although  loss mitigation actions taken by servicers affect investors, investors do  not receive adequate and consistent information from servicers that  would allow them to compare servicer performance in these areas.

Oversight of servicers’ foreclosure activities and of nonbank servicers  was limited prior to and during the financial crisis. We previously  found federal agencies’ past oversight of servicers’ foreclosure  activities had been limited and fragmented. Similarly, nonbank  mortgage servicers, especially those that were not affiliated with  banks or other regulated financial institutions, were historically subject  to little or no direct oversight by federal regulators. Prior to and during  the financial crisis, state banking regulators generally oversaw  independent mortgage servicers by requiring business licenses that  mandated meeting net worth, funding, and liquidity thresholds.  Nonetheless, according to VA officials, when borrowers in its Home  Loan program are experiencing financial hardship, VA provides direct  oversight of entities servicing those loans to ensure that all  reasonable effort has been made to help those veterans avoid  foreclosure.

section_title: The Government Has Taken Some Steps to Address Housing Finance Market Challenges through Regulation and Enforcement
paragraphs: The federal government revised guidance and regulations and enacted  legislation designed to address adverse developments or weaknesses  related to the housing finance market that contributed to the financial  crisis. For example, in 2006 to better protect borrowers and address the  safety and soundness of banks, the bank regulators issued Interagency  Guidance on Nontraditional Mortgage Product Risks. In 2008, HUD  revised the rules implementing RESPA so that the required forms would  provide additional disclosures, including clear summaries of loan terms  and conspicuous information about yield spread premiums designed to  make it easier for potential borrowers to compare originators when  shopping for a mortgage loan. Also in 2008, Congress passed HERA,  which created FHFA to address the safety and soundness issues and  weak oversight at the enterprises. HERA also gave FHFA responsibility  for overseeing the FHLBank System.

To address challenges related to limitations on mortgage information,  HERA required FHFA to collect market data. To fulfill this requirement,  in 2012, FHFA and CFPB announced an agreement to partner on the  creation of a National Mortgage Database to include detailed loan  information.  In addition, the Dodd-Frank Act amended the Home  Mortgage Disclosure Act of 1975, the main mechanism for collecting loan  origination data prior to the financial crisis, to require additional reporting  of loan level mortgage data. The act transferred Home Mortgage  Disclosure Act rulemaking authority from the Federal Reserve to CFPB  on July 21, 2011. Although these data are not yet being collected by  CFPB, officials at CFPB noted that the agency has taken steps in the  rulemaking process. On February 7, 2014, CFPB convened a panel to  discuss potential changes in the Home Mortgage Disclosure Act, and in  July 2014, the agency issued a notice of proposed rulemaking regarding  new and revised mortgage disclosure reporting requirements.

The Dodd-Frank Act includes many other provisions to address market  challenges in the areas of consumer protection, mortgage underwriting,  and investor protection. For example:

To protect consumers, the act established CFPB and authorized it to  supervise certain nonbank financial companies including mortgage  servicers and brokers, regardless of size, and large banks and credit  unions for consumer financial protection purposes. The act  transferred to CFPB rulemaking and enforcement authority over many  previously enacted consumer financial protection laws and requires  that CFPB track consumer complaints.

To protect mortgage borrowers, the act requires, among other things,  that servicers take timely action to respond to borrower requests to  correct errors in connection with payment allocation, final balances, or  avoiding foreclosure, or other standard servicer duties. The act also  requires that servicers provide notices in advance of initial interest- rate resets for adjustable-rate mortgages. Further, the act requires  that servicers credit mortgage payments promptly. CFPB has issued  rules to implement these provisions as well as to address other  weaknesses in servicing standards. Specifically, CFPB adopted rules  to address servicers’ obligations to correct errors raised by borrowers;  provide certain information requested by borrowers, including loss  mitigation options available to delinquent borrowers; and provide  borrowers with continuity of contact with appropriate servicer  personnel. CFPB also adopted rules to require servicers to provide  borrowers with enhanced information, including notices regarding  interest rate adjustments. The new rules took effect January 10, 2014.

To improve mortgage underwriting and protect borrowers, the act  amended TILA by prohibiting creditors from making mortgage loans  without regard to a consumer’s ability to repay the loan. According to  the act, a lender is presumed to have satisfied the ability-to-repay  requirement when it originates a “qualified mortgage” (QM). CFPB  had the responsibility to define QM generally and has included a  requirement that loans not guaranteed or insured by the government  not exceed a debt-to-income ratio of 43 percent. However, this  requirement does not apply to small creditors. HUD had  responsibility to define QM for loans insured by FHA. Both CFPB’s  and HUD’s QM-definition rules went into effect on January 10, 2014.  In May 2014, to comply with the requirements of the Dodd-Frank Act,  VA published an interim final rule amending its loan guaranty  regulations that implement provisions to define QM for VA-guaranteed  loans for the purpose of the new ability-to-pay provision of TILA. In  this rule, VA defines the types of VA-guaranteed loans that are  qualified mortgages for the purpose of the new ability-to-pay provision  of TILA. USDA also has authority under the Dodd-Frank Act to define  QM for its loans, but has not yet done so. The Dodd-Frank Act also  prohibits mortgage originators from “steering” borrowers to mortgages  that exhibit certain predatory features, restricts the use of prepayment  penalties, and requires increased consumer disclosures related to  certain mortgage features. In addition, the act established appraisal  independence requirements to reduce conflicts of interest between  appraisers and parties of interest in the transaction. Further, the act  required that HUD establish an Office of Housing Counseling, which,  according to HUD officials, began operating in October 2012.

To protect investors, the act includes provisions related to new  disclosures for asset-backed securities (ABS) including MBS. The  act requires SEC to prescribe regulations to require ratings agencies  to disclose in their ratings the use of representations and warranties  and enforcement mechanisms available to investors. The act also  requires ABS issuers filing a registration statement to review the  securities’ underlying assets and disclose the nature of the review in  the registration statement. It also requires SEC to adopt regulations  for MBS issuers to make additional disclosures of loan-level or asset- level data if such data are necessary for investors to independently  perform due diligence. Such data are to include, among other things,  the amount of risk retention by the originator and the securitizer of  such assets. In addition, the act prohibits conflicts of interest  between individuals responsible for developing ABS and investors.    The act also requires that SEC, among other things, issue regulations  requiring credit rating agencies registered with SEC to address  conflicts of interest arising from sales and marketing and to disclose  performance statistics.

To protect investors further, the act generally includes provisions  related to risk retention requiring MBS securitizers to retain a financial  exposure of no less than 5 percent of the credit risk of any securitized  residential mortgage that does not meet criteria associated with a  lower risk of default. Securitized mortgages meeting the criteria— referred to as a “qualified residential mortgages (QRM)—are exempt  from this risk retention requirement; the QRM criteria are to be defined  jointly by several agencies. The risk retention provision is designed to  protect investors by providing an incentive for securitizers of non- QRMs to ensure that the assets underlying a securitization transaction  are well-underwritten.

Since many of the regulatory actions required by the Dodd-Frank Act and  other legislative actions are not yet complete or have been recently  implemented, their impact on the marketplace remains to be seen.  Representatives of market participants have said that they faced  uncertainties because some regulations had not been implemented and  that these uncertainties could limit the return of private capital to the  secondary market.

In addition to legislative changes, federal and state agencies have taken  action to enforce consumer protections including legal and regulatory  enforcement actions against mortgage servicers and other industry  participants. The Department of Justice (DOJ) has pursued a number of  mortgage securities and mortgage fraud cases. For example, a  settlement was reached in February 2012 between DOJ, HUD, Treasury  and 49 state Attorneys General, with the nation’s five largest mortgage  servicers to address mortgage servicing and foreclosure abuses. A  large share of the $25 billion settlement is dedicated to financial relief for  homeowners including mortgage principal reduction and refinancing for  underwater homeowners. In addition, SEC has pursued a number of  enforcement actions related to, among other areas, improper disclosure  of investor risks related to CDOs, mortgage-related risks and exposure,  and concealment of the extent of mortgage-related risks in mutual funds  and other investment products. For example, in August 2012 SEC  charged Wells Fargo’s brokerage firm and a former vice president with  selling investments tied to mortgage-backed securities without fully  understanding their complexity or disclosing the risks to investors. Wells  Fargo agreed to pay SEC more than $6.5 million to settle the charges;  this settlement will go to an SEC fund for harmed investors.

section_title: A Framework for Assessing Potential Changes to the Housing Finance System
paragraphs: We have identified the role played by the federal government in the  housing finance system as a high-risk area for the government and have  also noted that the Dodd-Frank Act did not fully address weaknesses in  the housing finance system. Attention has now turned in Congress and  elsewhere to considering other significant changes to the housing finance  system (see app. III for a list of legislative proposals introduced in the  113th Congress). Some experts and interested parties believe that the  current system is unsustainable and warrants reform, while others believe  that certain features of the current system should be maintained because  they have served the United States well.

We are providing a framework consisting of nine elements that Congress  and others can use to assess or craft proposals as they consider changes  to the housing finance system (see table 2). Similar elements appear  throughout the literature we analyzed on the housing finance system,  including our prior reports (see related list of reports at the end of this  report) and, to some extent, in proposals to change the system. We  sought the input of a broad range of government officials, experts from  academia and research organizations, consumer advocates, and industry  representatives on this framework and have included their comments  related to the nine elements as appropriate. We believe each element in  the framework is critically important in establishing the most effective and  efficient housing finance system. Applying the elements of this framework  would help policymakers identify the relative strengths and weaknesses  of any proposals they are considering. Similarly, the framework can be  used to craft proposals or to identify changes to existing proposals to  make them more effective and appropriate for addressing any limitations  of the current system. However, any viable proposal for change will  involve choices that recognize that sometimes trade-offs will exist among  and within the nine elements. In addition, proposals will need to take into  consideration certain characteristics—transparency, accountability,  aligned incentives, and efficiency and effectiveness—associated with  appropriate controls and high-quality government performance that run  through each element.
subsections: section_title: Element 1: Clearly Defined and Prioritized Housing Finance System Goals
paragraphs: For some time, we have noted the importance of having clearly  articulated goals when considering federal intervention in and regulation  of market activities, and such requirements would apply to housing  finance as well. In our work on the Troubled Asset Relief Program, for  instance, we built on lessons learned from the financial crises of the  1970s and 1980s to identify guiding principles to help serve as a  framework for evaluating large-scale federal assistance efforts and  provide guidelines for assisting failing companies. As part of that work,  one of the key principles we developed was that national interests should  be determined and clear goals and objectives set that reflect those  interests. Further, in 2009 we identified clearly defined goals and  objectives as essential to reforming the financial regulatory system. For  housing finance, such goals include the general purpose of any  government guarantees in housing finance markets or other rules and  regulations governing activities in housing finance markets. Goals for  housing finance have also included goals relative to the housing market  and to the overall functioning of the financial and economic systems  including maintaining financial stability or creating jobs.

More generally, we have found that clear goals can help guide agency  activities and establish agency accountability. For example, clear goals  help agencies identify and achieve their missions, establish priorities, and  define responsibility and accountability for identifying risks. As part of  their strategic planning, agencies are expected to link their staffing,  activities, and budgets to their missions and goals. In addition, in our  work on government performance, we have concluded that agency  missions should begin with statutory requirements and that agencies  should coordinate with Congress when setting agency goals. Without  clearly stated goals, agency activities may lack focus and consistency.  For example, the lack of clearly stated goals for FHFA that recognize the  potential trade-off between bringing private capital back into the market  and making mortgage credit available has led to inconsistency in its policy  on the level of guarantee fees on MBS issued by the enterprises. In 2012,  under an acting director, FHFA increased guarantee fees and planned  further increases to encourage private capital back into the market.  However, when FHFA’s new director took over in 2014, he put further  increases on hold expressing concern about the implications an increase  would have for mortgage credit availability. FHFA has also reached out  for direction on its goals. In June 2014, FHFA issued a request for public  input on further changes to these fees including input on what goals  FHFA should seek to meet in setting guarantee fees. Additionally, the  Director noted in a speech on the strategic plan for the enterprises that  Congress and the Administration, not FHFA, have the important job of  deciding on housing finance reform legislation. A housing finance policy  goal that clearly identifies the importance of bringing private capital back  into the market relative to other goals of that system would help guide  FHFA activities. In addition, we have previously found that clearly stated  missions help to hold agencies accountable because they facilitate the  clear statement of agency objectives and the measurement of agency  performance.

Addressing weaknesses in the single-family housing finance system  could result in conflicting goals. The 2007-2009 financial crisis left the  government more involved in housing finance than it had been  traditionally. As a result, one potential goal of changes to the housing  finance system could be to reduce the government’s role. However, doing  so could conflict with a number of other potential goals, such as keeping  the cost of housing finance affordable or providing liquidity and stability  during market downturns. We have previously concluded that choosing  clearly among potentially conflicting objectives is important. Therefore, it  is important to first identify the primary objective, otherwise, deciding what  steps are appropriate and judging whether a program has succeeded will  be difficult.

Participants in our discussion groups stressed the importance of setting  appropriate goals, and some participants noted that divisions among  proponents of change generally stemmed from differences in goals.  Several of the participants or the groups they represented had published  lists of principles for or goals of housing reform prior to the meeting. For  example, one group’s goals can be summarized as including: the market  should principally function without direct government financial support;  programs for assisting low-income families to become homeowners  should be on budget and should limit risks to homeowners and taxpayers;  and the enterprises should be eliminated. While another group’s goals are  that the enterprises be phased out over an appropriate period: the private  sector play a far greater role; government-insured MBS play a continued  but more limited role for government-insured MBS; FHA play a continued  but more targeted role; and borrowers have access to safe and affordable  mortgages based on sound underwriting and risk management  throughout economic cycles. Some participants agreed that policymakers  need to be aware of trade-offs among goals when setting priorities.  However, one participant noted that having to be explicit about goals  could limit the opportunity for change. This view raises the question of  how much specificity any legislation should include and how much should  be left to entities responsible for implementing the rules. While having  clearly articulated goals is important, in prior work we have noted that  regulators also need the ability to be flexible and adaptable when  implementing financial reform. This is also important with housing  finance reform because these markets also evolve over time.

Proposals have defined goals for housing finance reform as well. One set  of goals includes maintaining access to the 30-year fixed-rate mortgage,  protecting taxpayers, providing stability and liquidity, requiring  transparency and standardization, and ensuring access to affordable  rental housing. However, goals sometimes conflict and their priority is  unclear. For example, one proposal includes a goal of protecting  taxpayers from bearing the cost of a housing downturn and a goal of  promoting a sound, stable, and liquid housing market. However, these  goals may conflict during an economic downturn, and the proposal does  not discuss priorities.

section_title: Element 2: Policies and Mechanisms That Are Aligned with Goals and Other Economic Policies
paragraphs: We have reported that aligning policies and mechanisms with the relevant  goals and priorities helps to achieve accountability and efficiency. In  addition, we have noted that housing reform needs to be considered on a  comprehensive basis, which could better control risks and reduce any  unnecessary overlap and duplication. For example, in our 2013 high-risk  report we concluded that decisions about the future role of the enterprises  should consider impacts on other parts of the housing finance system,  including FHA’s single-family mortgage insurance programs. Efforts to  reduce the market presence of the enterprises could shift some borrowers  currently served by that market segment to FHA, and the resulting  impacts on FHA’s risk exposure should be considered. Moreover, we  have noted the overlap between FHA insurance programs for single- family mortgages and USDA’s loan guarantee program and the potential  for consolidation of these programs. In 2012, we noted that the  administration announced in 2011 the creation of a task force to evaluate  the potential for coordinating or consolidating homeownership loan  programs at HUD, USDA, and VA. Although a working group that  includes these agencies has been meeting and considering ways to  better coordinate, it is not considering program consolidation.

Proposals for policy changes would need to consider the full range of  options for government action, such as direct participation in markets  through government guarantees, oversight and regulation, data collection  and dissemination, and tax and other federal incentives to promote  greater private market participation. As a first step, proposals would need  to look across current policies and mechanisms to determine whether  they are achieving their purpose, whether that purpose is consistent with  proposed housing finance policy goals, and whether the purpose might be  achieved more effectively through some alternative policy or mechanism.  As this report has shown, the U.S. government uses a range of policies  and mechanisms in the single-family housing finance area, including  insurance and guarantees in both the primary and secondary market; tax  expenditures such as the mortgage interest deduction; and data collection  and dissemination, primarily under the Home Mortgage Disclosure Act.  New proposals would need to consider whether these are still viable or  could be altered to produce a better result. For instance, some research  suggests that rather than increasing the number of home buyers, the  mortgage interest deduction provides an incentive for people to buy larger  homes than they otherwise would, an outcome that may conflict with  current policy goals. In addition, proposals would need to show how  suggested policies and mechanisms will interact, both among themselves  and with broader macroeconomic policies, to achieve goals on a  comprehensive basis while minimizing fragmentation, overlap, and  duplication. In light of weaknesses exposed during the financial crisis,  these policies and mechanisms would help align incentives, provide more  information and transparency, and restrain excessive risk taking.

Participants across the stakeholder groups at our panel discussions noted  that housing finance reform should be considered as a whole. Some  participants noted specifically that reforming one part of the housing  finance system, such as the secondary market, could create additional  risks elsewhere in the system, such as in the primary market. An official  at Treasury noted that reforming the housing finance system should  include a discussion of how the key risks of mortgage lending (credit,  interest rate, and prepayment risk) should be distributed between  households, governments, and private lenders, and investors.

One proposal for change addresses reform on a comprehensive basis  including a range of policies and mechanisms. That proposal includes  FHA reform along with reform of the secondary market and considers  alternatives to the latter, such as developing a market for covered  bonds. That same proposal also addresses an opportunity to reduce  overlap and duplication by recognizing the potential for efficiencies that  could be achieved by requiring that FHA develop and maintain  appropriate financial, underwriting, and operations systems that USDA  can also use for its rural housing programs. Proposals also contain  policies and mechanisms intended to address weaknesses exposed  during the financial crisis. For example, one proposal to change the  housing finance system would better align incentives and limit risk by  requiring that some lenders making FHA-insured loans take greater  responsibility for errors or fraud and abuse and consider borrowers’ ability  to repay. To facilitate public access to more mortgage information, at  least three proposals would establish new databases to store uniform  loan-level data. These proposals also aim to improve transparency in  market operations through uniform securitization agreements for covered  securities, to include standard documents such as pooling and servicing  agreements, representations and warranties, and loss mitigation  procedures. To better manage risk, some proposals also would require  that credit risk-sharing structures be established wherein private market  participants share or assume the credit risk associated with mortgage  securities.

section_title: Element 3: Adherence to an Appropriate Financial Regulatory Framework
paragraphs: In 2009, GAO proposed a framework for crafting or assessing proposals  to modernize the financial regulatory system that included some of the  elements listed here, along with others that were designed to help ensure  that regulation was appropriately comprehensive, consistent, flexible and  adaptable, and had a systemwide focus. We also found that a  regulatory system should ensure that regulators have independence from  inappropriate influence; have sufficient resources, clout, and authority to  carry out and enforce statutory missions; and are clearly accountable for  meeting regulatory goals. To strengthen decision-making and  accountability, regulators will need access to the best reasonably  obtainable scientific, technical, economic, and other information. Given  the market weaknesses we noted earlier in this report, and consistent  with our previous framework, regulators under a new housing finance  system should consider how their activities could better identify and  address any systemic risks posed by the housing finance system. We  also have previously found that any financial regulatory reform needed to  address gaps, overlapping missions, and fragmentation in the regulatory  system.

These elements would be applicable to any regulatory system developed  to make rules and oversee the housing finance system. For example:

A comprehensive, systemwide focus. Any proposed regulatory  system for single-family housing finance would need to have a  systemwide focus that addresses the complexity of the housing  finance system on a comprehensive basis. For example, proposals  would need to consider how any new regulatory entities will interact  with existing regulators, such as CFPB, FHFA, and the Financial  Stability Oversight Council. A systemwide focus would also increase  the attention given to the effects of incentives and constraints that  regulations place on market participants’ risk taking and to actions  regulators can take to anticipate and mitigate any such risk taking.

Consistency. Regulatory consistency across relevant federal  agencies would help ensure that market participants are better able to  understand the rules governing their behavior. Although there are  similarities among the various rules creating safe harbors for  regulatory treatment of mortgages including CFPB’s QM rule, HUD’s  QM rule, VA’s QM rule, and multiagency rules being developed for  QRM, some participants in our discussions, including regulators,  noted the lack of regulatory consistency. CFPB officials noted that  CFPB has consulted with other agencies and given them  opportunities to identify inconsistencies before issuing proposed and  final QM rules. In addition, CFPB officials noted that the Dodd-Frank  Act specifically allowed for differences across the agencies issuing  these rules. A consumer advocate who attended our group  discussions also noted possible inconsistencies in regulatory  oversight that could occur as mortgage servicing moves from banks to  nonbanks. This move may be driven, in part, by heightened capital  and liquidity requirements for banks that engage in mortgage  servicing. Nonbanks would not have these requirements, but CFPB  oversees compliance with consumer financial protection regulations at  nonbanks as well as banks. As noted earlier in this report, CFPB's  servicing rules apply to all mortgage servicers, including non- depository institutions, regardless of size.

Flexibility and adaptability. Designing a system to be flexible and  proactive involves determining how much of the system would need to  be dictated by law and how much would need to be left to federal  entities responsible for implementing the law. Flexibility and  adaptability may be particularly important during a transition from the  current system to a new housing finance system.

Accountability. As noted earlier, any housing finance system would  need to ensure that regulators are accountable to the public and to  Congress for meeting clearly stated regulatory goals. The  Government Performance and Results Act (GPRA) of 1993 requires  agencies to clarify their missions, set strategic and annual  performance goals, and measure and report on performance toward  those goals. Congress may also require regulators to submit annual  reports, performance audits, and testify before Congress. The GPRA  Modernization Act of 2010 further requires that agencies disclose  more information about the accuracy and validity of their performance  information in their performance plans and reports, including the  sources for their data and actions to address any data limitations.  Additionally, in 2009 in our report on a regulatory framework, we  concluded that policymakers may want to consider how to ensure that  agencies are recognized for successes and held accountable for  failures to act in accordance with regulatory goals as part of any  reform effort. The housing finance system is somewhat fragmented,  with multiple agencies responsible for regulating various aspects of  the housing finance system. The International Monetary Fund, in its  2010 review of the U.S. bank regulatory system, found that a  multiplicity of regulatory agencies can lead to overlap that dilutes  accountability. When regulation and missions overlap, defining the  specific responsibilities of each entity is critical for ensuring that each  regulator can be accountable for its defined mission. In addition, in a  fragmented system, collaboration among regulators may help ensure  that agencies are accountable by helping to define the roles and  responsibilities of each regulator. We also have found that fragmented  regulation can make more challenging the identification of systemwide  risks. Therefore, all regulators under a new system for housing  finance would need to consider how their activities could better  identify and address any systemic risks posed by the housing finance  system.

Proposals vary in the extent to which they address the regulatory  elements noted above. Few proposals have a comprehensive,  systemwide focus. For example, one proposal addresses changes in both  the primary and secondary markets, while other proposals focus on  regulation of the secondary market. At least two proposals address  regulation of the broader housing finance system and how the new  regulatory entities may interact with existing regulators. For example, one  proposal would establish a new independent government agency to  regulate all of the participants in the housing finance system, insure  eligible mortgage securities in a system similar to FDIC’s deposit  insurance in the banking system, and assume FHFA’s seat on the  Financial Stability Oversight Council, an organization created by the  Dodd-Frank Act to identify risks and respond to threats to financial  stability. At least one proposal calls for the director of the new regulatory  agency to share information with other federal regulatory agencies  regarding the financial condition and risk management practices of  market participants, thereby potentially enabling federal regulators to  better identity systemic risks. Consistent with existing QM underwriting  standards recently established by CFPB, four proposals recommend the  same QM standards for the secondary market platform. At least four  proposals would require regulatory coordination among the newly  established secondary market regulatory bodies and existing regulators.  For example, one of these proposals specifically requires that the new  regulator coordinate standards for approval of servicers and mortgage  servicing standards with CFPB and the federal banking regulators,  respectively. Another proposal would permit the new regulator to consult  with other federal agencies as appropriate, and avoid duplication with the  regulatory activities of other agencies, such as examination activities and  reporting requirements. At least one proposal would create an advisory  committee to provide a mechanism for stakeholders to provide input to  the regulatory entity, which could potentially help the regulator adapt to  developments in the primary and secondary mortgage markets. Some  proposals would also establish accountability mechanisms for the  regulator, including annual reporting to Congress by key agencies and  officials of proposed regulatory structures including an Office of Inspector  General.

section_title: Element 4: Government Entities That Have Capacity to Manage Risk
paragraphs: We have previously stated that government agencies should assess risks  associated with both internal management factors and external  sources. We have also identified strategic human capital management  as a high-risk area because for agencies to cost-effectively carry out their  missions and respond to emerging challenges, they will need to take a  strategic and efficient approach to acquiring, developing, and retaining  individuals with needed skills. Government entities in the housing  finance system that make loans or provide insurance or guarantees on  loans or MBS will need adequate skills and resources to understand,  price, and manage risks to the housing finance system. These  government entities will also need the capacity to ensure that their  counterparties in the private sector are able to manage the risks inherent  in their activities. For example, when government entities act to insure  mortgages or guarantee MBS, they need the capacity to manage their  own credit and operational risks and to ensure that their counterparties,  such as lenders, servicers, and investors, can manage their respective  risks. We have found previously that agencies with loan insurance  programs, such as FHA, face credit risks including borrower default risk,  which arises as borrowers become unable to make payments on insured  mortgages. Agencies also face counterparty risk. That is, an agency  may suffer losses due to weaknesses or uncertainties in the work of its  counterparties, including lenders and appraisers for FHA and issuers for  Ginnie Mae. At the enterprises, private mortgage insurer counterparties  have historically provided the main mechanism to help reduce credit risk  exposure for the enterprises. Generally, we have found that private  mortgage insurers experienced weakened financial conditions during the  financial crisis. In May 2014, FHFA’s Office of Inspector General  reported that 5 of the 10 private mortgage insurers eligible to conduct  business with the enterprises are considered financially weakened. And  all agencies face operational risks—that is, the risk of loss resulting from  inadequate or failed internal processes; deficiencies in staff numbers,  training, and skills; or external events. For example, between 2002 and  2004, the enterprises were cited for failures in their accounting systems  that did not adequately capture their risk-taking activities. We have made  a number of recommendations aimed at improving FHA’s risk  assessment and human capital management, as well as HUD’s  information technology systems.

FHA and FHFA have considered risk-sharing strategies as a way to help  manage risk at FHA and the enterprises. FHA officials have told us in the  past that FHA would need to increase its staff and analytic capacity to  safely implement risk-sharing agreements. Ginnie Mae officials told us  that any FHA risk-sharing agreements that shift additional credit risk to  servicers would increase the agency’s counterparty risk and noted that  Ginnie Mae would probably require issuers to hold more capital to  mitigate this risk. They further noted that Ginnie Mae’s counterparty risk  would not increase if FHA shifted risk to a third party in a way that is  similar to the way the enterprises shift risks to third parties. In The 2014  Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac,  FHFA noted that the enterprises have completed several risk-sharing  transactions, which support FHFA’s plan to reduce the enterprises’  presence in the housing finance market. Specifically, the 2014 strategic  plan requires each enterprise to transfer a substantial portion of the credit  risk on $90 billion of new MBS—a three-fold increase over the amount  required in 2013. FHFA’s 2014 strategic plan also states, upon FHFA’s  direction, the enterprises would take steps to strengthen counterparty  standards for private mortgage insurers to ensure that the insurers are  able to fulfill their intended role of providing private capital. As part of this  effort, on July 10, 2014, FHFA requested input on draft eligibility  requirements the enterprises would use to approve private mortgage  insurers that provide mortgage insurance on loans owned or guaranteed  by the enterprises. According to FHFA, these new standards are  designed to ensure that approved insurers maintain sufficient financial  and operational capacity to withstand a severe stress event. Any proposal  for sharing risks between public and private entities requires careful  consideration, not only of the capacity of these entities to understand and  manage risks, but also to ensure that the risk-sharing structure does not  create incentives for either party to engage in excessive risk taking.

Proposals to change the housing finance system address capacity to  manage risk in a number of ways. In the primary market, two proposals  would provide FHA with increased capability to manage risk. One of the  proposals would allow FHA and USDA to share risk-management  expertise. One proposal for changing the secondary market would  authorize FHFA to regulate and examine contractual counterparties, and  another proposal would require FHFA to report annually to Congress on  risk-sharing structures. Proposals calling for a single government-owned  independent corporation to support the secondary market recognize that  the corporation’s director would need technical expertise in mortgage  securities and housing finance. These proposals also would establish  boards of directors and advisory committees comprised of members with  diverse housing finance expertise, including asset management. Some  proposals for changing the primary and secondary markets would  establish salary structures that are competitive with those of existing  federal financial regulators for any new federal agencies overseeing the  markets.

section_title: Element 5: Mortgage Borrowers Are Protected and Barriers to Mortgage Market Access Addressed
paragraphs: In our 2009 report presenting a framework for assessing or crafting a  financial regulatory system, we found that it is important for market  participants to receive consistent, useful information, as well as to have  legal protections, including disclosures, sales practices for similar  financial products and services, and suitability requirements. Similarly,  a housing finance system should provide borrowers with the information  to determine the loan product best suited to their needs, and the system  should include borrower financial protections over the lifecycle of a  mortgage loan—origination, securitization, and servicing. In September  2011, we reported that homeownership counseling could help borrowers  learn about buying a home and could improve outcomes for delinquent  borrowers. In June 2012, we found that reaching delinquent borrowers  early, when they had missed fewer payments, resulted in more successful  loan modifications. And in April 2014, we recommended that regulatory  agencies strengthen oversight activities to determine the extent to which  servicers are implementing foreclosure prevention principles and  protecting borrowers. Housing finance system reforms will also need to  address any barriers that creditworthy borrowers face in accessing the  housing finance market. Key issues include encouraging innovation to  reduce barriers to mortgage credit while ensuring that mortgage products  are suitable for borrowers, and developing alternative tools to assess  creditworthiness for broader market access.

Federal agencies have taken some steps designed to better protect  borrowers throughout the mortgage loan lifecycle and improve mortgage  market access; many of these actions have been discussed earlier in this  report. For example,

Origination. CFPB, HUD, and VA have issued rules related to  assessing borrowers’ ability to repay their loans, which addresses  some aspects of suitability. CFPB also finalized loan originator  compensation rules designed to reduce incentives for loan originators  to steer borrowers to unaffordable mortgages. As previously noted  in this report, in 2008, HUD revised the rules implementing RESPA so  that the required forms would provide additional disclosures at  origination. In November 2013, CFPB issued final rules consolidating  the disclosures required by TILA and RESPA for applicants  considering a home mortgage loan. These rules take effect on August  1, 2015. In its Blueprint for Access issued in March 2014, FHA  outlined steps the agency is taking to expand access to credit for  underserved borrowers, including encouraging broader use of housing  counseling intended to ensure that borrowers are well-educated about  the home-buying and mortgage finance process. For example, in May  2014, the agency began soliciting comment on a 4-year pilot program  that would provide FHA insurance pricing incentives to first-time  homebuyers who participate in housing counseling and education that  covers how to evaluate housing affordability and mortgage  alternatives, better manage their finances, and understand the rights  and responsibilities of homeownership. HUD officials told us that  housing counseling can divert consumers who are not ready for  homeownership from entering into a contract for an unaffordable  home, and also bring consumers to the housing finance system who  might otherwise be afraid of being denied.

Securitization. FHFA has specified the need for greater clarity about  requirements for loans to be securitized by the enterprises, saying  that the lack of clarity was likely restricting access for some  creditworthy borrowers. FHFA noted in its 2014 Strategic Plan that  some originators and mortgage insurers have been requiring higher  minimum credit score requirements than would be required by the  enterprises, resulting in the rejection of many loans that would  otherwise meet enterprise credit standards. The FHFA Director  acknowledged that these higher credit standards were the result of  lender uncertainty about having to repurchase these loans in the  future if they were found to violate enterprise requirements for  securitization.

Servicing. CFPB established new mortgage servicing rules that took  effect in January 2014 requiring servicers to follow certain standards  and procedures when working with troubled borrowers in an effort to  avoid unnecessary foreclosures. According to VA, the VA Home  Loan program oversees mortgage servicers by reviewing every loan  to ensure that the servicer has made all reasonable efforts to help the  veteran avoid foreclosure. In cases of mortgage default, VA  employees in regional offices serve as intermediaries between the  veteran and servicer to negotiate a resolution to the default. FHA  requires servicers to address delinquencies through an early  intervention process, which could include default counseling, prior to  engaging in formal foreclosure mitigation actions. A 2012 HUD  study found that 69 percent of housing counseling clients enrolled in  foreclosure and prepurchase counseling obtained a mortgage  remedy, and 56 percent were able to become current on their  mortgages with a counselor’s help. In The 2014 Strategic Plan for  the Conservatorships of Fannie Mae and Freddie Mac, FHFA requires  the enterprises to continue, and improve upon servicing standards  and loss mitigation outcomes for borrowers.

Some participants in our discussion groups noted that CFPB’s Ability-to- Repay and Qualified Mortgage Standards Rule, which went into effect on  January 10, 2014, promotes borrower protection by requiring mortgage  lenders to consider borrowers’ ability to repay the loans before extending  them credit. However, some participants have noted the rule could limit  access to the housing finance market for some creditworthy borrowers  who do not satisfy certain QM standards, such as the 43 percent debt-to- income ratio for private loans. Several industry groups that participated  in our discussions jointly submitted a letter to CFPB and HUD regarding  their concerns about potential liability for fair lending violations based on  disparate impact; they expressed concern that the QM criteria may  tighten credit and inadvertently exclude a disproportionate number of  minorities and protected classes. In an interagency statement about fair  lending compliance and the Ability-to-Repay Rule issued in October 2013,  five federal agencies noted that they do not anticipate that a creditor’s  decision to offer only QM mortgage loans would, absent other factors,  elevate a supervised institution’s fair lending risk. The agencies  counseled creditors to continue to evaluate fair lending risk for QM loans  as they would for other types of product selections, including by carefully  monitoring policies and practices and implementing effective compliance  management systems.

In our discussions, some participants expressed additional concerns  about access to housing finance for some borrowers and overall access  to housing. For example, two consumer advocates who attended our  discussions have noted that standard underwriting criteria and down- payment thresholds reflect accumulated wealth that can differ across  groups and may be a barrier to accessing housing finance. Other group  discussion participants noted that as a result of the financial crisis, many  borrowers have lost their homes through foreclosure and experienced  periods of unemployment, and consequently, they will have difficulty  qualifying for loans in the future unless underwriting standards are more  flexible. One industry representative also noted that prospective first-time  homebuyers who have accumulated large student debt will have difficulty  qualifying for a mortgage under the debt-to-income ratios required by QM.  Some participants at our discussions said that the housing finance  system should promote broader market access through flexible  underwriting standards that include innovations in the way  creditworthiness is assessed, such as alternative credit scoring,  consideration of compensating factors, and no- or low-down payment  requirements. Other participants emphasized the role that small lenders  play in providing credit to those who might otherwise not have access to  it, and said that a housing finance system needs to include secondary  market access to all lenders. For those who are not prospective mortgage  borrowers, participants across our group discussions emphasized the  need for affordable housing options and the importance of including  financing for rental housing in any housing finance system. Consumer  advocates noted specifically that a comprehensive housing finance  system should include a steady, reliable, and liquid source of capital to  support rental housing.

Participants at our discussion groups also noted the benefits of home  ownership counseling and the need for protection for those borrowers  facing mortgage default. Participants noted that homeownership  counseling should be included in a new housing finance system. They  said that it was helpful in educating borrowers about the risks they are  assuming and which products are best suited for them. Some participants  in our discussions also noted that borrower protections in any housing  finance system should cover the entire mortgage lifecycle, including  setting stringent loan modification requirements for servicers who had  sometimes benefited from pursuing foreclosure over loss mitigation  efforts.

Some participants at our discussion groups also discussed how  standardization of mortgage products may promote borrower protection  and access to credit, but also may limit beneficial innovation. Some  participants at our discussions noted that the 30-year fixed-rate mortgage  is a product that borrowers have long understood. Several participants  also noted that the TBA market should be maintained as the conduit for  the 30-year fixed-rate mortgage, because it makes mortgage credit widely  available by ensuring a predictable path to securitization for small lenders  as well as larger institutions. Other participants who attended our group  discussions have proposed that in a reformed system, borrowers would  have a variety of well-underwritten mortgage loan choices. As with  standardized underwriting, some participants noted that standardizing  products may limit innovation that could benefit some potential  homeowners. Two housing finance experts who attended our group  discussions noted that certain innovations to the standard mortgage  contract could increase the affordability of home ownership. For example,  under a shared appreciation mortgage the borrower gives the lender a  share of any increase in home value in exchange for lower interest rates  and monthly mortgage payments. The Dodd-Frank Act required HUD to  conduct a study to determine statutory and regulatory requirements for  widespread use of shared appreciation mortgages within 6 months after  the act was enacted, but as of June 1, 2014, this study had not been  completed.

Several proposals provide for borrower protections and promote  mortgage market access. One proposal calling for FHA reform would  require lenders to provide each borrower at origination with a disclosure  detailing the likelihood of default for a borrower with a similar risk profile  and mortgage product. Some proposals would preserve the existing QM  criteria, and explicitly authorize the development of standards to ensure  access for affordable mortgage credit, including maintaining the 30-year  fixed-rate mortgage. At least one of these proposals would explicitly  preserve the TBA market. However, a press release accompanying  another proposal says that it is based on a previously issued set of  principles that include ensuring the continued, smooth operation of the  TBA market through any transition and after, so that market participants  do not lose the ability to lock in a price for securities before loans are  sold. Some proposals address secondary market access by smaller  lenders. For example, at least one proposal would authorize the creation  of a mutually owned company to facilitate small lenders’ access to the  secondary market, and another proposes that the FHLBanks facilitate that  access, by creating a TBA market for those lenders. Some proposals  promote lending innovations to address the needs of underserved  markets and populations. For example, some proposals would create a  mechanism to support innovation in responsible lending products,  underwriting, and servicing specifically targeted to underserved groups.  Another proposal would require mortgage servicing standards to include  foreclosure loss mitigation programs. Some proposals address the trade- off between consumer protection and innovation. For example, they  include mechanisms whereby the impact on consumers of new mortgage  products would be evaluated during a trial period. At least one proposal  preserves the Housing Trust Fund to increase the supply of affordable  rental housing for extremely low-, very low-, and low-income families in  rural and urban areas and the Capital Magnet Fund at Treasury to  develop, rehabilitate, or purchase affordable housing for these  households.

section_title: Element 6: Protection for Mortgage Securities Investors
paragraphs: In any housing finance system, investors in the secondary mortgage  market require adequate, reliable information to assess risks related to  mortgage-backed securities, and incentives need to be better aligned  across market participants. In our 2009 report presenting a framework for  assessing or crafting a financial regulatory system, we found that  investors need to receive consistent, useful information as well as legal  protections. As we noted earlier in this report, prior to and during the  financial crisis, investors lacked reliable information, and the securitization  process displayed misaligned incentives between investors and other  parties. For example, investors did not have access to the same  information about the assets collateralizing MBS as did the originators of  securitized loans. Moreover, before the crisis some investors did not  independently assess asset risk but relied instead on ratings provided by  credit rating agencies. As we have previously reported, some of the  ratings agencies had conflicts of interest and provided ratings that did not  adequately reflect the risks posed by MBS and CDOs. In a study  mandated by the Dodd-Frank Act, we identified seven alternative models  for compensating credit rating agencies that were designed to address  the conflict of interest inherent in having issuers-pay for ratings, better  align credit rating agencies’ interest with users of ratings, or improve  incentives credit rating agencies have to produce reliable and high-quality  ratings.

As required by the Dodd-Frank Act, SEC, which is generally responsible  for investor protection, has taken steps designed to provide investors with  more information to evaluate risks. For example, in 2011, SEC adopted  rules related to the disclosure of information on breaches of  representations and warranties in ABS transaction documents.  Specifically, securitizers must provide the history of repurchase or  replacement requests if the transaction agreements include repurchase or  replacement rights for breaches of representations and warranties. The  rules also require registered credit rating agencies to include in any report  accompanying the credit rating information regarding the representations  and warranties and enforcement mechanisms available to investors.  SEC has also engaged in rulemakings designed to provide investors with  the information they would need to compare the performance of different  MBS and better evaluate investment risk. SEC officials with whom we  spoke noted that providing investors with better information helps improve  transparency thus enabling more effective monitoring and investor  decision making. In September 2014, SEC adopted a rule governing the  disclosure, reporting, and offering process for ABS, including those  backed by residential mortgages. Among other things, the rule requires  ABS issuers to provide standardized loan-level information, such as  borrowers’ credit and mortgage payment terms, at the time the ABS is  offered and in ongoing reports. According to SEC, providing investors  with access to such information will allow them to better understand,  analyze, and track the performance of ABS. The rule also provides  additional time for investors to analyze the specific structure, assets, and  contractual rights for certain ABS transactions. In August 2014, SEC  also adopted a rule that addresses new requirements for credit rating  agencies, which, according to SEC, is designed, in part, to increase  transparency and credit rating agency accountability. Among other  things, the rule requires a number of credit rating agencies to provide  certain disclosures including credit rating performance statistics and credit  rating methodologies.

As required by the Dodd-Frank Act, SEC has taken some actions  designed to protect investors from misaligned incentives related to credit  rating agencies. In June 2012, SEC established an Office of Credit  Ratings as required by the act, and completed its required study of  alternative means for compensating rating agencies intended to create  incentives for accurate credit ratings later that year. In its August 2014  credit rating agency rule, SEC took actions designed to address credit  rating agencies’ conflicts of interest.

Regulators have taken some additional actions designed to better align  incentives, as required by the Dodd-Frank Act. For example, FDIC, the  Federal Reserve, FHFA, HUD, OCC, and SEC have jointly proposed a  rule to implement credit risk retention requirements. Specifically, the  proposed credit risk retention rule would require that the securitizer retain  at least 5 percent of the credit risk of the assets they securitize so they  would have an incentive to exercise due care in selecting assets for  securitization. The proposed rule includes an exemption for QRM loans,  which are defined based on CFPB’s definition for QM loans. CFPB’s  QM rule also includes a temporary QM definition for loans eligible for  purchase or guarantee by an enterprise. The temporary definition expires  once the enterprises exit conservatorship or no later than 7 years after  January 10, 2014. In addition, the agencies responsible for the QRM  rule expect to revisit and, if appropriate, modify the proposed rule after  the future of the enterprises and any related statutory and regulatory  framework becomes clearer. The extent of the impact of credit risk  retention on housing finance market participants, however, may, depend  on the final definition of QRM and the percentage of the market that is  non-QRM.

To further protect investors, FHFA and others have recommended that  the enterprises or any subsequent securitizer create a standard  securitization platform. FHFA is developing an infrastructure for single- family mortgage securitization that it says is aimed at standardizing  practices and helping achieve investor certainty and confidence through  uniform contractual terms and standards for transparency. The  infrastructure also includes a common securitization platform with design  principles intended to help align and standardize existing practices,  including issuance, master servicing, bond administration, collateral  management, and data integration. In March 2014, FHFA and the  enterprises began an initiative intended to improve and standardize the  collection of mortgage servicing data.

Representatives of investors at our discussion groups noted the  importance of robust, loan-level disclosure requirements and of timely  and reliable information for appropriately pricing risk. One representative  of investors said that risk retention was the single most important way to  repair the misalignment of incentives in the securitization market and  promote investor protection. As discussed earlier in this report,  misalignment of incentives in the securitization market occurred when, for  example, originators lowered underwriting standards but did not retain the  risk and passed on the risks of these mortgage loans to the secondary  market. He noted that while aligning the QRM definition with CFPB’s QM  definition in the proposed joint credit risk retention rule, would streamline  regulatory certainty and compliance with underwriting standards, it may  exempt some risky loans from risk retention requirements, including those  with low down payments and high LTVs and debt-to-income ratios.  Another investor representative who attended our discussions later noted  at a panel on bringing private capital back to the mortgage market that  including government-insured loans and loans securitized by the  enterprises in the definition of QRM would result in too few non-QRM  loans to make their securitization economical. As noted earlier in this  report, the five agencies that have issued the proposed credit risk  retention rule recognize that modifications to the proposed rule may be  necessary depending on changes in the current housing finance system.

In addition to better aligning incentives through risk retention initiatives,  some participants at our discussions noted that more effective resolution  of representations and warranties issues would protect investors. SEC  has noted that without access to documents relating to each pool asset,  determining whether or not a representation or warranty relating to a pool  asset has been breached can be difficult for the trustees that typically  notify sponsors of alleged breaches. One investor representative at our  discussions, has noted that a third party mechanism for investigating and  resolving breaches of representations and warranties concerning the pool  assets could help serve the interests of investors. The September 2014  rule governing ABS disclosure includes such a third-party mechanism for  reviewing pool assets and providing certain information from the review to  the trustee who would decide whether to pursue actions based on a  breach of the representations and warranties. In May 2014 FHFA  announced increased efforts to improve the enterprises’ representation  and warranty framework in the agency’s strategic plan for the  conservatorships of the enterprises. One participant at our group  discussions has recognized that while standardization of securitization  generally provides investors with greater protection, it may inhibit  beneficial innovation in the secondary market.

Many of the proposals for changing the housing finance system include a  standardized platform and some address issues of transparency in  market operations, including making improvements in loan document  disclosures for investors. These proposals also would require the  development and adoption of standard uniform securitization agreements,  which would include terms relating to representation and warranty  violations and trustee responsibilities. One of these proposals requires  that the secondary market regulator submit a report to Congress on any  effects such trustee responsibilities would have on market liquidity and  additional costs and expenses to borrowers.

section_title: Element 7: Consideration of Cyclical Nature of Housing Finance and Impact of Housing Finance on Financial Stability
paragraphs: We have identified financial system stability and reforms related to  promoting that stability as a key issue. We have also issued several  reports on the ways the Dodd-Frank Act attempted to address market  weaknesses leading up to the 2007-2009 financial crisis and the extent to  which requirements of the act related to financial stability have been  implemented. However, we have found that the housing finance  system, which is characterized by cyclical fluctuations, still poses risks to  financial stability. We noted earlier in this report a number of weaknesses  in the housing finance system including the weakening of underwriting  standards during the economic expansion and the tightening after the  onset of the financial crisis. These weaknesses contribute to cyclical  fluctuations in housing finance. According to the former Chairman of the  Financial Stability Oversight Council, these cycles are to some extent  related to the ability of originators and securitizers who do not retain risk,  to, at least in the short run, maximize their own returns by lowering loan  underwriting standards in ways that investors may have difficulty  detecting, thus exposing investors and the overall economy to greater  risks. Eventually, the accumulation of these risks during the housing  bubble led to a downturn, with some participants leaving the market and  those remaining imposing tighter credit standards. In addition, housing  finance cycles may be amplified by expectations among all participants in  the mortgage process that housing prices will continue to do what they  have done in the recent past. When house prices have been rising,  participants in the mortgage process may act on the assumption that  prices will continue to rise and, thus for some time, perpetuate and  amplify such increases. But if underlying factors, such as a growth in  population or income, do not support the growth in the market, such  increases will not be sustained. Because housing is a significant part of  the economy, these cycles generally pose risks to overall financial and  economic stability.

Financial regulatory actions, or inaction, can exacerbate housing finance  cycles, and the potential for these actions to do so should be considered  and perhaps avoided. For example, while regulators did not take sufficient  actions to stem a decline in underwriting standards during the run-up in  house prices preceding the financial crisis, they did require regulated  financial institutions to raise their capital levels during the downturn. The  Ability to Repay and QM rules may play a countercyclical role by, as  CFPB notes in its official interpretations of the final rules, setting a floor to  the loosening of credit to prevent the deterioration of lending standards to  dangerous levels and preventing a repeat of the deterioration of lending  standards that contributed to the financial crisis. Researchers and  government officials participating in a conference on regional housing  finance cycles in the aftermath of the savings and loan crisis said that  public policy should avoid reinforcing any speculative activity during the  emergence of housing bubbles.

Government policies and practices can also be countercyclical. FHA has  played a countercyclical role during the recent downturn but is sometimes  criticized for doing so. For example, FHA lending standards remained  relatively unchanged and its loan limits grew during the onset of the  financial crisis when other market participants were tightening mortgage  credit standards, resulting in the rapid growth of FHA’s share of the  market. Later FHA experienced higher-than-expected losses because of  higher than expected defaults and, in response, tightened requirements  for lender underwriting and raised its insurance premiums. As we have  previously reported, mortgage industry observers have proposed options  that would limit FHA’s market presence as a way of either reducing FHA’s  liability or better ensuring that it serves a certain market—that is, low- or  moderate-income borrowers and first-time homebuyers. Other  government entities have taken countercyclical actions, such as varying  loan-to-value ratios over the cycle. For example, according to a paper  from the Hong Kong Monetary Authority, Hong Kong has varied the loan- to-value ratios for residential loans for depository institutions in response  to cyclical changes. According to the Hong Kong Monetary Authority, this  policy was introduced as an instrument for strengthening the banking  system’s resilience to asset price volatilities and reducing the risk of cycle  amplification through bank credit, rather than as a means of managing  asset price cycles and market activities or targeting asset prices. The  paper also notes a number of special circumstances facing the Hong  Kong Monetary authority, including that it is precluded from conducting  independent monetary policy. Officials at one U.S. government agency  noted that varying the loan-to-value ratio over the cycle would be less  advantageous than setting these ratios at a level that would be  sustainable over a cycle, and researchers have suggested that limits on  certain loan-to-value ratios in Texas, that did not vary over a cycle, may  have led that state to have fewer defaults during the financial crisis.

Some participants at our discussion groups also noted that at times  government actions may intensify housing finance cycles and that such  actions should be avoided. For example, one participant noted that  financial regulation encouraged the formation of the housing bubble and  then government officials failed to act early enough to limit the impact of  the crisis. Another noted that because policy responses to the crisis had  been late in terms of moderating the downturn in the cycle, it would be  better to rely on policies that change automatically over the cycle, such as  requiring borrowers to make higher down payments on subsequent  mortgage loans when they increase the number of mortgage loans they  take out, rather than on discretionary government actions. Although some  participants at our discussion groups acknowledged that FHA had played  a countercyclical role, one participant noted that there will be lots of  pressure to let the next housing bubble continue and that FHA may need  flexibility, such as being able to vary down payment requirements, to  provide a countercyclical force. However, one participant noted that  FHA’s goal of providing financing for lower-income homebuyers might  lead it to use that flexibility to lower downpayments. Another participant at  our discussion groups said that it would be difficult to design national  countercyclical policies for the U.S. housing markets because of local  variations in those markets.

In proposals for changing the housing finance system and related  research, policymakers and researchers have concentrated on  countercyclical policies directed at severe downturns in the market. Some  proposals to change the housing finance system provide a government  backstop if losses exceed some threshold. The backstop generally  consists of government mortgage guarantees that would be activated  when mortgage losses reach a particular level. Those making proposals  with a government backstop have said that it is unreasonable to assume  that the federal government would not enter the market to soften a severe  downturn in the future.

section_title: Element 8: Recognition and Control of Fiscal Exposure and Mitigation of Moral Hazard
paragraphs: Recognition and control of fiscal exposures depends, in part, on the  treatment of these exposures in the federal budget. In a 2013 report that  discussed fiscal exposures in a number of programs, including the  activities of the enterprises, we noted that fiscal exposures may be  explicit in that the federal government is legally required to pay for the  commitment; alternatively, they may be implicit in that the exposures arise  from expectations based on current policy or past practices. In that  report we concluded that the federal budget has not provided complete  information about some significant fiscal exposures. Therefore, we  continued to support many past recommendations to improve budget  recognition of these exposures, both to increase the attention given to  them and also to allow for more comparable cost information for decision  makers to consider when determining the best way to achieve various  policy goals or to design a program. These recommendations include  incorporating measures of the full cost of programs into primary budget  data. We have also noted in prior reports that government actions that  respond to private sector losses may contribute to moral hazard—a  situation in which private market parties may make decisions that affect  certain risks believing that the federal government will ultimately bear the  losses, and as a result, may take on excessive risk. Nonetheless, we  have found that the government may choose to assist private companies  or markets when that assistance would reduce the impact of systemic  crises and have recommended that the government take actions to  mitigate the effects of weakened market discipline when it provides  certain kinds of assistance.

The estimated cost for FHA, VA, and USDA direct loans and loan  guarantees—generally referred to as credit subsidies—is explicitly  recognized in the federal budget under the Federal Credit Reform Act of  1990. Agencies estimate their programs’ credit subsidy costs based on  estimated future cash flows on their guarantees, and reestimate the credit  subsidy cost each year. The subsidies are explicitly accounted for in the  federal budget and fiscal exposure as measured by those estimated costs  is known. However, the ultimate subsidy costs may differ from the  estimates. We have previously found challenges in estimating the cost of  credit programs and made a number of recommendations for improving  FHA’s estimates. In addition, we found that FHA has taken actions to  improve the models it uses for estimating its credit subsidy costs and  other purposes. Nonetheless, estimating credit subsidy costs for a  mortgage guarantee program can be difficult, in part, because the  estimates are based on long-term assumptions about house prices and  interest rates that are inherently uncertain.

The activities of the enterprises have had limited transparency in the  federal budget, despite a series of events that have led to significant fiscal  exposure. Prior to 2008, the enterprises did not represent an explicit fiscal  exposure. However, because of an assumption in financial markets of an  implied federal guarantee, the enterprises were able to borrow at lower  costs than other market participants. Implicit exposures can be difficult to  estimate and do not appear in the federal budget. As noted earlier in this  report, in 2008, FHFA placed the enterprises into conservatorship and  Treasury agreed to provide temporary capital assistance under the Senior  Preferred Stock Purchase Agreements, creating a new explicit  exposure. For budgetary purposes, Treasury recorded its assistance as  budget outlays to the enterprises in the year Treasury made the actual  disbursement. As this support for the enterprises did not represent a  direct loan to the enterprises or a loan guarantee, Treasury deemed that  the budgetary credit subsidy accounting (consistent with the Federal  Credit Reform Act of 1990) did not apply. As noted earlier in this report,  since entering the Senior Preferred Stock Purchase Agreements with the  enterprises in September 2008 through March 31, 2014, Treasury has  disbursed $187.5 billion to the enterprises and received dividend  payments of $202.9 billion. Treasury records these dividend receipts from  the enterprises in the federal budget as reductions in budget outlays  when received. While neither enterprise has needed additional funding  from the Treasury since the second quarter of 2012, the remaining  reported authorization available to the enterprises was about $258 billion  as of March 31, 2014. On April 14, 2014, FHFA published the results of  stress tests designed to estimate fiscal exposure under a range of  economic scenarios. They found that payments to the enterprises could  range from $0 up to $190 billion under various economic assumptions. In  addition, while recognizing that the federal government is not obligated to  provide additional assistance beyond the scope of the Senior Preferred  Stock Agreements, its past responses may influence expectations related  to future support, representing an additional implicit exposure that is  difficult to estimate.

Some participants at our discussions noted the need to manage moral  hazard saying that if there is another housing crisis, the government will  step in. One participant said that we should admit first that there will be  some type of catastrophic government backstop. The participant noted  that we should define moral hazard and try to price it, saying that moral  hazard is endemic, but we need to determine how to best control and  manage it by determining how much capital is necessary. Another  participant added that the cost of a government backstop is part of a  discussion of trade-offs among the goals of the housing finance system.  The participant also noted that private insurers tend to handle moral  hazard better than public insurers.

One proposal to change the housing finance system recognizes the  possible fiscal exposure and therefore does not include a government  guarantee in the secondary market. However, others have asserted that  the government would step in if the housing sector faced a severe  downturn and try to minimize fiscal exposure by having private capital  assume some level of losses before any government guarantees would  be activated. In addition, these proposals attempt to offset fiscal exposure  and minimize moral hazard by assessing risk-based fees for market  participants. However, as is evident in other government insurance  programs, such as deposit or flood insurance, assessing appropriate fees  outside of a market is difficult. In addition, pressure may develop to  reduce the buildup of any fund that collects such insurance payments  during the upswing of a cycle. One proposal that includes changes for  FHA is designed to promote controls over lenders, such as explicitly  requiring that lenders—whether operating under its direct endorsement  program or delegated authority—that misrepresented loans repay FHA in  cases where the loans default.

section_title: Element 9: Emphasis on Implications of the Transition
paragraphs: Because reforming the housing finance system may represent substantial  changes in the marketplace, policymakers should consider how best to  ensure that the transition to any new system does not hamper the  functioning of markets, individual institutions’ ability to conduct their  activities, and consumers’ ability to access needed services. Any action  that would severely limit market liquidity—negatively impacting mortgage  borrower access—should be of particular concern. A transition period  might allow for changes to be phased in at a pace that market participants  could manage. In addition, we found in 2009 that certain critical factors,  such as effective communication strategies, could help to ensure that any  large-scale transitions were implemented successfully. Further,  attention should be paid to developing a sound human capital strategy to  ensure that any new or consolidated agencies are able to retain and  attract additional quality staff during the transition period, and  policymakers should consider how best to retain and utilize the existing  skills and knowledge base within agencies subject to changes as part of a  transition. However, any housing finance reform policies should  consider that there may be trade-offs between making smaller changes to  help ensure a smooth transition in the short run and making more  significant changes that would provide greater long-term benefits but  might result in a more difficult transition.

Because changes to the housing finance system may have large  unintended consequences for housing finance markets, policymakers and  federal officials would need to monitor the system during the transition  and make any needed changes. Specifically, the impact on housing  affordability would need to be monitored during the transition to ensure  that effects are aligned with expectations. Such monitoring would permit  adjustments to be made through flexibilities provided to government  entities or legislation. No matter how the housing finance system is  ultimately restructured, or even if it remains as is, mortgage rates are  expected to be higher in the future. How much higher depends on  numerous factors, including the sources and cost of private capital  supporting the system and the extent and nature of any government  guarantees. One researcher has estimated that in a new housing finance  system, the cost of mortgages will rise depending on the extent of the  federal role in the secondary market. Estimates of the increase in  mortgage rates range from .1 to 1.8 percentage points, depending on  borrower and loan characteristics. However, housing affordability rests  on many factors other than mortgage rates, including the price of housing  and the types of mortgage products available.

Agency officials, industry representatives, consumer advocates, and  researchers who attended our discussions emphasized the importance of  a deliberate, well-defined transition from the current housing finance  system to any new one that would minimize market disruption. In  particular, they noted that ongoing mortgage liquidity would have to be  maintained during the transition to ensure the availability of credit. Across  stakeholder groups, participants also emphasized the need to maintain  the smooth functioning of the TBA market during the transition and the  availability of the 30-year-fixed rate mortgage. Some participants noted  that a transfer of human capital from the enterprises to any new system  set up in the secondary market would be helpful. Two consumer  advocates also noted that monitoring of any increasing costs to potential  borrowers during a transition is critical. One of these consumer advocates  and several other group participants noted the importance of weighing the  benefits and costs involved in a transition to a new system relative to  maintaining the current housing finance system.

Proposals to change the housing finance system include details on the  transition to a new system, including time frames and operational issues  such as the transfer of powers, personnel, and facilities from current  entities to those that are proposed to replace them. At least two proposals  provide for flexibility, such as allowing the enterprises to continue to  operate past a proposed time limit even if certain conditions are not met.  Two proposals include requirements for formal transition planning. For  example, one proposal requires the new secondary market regulator to  provide Congress with a plan that specifies all the legislative,  administrative, and regulatory actions necessary to transition to a fully  privatized secondary mortgage market. Some proposals also consider the  impact of the transition on a range of other factors. For example, one  proposal considers how transition options may affect housing prices and  affordability, the effectiveness of borrower protections, small-lender  participation in the secondary mortgage market, access to credit in rural  and underserved communities, innovation among secondary market  participants, and taxpayer repayment. It also provides for transition  oversight, including annual testimonies before Congress on transition  progress and reports to Congress on the status of the transition.

section_title: Any Changes Will Involve Trade-offs and Should Consider Characteristics Associated with Controls and Performance
paragraphs: One of the most difficult parts of changing the single-family housing  finance system will be to make choices when there are trade-offs among  and within the elements. As we have noted, trade-offs and priorities need  to be considered when the goals of the housing finance system are being  defined. Establishing competing goals or principles, without an indication  of their relative importance, will not provide government agencies with  sufficient certainty as to what is expected of them going forward.  Identifying these trade-offs and defining priorities are essential to  developing policies and mechanisms to achieve goals. Within the  elements related to protecting borrowers and investors, for example, the  benefits of standardization will need to be weighed against possible limits  to beneficial innovation and access to credit for people who do not meet  the criteria for standardized products.

In addition, any housing finance system should have appropriate controls  and high-quality performance that are characterized by transparency and  accountability and that align incentives and ensure efficiency and  effectiveness. These interconnected characteristics apply to many of the  nine elements that we laid out earlier in this report.

Transparency. In prior reports, we have cited the value of  transparency in such areas as improving program outcomes and  strengthening oversight. In those reports, we have found that  transparency is essential for Congress and the public to hold  government agencies accountable and that transparency includes  clarity of communications. We have also recognized that an  appropriate level of transparency takes into account the need to  maintain confidentiality and information security and must be  balanced with the need for those involved in deliberations to be able  to express their views. Transparency includes clearly communicating  goals and trade-offs to the public; ensuring that adequate data are  disseminated; and ensuring that borrowers and investors have  adequate information to assess risks. Clear communications will be  especially important during any transition from the current system to a  new one. As a result, any system that satisfies the elements will be  one with appropriate levels of transparency.

Accountability. Clarity of responsibility and transparency of actions  taken by government entities is necessary for Congress and the  public to hold them accountable—a key control for promoting an  efficient and effective government. In housing finance, market  participants must be accountable for their actions as well. Holding  market participants accountable means that those making the  decisions will be the ones who benefit or lose as a result of those  decisions. Such accountability would reduce the moral hazard in the  housing finance system. In addition, federal agencies will need to  oversee market participants and enforce rules related to preventing  fraud and abuse. Further, specifying goals and trade-offs is essential  to holding federal agencies and the private sector accountable.  Accountability is also important in elements related to policies and  mechanisms, an effective regulatory system, and the capacity of  federal agencies to understand and manage risk. Any system  addressing the nine elements will have accountability embedded  throughout.

Aligned incentives. Holding the private sector accountable requires  that incentives be better aligned and moral hazard minimized. As we  have seen, misaligned incentives likely contributed to the financial  crisis. The Dodd-Frank Act and some proposals seek to have  participants in the mortgage process hold some of the risk associated  with a mortgage. For example, the Dodd-Frank Act requires that, in  certain circumstances securitizers retain some portion of the risk of  their MBS, and some proposals want borrowers to have some equity  in their property. Some proposals require market participants to pay  for government insurance and guarantees, which could be used to  recognize their contributions to systemic risk and reduce excessive  risk taking, but determining appropriate pricing and reserving  practices for providing this guarantee poses significant challenges.  Aligning incentives means basing decisions, in part, on the ability of  borrowers to repay rather than solely on the collateral of the house  itself. Aligning incentives across the elements will help to mitigate  moral hazard throughout the housing finance system.

Efficiency and effectiveness. Changes in the single-family housing  finance system should be made in ways that support efficiency and  effectiveness. Policymakers and interested parties should consider  the benefits and costs of making various changes in policies,  mechanisms, or the regulatory systems relative to other alternatives  and to allowing the current system to persist. They should also  consider the extent to which the missions, goals, and programs of  government entities may contribute to costly fragmentation, overlap,  and duplication. Finally, policymakers and interested parties should  recognize that changes to the single-family housing finance system  that address weaknesses in the system while preserving its strengths  are likely to have costs. Weighing potential benefits and costs of  changes to the housing finance system, including costs and risk for  the federal government, will require careful consideration.

section_title: Agency Comments and Our Evaluation
paragraphs: We provided copies of this report to CFPB, FDIC, the Federal Reserve,  FHFA, HUD, OCC, SEC, Treasury, USDA, and VA for review and  comment. All but one of the agencies provided technical comments on  the draft, and we addressed technical comments as appropriate. None of  the agencies provided formal written comments on the draft. USDA,  which did not provide technical comments on this draft, noted that it  generally concurred with the information in the draft pertaining to its rural  housing program.

Some of the technical comments raised some higher level issues  including the following:

CFPB noted that regulators need access to timely information for  effective regulation. We agree and note in the final report that to  strengthen decision-making and accountability, regulators will  need access to the best reasonably obtainable scientific,  technical, economic, and other information.

In response to a statement in the draft report saying that  regulators did not take actions to stem the decline in underwriting  standards prior to the financial crisis, FDIC noted that regulators  had taken some actions beginning in 2006 to stem the decline in  underwriting standards. We agree that the regulators did take  some actions, and the final report says that regulators did not take  sufficient actions to stem the decline in underwriting standards.

HUD noted that the draft report did not discuss improvements to  borrower protection made prior to the Dodd-Frank Act, specifically  changes made to rules implementing RESPA. As a result, we  added information on 2008 revisions requiring that RESPA forms  provide additional disclosures, including clear summaries of loan  terms and conspicuous information about yield-spread premiums  designed to make it easier for potential borrowers to compare  originators when shopping for a mortgage loan.

We will send copies of this report to the Chairs of FDIC, the Federal  Reserve, and SEC; Comptroller of the Currency; Directors of CFPB and  FHFA; and Secretaries of HUD, the Treasury, USDA, and Veterans  Affairs; and other interested parties. In addition, the report will be  available at no charge on GAO’s website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-8678 or sciremj@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs are listed on the last page  of this report. GAO staff who made major contributions to this report are  listed in appendix V.

section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: To help policymakers assess various proposals for changing the single- family housing finance system and consider ways in which it could be  made more effective and efficient, we prepared this report under the  authority of the Comptroller General. Specifically, this report (1) describes  market developments since 2000 that have led to changes in the federal  government’s role in single-family housing finance; (2) analyzes whether  and how these market developments have challenged the housing  finance system; and (3) presents an evaluation framework for assessing  potential changes to the housing finance system.

To meet these objectives, we reviewed literature, including existing GAO  reports on housing finance and housing market developments, as well as  prior GAO reports presenting frameworks for reform in the financial sector  and reports that contain criteria for appropriate controls and high-quality  government performance. These reports are referenced in footnotes  throughout this report and some are included in a list of related GAO  products at the end of the report. In addition to prior GAO reports, we  conducted a literature review including academic and industry reports on  housing finance and housing market developments; current and past  financial and housing market events which have revealed limitations in  our existing regulatory and housing finance system; and proposals for  modifying the current housing finance system. To identify literature, other  than GAO reports, included in this review, we relied, in part, on Internet  and electronic database searches on housing finance. We also searched  for literature written by those who had testified before Congress or  participated in relevant conferences between September 1, 2013 and  January 31, 2014.  We also attended a number of conferences on  housing finance reform. Further, we reviewed footnotes and  bibliographies in the literature we reviewed to identify additional literature  for review. We also relied on recommendations from GAO staff who  worked in the area of housing finance and officials from other relevant  government agencies. These agencies included the Board of Governors  of the Federal Reserve System (Federal Reserve), Bureau of Consumer  Financial Protection known as the Consumer Financial Protection Bureau,  Departments of Agriculture (USDA), Housing and Urban Development,  Treasury and Veterans Affairs (VA), Federal Deposit Insurance  Corporation, Federal Housing Finance Agency, Office of the Comptroller  of the Currency, and Securities and Exchange Commission.

To provide input on a draft housing finance framework and key market  developments, we convened seven discussion groups comprised of  government officials, researchers, consumer advocates, and industry  representatives. The participants were selected because they had made  reform proposals, written or testified before Congress on housing finance  reform issues, or been recommended by government officials or GAO  staff who had participated in prior GAO studies of housing finance issues.  Although we grouped the discussions into categories such as government  officials, researchers, consumer advocates, and industry representatives,  we chose the participants because they had a range of views. As a result,  we were not expecting to find consensus about our framework or key  market developments during the discussions. A list of the participants is  included in appendix IV of this report. In a few cases where key  participants could not attend our discussion groups, we interviewed them  separately. How these discussions and interviews were used to address  issues across the objectives is further discussed below.

Specifically, to address our first objective, we identified relevant market  developments from 2000 through 2013. To help identify pertinent market  developments and relevant prior reports and analyses, we held an  internal discussion with a broad group of GAO staff who had experience  with housing finance issues. During our discussion groups with experts  and other relevant parties, we also asked participants to identify the most  important market development that housing finance reform would need to  address. We relied primarily on prior GAO reports that identified and  analyzed key national housing market indicators, including measures of  home prices, loan performance, home equity, and unemployment. We  used data that had been collected for these reports and reviewed the data  reliability assessments that had been completed for those reports to  determine if the data were reliable for our purposes. Based on these  reviews, we determined that the data were reliable for our purposes. To  update the data and analyses, we relied on several data sources  including CoreLogic’s Home Price Index, the National Delinquency  Survey data issued by the Mortgage Bankers Association, data issued by  the National Bureau of Economic Research, the Federal Reserve’s  statistical releases on the Flow of Funds Accounts of the United States  and the 30-year conventional mortgage rate, and consumer price index  data reported by the Bureau of Labor Statistics. Generally, we updated  our assessments of the reliability of these data by reviewing existing  information about data quality and corroborating key information. We  determined that the data were sufficiently reliable for our purposes.

To describe changes in market participants and products in the primary  and secondary markets, we calculated the percentage of the dollar value  of mortgage originations supported by the Federal Housing  Administration, VA, and USDA and the percentage supported by Fannie  Mae and Freddie Mac from 2000 through 2013. We relied on data  published by Inside Mortgage Finance on new mortgage originations and  issuances of mortgage-backed securities. To determine the reliability of  these data, we reviewed publicly available information on the data source  and queried a knowledgeable official about the accuracy of the data. We  determined the data were sufficiently reliable for our purposes, which  were to provide information about how the federal role changed over the  relevant time period.

To address our second objective, which describes weaknesses revealed  by developments in the housing finance market beginning in 2000, we  used information from our literature review and interviews. We identified  developments based on available literature, interviews and discussions  with external experts and other relevant parties, and internal suggestions.  We determined which market developments revealed weaknesses based  on which developments were most often cited as posing challenges for  the market. For example, several developments were cited in our sources  as contributing to the 2007-2009 financial crisis. Further, through our  review of the literature, we defined certain weaknesses—misaligned  incentives, lack of information or transparency, and excessive risk  taking—and found that many of the identified market developments fell  into these categories. In addition, we identified and described government  legislative and legal enforcement responses to the identified weaknesses.

To address our third objective, we reviewed the elements of frameworks  in prior GAO reports including those for modernizing the financial  regulatory framework, determining when the federal government should  provide assistance to the private sector, and assessing catastrophic  insurance programs. From these, an initial review of existing proposals to  change the housing finance system, and meetings with government  officials, we developed a list of potential elements of a framework that  could be used by Congress and others to assess proposals. We then  reviewed the literature to determine if these elements were relevant,  useful, and appropriate for such a framework. As a result of this analysis,  we were able to develop a draft framework that included a number of  elements and certain characteristics associated with good governance— appropriate controls and high-quality performance. We then shared this  draft framework with government officials, researchers, and other relevant  parties at our discussion groups. During the discussions, we asked  participants to exchange views on the usefulness, relevance, and  appropriateness of the draft framework; any priorities and trade-offs  among the framework elements and characteristics; and whether any  elements or characteristics of good governance had not been included in  the draft framework. Based on discussions at these meetings, we  determined that certain aspects of the framework needed to be clarified  by separating some of the elements that had originally been combined,  and by reassessing the division of the framework between its elements  and the characteristics of good governance. Where possible, we used the  remarks of participants to help clarify and enrich the discussion of the  framework elements.

Throughout the engagement we reviewed proposals for changing the  single-family housing finance system, including legislative proposals and  those made by experts participating in our discussion groups. As noted  earlier in this report, we used these proposals to help us develop an initial  list of potential elements for our framework. We also used these  proposals to help test the usefulness, relevance, and appropriateness of  the elements. For each element in the framework, we used actual parts of  proposals to illustrate how the element could be used to assess potential  changes to the housing finance system. In addition, to help ensure that  the framework was useful, relevant, appropriate, and sufficient, we  applied it to a legislative proposal.

We conducted this performance audit from August 2013 to October 2014  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.

section_title: Appendix II: History of Federal Involvement in Housing Finance from 1913 to 2014
paragraphs: Between 1913 and 2014, the federal government’s role in the housing  finance market has evolved, and these changes have influenced the  types of mortgage products available to home buyers. The federal  government employs multiple tools supporting homeownership and  financing of homes. These tools include sponsorship of mortgage market  entities, regulation of certain aspects of mortgage market operations,  insurance and guarantees of mortgages and mortgage securities, direct  lending, and favorable tax treatment. In some cases, these tools, for  example, the federal tax deduction for mortgage interest, apply broadly  and are designed generally to facilitate mortgage lending and  homeownership. In other cases, tools have been designed to facilitate  home ownership and housing opportunities for targeted populations and  groups. For example, programs administered by the Department of  Veterans Affairs (VA) and the Department of Agriculture’s Rural Housing  Service (RHS) are designed to facilitate homeownership and housing  opportunities for veterans and residents of rural areas respectively. This  appendix provides a brief overview of the developments that over time  have led to the federal government’s current role in the housing finance  markets, and GAO’s prior reviews of these topics as noted.
subsections: section_title: First Steps
paragraphs: The federal government’s current involvement in housing finance can be  traced back to the 1913 Internal Revenue Act, which established the  federal income tax. Under the Internal Revenue Act, taxpayers were  allowed to deduct mortgage interest payments and property taxes from  their taxable income when determining their federal tax liability. At that  time, the deduction for home mortgage interest was part of the deduction  allowed for any interest paid, and the deduction for property taxes was  part of the deduction for all state, local, and federal taxes. The  Congressional Research Service has noted that there is no evidence in  the legislative history that these deductions were intended to encourage  home ownership or to stimulate the housing industry when they were  introduced.

Prior to the Great Depression, mortgages featured short terms (typically 3  to 10 years), and loan-to-value ratios of less than 50 percent. These loans  also normally did not fully amortize, meaning that payments over the term  of the loan did not reduce the principal balance to zero, and borrowers  were left to pay off or refinance the balance of the loan at the end of the  term. The market for mortgages was largely local, as banks and other  lenders relied heavily on local deposits to fund mortgages. As a result, if  savings in an area were too low to meet the local demand for mortgages,  borrowers faced higher interest rates than in markets with a surplus of  savings. The lack of a nationwide housing finance market created  regional disparities in mortgage interest rates and credit availability.  These structural features of the mortgage market made it susceptible to  disruptions in the availability of funding.

section_title: The Great Depression
paragraphs: During the Great Depression, thousands of thrifts and banks failed due to  their credit losses, and housing finance generally became unavailable.  The Congressional Budget Office noted that the steep declines in  incomes during the Depression resulted in a surge of mortgage  delinquencies and foreclosures. By 1934, roughly half of home mortgages  in urban areas were delinquent, and the annual foreclosure rate was over  13 percent.

The federal government began its response to the Great Depression  housing crisis in 1932, with the enactment of the Federal Home Loan  Bank Act, which created the Federal Home Loan Bank (FHLBank)  System and the FHLBank Board as its regulator. The FHLBank System  was designed to increase liquidity in the mortgage market and serve as a  low-cost lender to thrifts to support housing finance, and continues to  operate this way today. The FHLBank System consisted of 12 FHLBanks  and was cooperatively owned by its member institutions, which originally  included only thrifts (also known as savings and loans) and insurers,  before being expanded to include commercial banks and credit unions in  1989. The primary mission of the FHLBank System was to promote  housing and community development by making loans, also known as  advances, to member financial institutions, which used the funds to  originate new mortgages. To raise the funds necessary to carry out its  activities, the FHLBank System issued debt in the capital markets at  favorable rates compared to those available to commercial borrowers.  Investors were willing to purchase FHLBank bonds at these prices  because they believed that the bonds were implicitly guaranteed by the  federal government, because of the FHLBank System’s government  sponsorship.

Fixed-rate mortgages were expanded in the 1930’s by the Home Owners’  Loan Corporation (HOLC), as the federal government sought to refinance  the large numbers of delinquent mortgages. As part of the New Deal,  President Roosevelt signed into law the Home Owners’ Loan Act of 1933,  which established HOLC. The HOLC raised funds with government- backed bonds, used the funds to purchase defaulted mortgages, and  refinanced the mortgages with new interest rates and terms. The HOLC  often converted variable-rate, short-term, non-amortizing mortgages into  fixed-rate, fully amortizing mortgages with terms as long as 15 years.  Between August 1933 and June 1936, when the corporation stopped  making loans, the HOLC refinanced about 1 million loans—or roughly 20  percent of the outstanding mortgages on nonfarm, owner-occupied  properties. In 1934, the HOLC accounted for about 70 percent of new  mortgages originated. The HOLC was dissolved in 1953.

While the HOLC addressed refinancing of existing home loans, the  Federal Housing Administration (FHA) was created to encourage new  lending for home purchases. FHA was established in 1934 under the  National Housing Act to broaden homeownership, strengthen and protect  lending institutions, and stimulate employment in the building industry.  FHA’s single-family mortgage insurance programs insured qualified  private lenders against losses on home mortgage loans they originated.  As the Federal Housing Finance Agency’s (FHFA) Office of the Inspector  General noted, FHA insurance gave lenders added security and  expanded the pool of potential homebuyers for whom lenders were willing  to underwrite loans. FHA financed its operations through insurance  premiums charged to borrowers and interest earned on its reserves. The  original FHA mortgage insurance contracts enabled borrowers to obtain  financing with a minimum 20-percent down payment. The maximum  mortgage was limited to $16,000, which enabled families to purchase up  to a $20,000 home with a minimum down payment. FHA further  expanded the use of fixed-rate, long-term mortgages and changed  mortgage underwriting standards to allow for a much broader segment of  American households to qualify for mortgage finance. Further, FHA  created new uniform construction and appraisal standards to be used by  private sector practitioners in the building and finance industries so that  FHA insured mortgages were available across the country, and  homebuyers would have access to the lowest cost funds available  nationally rather than locally.

The National Housing Act gave FHA authority to create national mortgage  associations for the purchase and sale of mortgages. In 1938, FHA  established a national mortgage association, which became the Federal  National Mortgage Association (Fannie Mae). Originally, Fannie Mae  was a federal agency with a mandate to purchase, hold, and sell FHA- insured loans. By purchasing FHA-insured loans from lenders, Fannie  Mae created liquidity in the mortgage market, providing lenders with cash  to fund new home loans. Because the loans were insured by FHA, the  lenders did not face credit risk, but by selling their mortgages to Fannie  Mae lenders were able to pass on their interest rate risk. Further, by  selling loans to Fannie Mae, lenders could now make loans with FHA  insurance and replenish their funds to lend again.

section_title: World War II and Post-War Era
paragraphs: In response to a serious housing shortage, the federal government  expanded its role in the housing finance markets during and following  World War II. Researchers have noted that the return of millions of  veterans at the end of the war, created an acute housing shortage.  Expansions in the federal government’s role in housing finance were  included in provisions of the Revenue Act of 1951, the Servicemen’s  Readjustment Act of 1944, known informally as the G.I. Bill, and the  Housing Act of 1949. The Revenue Act of 1951 introduced the concept of  deferring the tax on the capital gain from the sale of a principal residence  if the proceeds of the sale were used to buy another residence of equal or  greater value. This provision was modified in 1964 and again to its  current form in 1997.

The Servicemen’s Readjustment Act of 1944, known informally as the G.I.  Bill, created VA’s mortgage guarantee program, as part of larger package  of benefits for returning veterans. Under the act, the maximum amount of  guaranty was limited to 50 percent of the loan, not to exceed $2,000, and  loans were limited to a maximum 20 years. To be eligible, veterans must  have served in active duty for at least 90 days during World War II. The  program was amended in 1945 to increase the maximum guarantee to  $4,000, extend the maximum length of loans to 25 years, and make any  veteran that could meet credit requirements eligible. In 1948, Congress  authorized Fannie Mae to purchase VA-guaranteed mortgages to  facilitate the efforts of veterans to purchase homes. The program is still in  operation in 2014, and has undergone many revisions since 1944,  including changes in loan terms, eligible uses, and fee structures.

The Housing Act of 1949 authorized new rural lending programs through  USDA under Title V. These programs authorized USDA to provide direct  loans to farm owners for home construction and improvement on land  capable of producing at least $400 worth of agricultural products annually.  In 1965, the act was amended to authorize housing loans and grants to  rural residents in general and to authorize USDA to insure loans made by  private lenders to rural borrowers. Today, RHS administers direct loan  and loan guarantee programs under sections 502 and 504 of the Housing  Act of 1949, as amended. The section 502 program offers persons who  do not currently own adequate housing, and who cannot obtain credit  through conventional financing, the opportunity to acquire, build,  rehabilitate, improve, or relocate dwellings in rural areas by guaranteeing  loans made by commercial lenders or by directly lending to eligible home  purchasers. Loans guaranteed under the 502 program are limited to  borrowers with low or moderate income, and loans made directly under  the program are further limited to borrowers with low incomes (below 80  percent of the area median). The section 504 program offers direct loans  of up to $20,000 to very low-income homeowners who cannot obtain  other credit to repair or rehabilitate their properties. The section 504  program also offers grants of up to $7,500 to senior citizens without the  ability to repay their loans. Amendments to the Housing Act added in  1961 made nonfarm rural properties eligible for these single-family loan  programs, and both continue to operate in 2014. In 2012, we found that  the RHS loan guarantee programs overlapped significantly with FHA’s  loan guarantee program and that FHA guarantees more mortgages in  rural areas than RHS.

Until 1968, federal policies did not explicitly ban redlining, which is the  refusal of lenders to make mortgage loans in certain geographic areas,  typically minority or low-income neighborhoods, regardless of the  creditworthiness of the loan applicant. Prior to that time, in its 1938  underwriting manual, FHA established criteria for rating the economic  viability of property locations and neighborhoods, and required an  assessment of the quality of development near the property location “to  determine whether incompatible racial and social groups are present, for  the purpose of making a prediction regarding the probability of the  location being invaded by such groups”. However, redlining was explicitly  banned in the Fair Housing Act.

section_title: Privatization of Fannie Mae and Creation of Freddie Mac
paragraphs: In the post-war period, as the mortgage market became more  standardized, Congress transitioned Fannie Mae into a private  corporation with a congressional charter. Congress began the process  of changing Fannie Mae’s ownership structure with the Housing Act of  1954. Banks that sold mortgages to Fannie Mae were required to  purchase nonvoting common stock in Fannie Mae, but the federal  government remained the enterprise’s majority owner. The Housing and  Urban Development Act of 1968 chartered Fannie Mae as a government- sponsored enterprise and provided for its sale to private shareholders,  completing the transition to private ownership. The act also gave Fannie  Mae the power to securitize loans, but initially Fannie Mae continued to  primarily hold mortgages that it purchased in its portfolio. The act also  split Fannie Mae into two corporations: Fannie Mae and the Government  National Mortgage Association (Ginnie Mae). Ginnie Mae was and  continues to be an on-budget, federally owned corporation within HUD  that guarantees timely payment of principal and interest on privately  issued mortgage-backed securities (MBS) collateralized by FHA, VA, or  other government insured or guaranteed mortgages.

The Emergency Home Finance Act of 1970 created the Federal Home  Loan Mortgage Corporation (Freddie Mac). Freddie Mac was intended  to add liquidity to the secondary mortgage market and to complement the  FHLBank System. Freddie Mac was initially owned by the member  institutions of the FHLBanks, which were primarily thrifts, and was  authorized to carry out transactions with any institution with federally  insured deposits. Freddie Mac began to purchase long-term mortgages  from thrifts, increasing their capacity to fund additional mortgages and  reducing their interest rate and credit risk. Freddie Mac focused its  business activities on purchasing loans and issuing MBS rather than  holding mortgages in its portfolio. Freddie Mac issued its first MBS in  1971. The Emergency Home Finance Act of 1970 also authorized both  Fannie Mae and Freddie Mac to purchase loans that satisfied certain  requirements in terms of size and leverage that were not insured by the  federal government, and the enterprises focused their business activities  on these “conventional” mortgages. The secondary market for  conventional loans created by the enterprises increased the liquidity of  the primary mortgage market, allowing lenders to fund additional  mortgages. In addition to providing liquidity, by purchasing mortgages that  were not federally-insured, the enterprises took on the credit risk  associated with the mortgages. Further, because of the ability to sell the  loans, banks and thrifts had an incentive to originate mortgages that  conformed to Fannie and Freddie’s standards, and this made  underwriting standards more uniform across the country.

section_title: Response to Savings and Loan Crisis
paragraphs: The savings and loan crisis required a large financial intervention by the  federal government and led to changes in the FHLBank System. Prior to  changes made in the early 1980s, thrifts were limited by regulation in both  the amount of interest they could pay on deposits and the types of loans  they could offer. In 1979, the Federal Reserve System (Federal Reserve)  substantially increased interest rates in an effort to reduce inflation. Thrifts  were not able to offer depositors market rates on deposits due to the  regulatory limitations, and lost substantial funding as depositors withdrew  funds. As numerous thrifts became insolvent and were at risk of failure,  the federal government’s initial response was to remove some of the  regulations that restricted thrifts, increase deposit insurance limits, and  decrease capital requirements for thrifts. The two primary pieces of  legislation in this response were the Depository Institutions Deregulation  and Monetary Control Act of 1980 and the Garn–St Germain Depository  Institutions Act of 1982. Together these acts removed limits on the  amount of interest that could be charged on deposits and allowed certain  banks and thrifts to provide many new types of products, including  adjustable-rate mortgages. However, the crisis deepened and the federal  government ultimately provided more than $100 billion in direct outlays to  resolve more than 700 failed thrifts. Congress passed the Financial  Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA),  which placed thrifts under Federal Deposit Insurance Corporation (FDIC)  insurance, created the Office of Thrift Supervision (OTS) as a new  regulator for thrifts, and made changes to the FHLBank System. For  example, the act allowed commercial banks and credit unions, to become  members of the FHLBank System.

section_title: Regulation of the Enterprises
paragraphs: During the 1990s the federal government continued to restructure the  enterprises and put in place a new regulatory structure for them. FIRREA  restructured Freddie Mac as a publicly traded corporation, with a similar  corporate structure as Fannie Mae. With this change Fannie Mae and  Freddie Mac’s structures and strategies were very similar. Both of the  enterprises issued MBS that included their own guarantees to investors  against credit risk on the securitized mortgage pools, and both held  mortgages and MBS on their respective balance sheets. By 1992,  Congress concluded that the enterprises posed potential safety and  soundness risks, and regulations that had been in place since 1968 were  inadequate to manage such risks. Through the Federal Housing  Enterprises Financial Safety and Soundness Act of 1992 (Title XIII of the  Housing and Community Development Act of 1992), Congress  fundamentally revised regulation of the enterprises and took steps to  clarify Fannie Mae’s and Freddie Mac’s roles within the housing finance  system and better define their public housing mission responsibilities.   The act expanded the enterprises’ previous housing mission  responsibilities, requiring a percentage of the loans they purchased to be  mortgages serving low or moderate-income families; special affordable  housing for families (that is, low-income families in low-income areas, and  very low-income families); and housing located in central city, rural, and  other underserved areas. HUD was given responsibility for regulating  the enterprises compliance with these goals. Recognizing the potentially  large financial costs that the enterprises posed to the federal government,  the act also established the Office of Federal Housing Enterprise  Oversight (OFHEO) as an independent office within HUD whose mission  was to help ensure the enterprises’ safety and soundness. One of  OFHEO’s most important means of helping to ensure the enterprises’  financial soundness was to establish capital requirements that are related  to potential risks that the enterprises face. In 1992, Fannie Mae and  Freddie Mac became subject to a statutory 2.5 percent equity capital  charge against mortgages or MBS that were funded on their balance  sheets and a 0.45 percent equity capital charge against the MBS that  they had issued to investors. Both of these capital requirements were  lower than the requirements for depository institutions, which were bound  by the 4.0 percent minimum Basel I requirement.

However, in 2008, we found that the regulatory structure for the  enterprises was fragmented and not well equipped to oversee their  financial soundness or housing mission achievement. We reported that  OFHEO lacked key statutory authorities needed to fulfill its safety and  soundness responsibilities as compared to the authorities available to  federal bank regulators. For example, OFHEO was not authorized to limit  the asset growth of housing enterprises if capital falls below  predetermined levels. Moreover, HUD, which had housing mission  oversight responsibility for the enterprises, faced a number of challenges  in carrying out its responsibilities. In particular, HUD may not have had  sufficient resources and technical expertise to review sophisticated  financial products and issues. The Housing and Economic Recovery Act  of 2008 (HERA) created FHFA to oversee the enterprises and the  FHLBanks. The law gave FHFA such new regulatory authorities as the  power to regulate the retained mortgage portfolios, to set more stringent  capital standards, and to place a failing entity in receivership. In addition,  the law also combined the regulatory authorities that were previously  distributed among OFHEO; the Federal Housing Finance Board, which  had replaced the FHLBank Board in 1989; and HUD.

section_title: Response to Financial Crisis
paragraphs: The 2007-2009 financial crisis, which according to many researchers,  was triggered by losses in the mortgage market, led the federal  government to significantly increase the federal role in the housing  finance markets. On October 3, 2008, the Emergency Economic  Stabilization Act of 2008 was signed into law. The act authorized the  Troubled Asset Relief Program, a $700 billion program designed to  restore liquidity and stability to the financial system and to preserve  homeownership by assisting borrowers struggling to make their mortgage  payments. Troubled Asset Relief Program funds supported a variety of  mortgage- and nonmortgage-related programs, including programs to  make capital investments in shares of financial institutions. Treasury  estimates several of the programs over their lifetimes will provide income  to the government while others will incur a cost.

Another significant response to the crisis was enactment of the Dodd- Frank Wall Street Reform and Consumer Protection Act. The act is  intended, among other things, to reform residential mortgage lending and  securitization practices that contributed to the financial crisis. The act  provides some liability protection for lenders originating mortgages that  meet nine specified criteria, as applicable, associated with a borrower’s  ability to repay (“qualified mortgages”). The act also requires securitizers  of mortgages that do not meet the definition of a qualified residential  mortgage to retain at least 5 percent of the credit risk, though federal  rulemaking agencies may adopt exemptions from this 5 percent  requirement for certain classes of institutions or assets. A number of the  act’s other provisions seek to reform the mortgage market—for example,  by authorizing CFPB to supervise nonbank mortgage lenders and by  prohibiting certain mortgage lending practices, such as issuing mortgage  loans without making a reasonable and good faith effort to determine that  the borrower has a reasonable ability to repay. The act also eliminated  the OTS and transferred its regulatory authorities to OCC, the FDIC, and  the Federal Reserve.

section_title: Financial Crisis Impact on FHA’s Financial Position
paragraphs: As housing prices began to decline in April 2006 and conventional  mortgage lenders tightened their underwriting standards, more  homebuyers began taking advantage of FHA-insured loans, which tend to  have less strict underwriting standards and require lower down payments,  as compared with conventional loans. Additionally, the Economic  Stimulus Act of 2008 increased the limits of loans eligible for FHA  insurance to 125 percent of the median house price in each area. As a  result, FHA’s share of the market increased. In 2006, FHA insured  approximately 4.5 percent of purchase mortgages. At its peak in 2009, it  insured 32.6 percent of purchase mortgages. As FHA’s market share  grew, the economic value of FHA’s insurance fund declined dramatically.  Specifically, it declined from about $21 billion at the end of 2007 to less  than $4 billion by the end of 2009. At the end of 2012, the fund’s  economic value was negative. As a consequence, the insurance fund’s  capital ratio fell to negative 1.44 percent in 2012, below its statutory  minimum of 2.0 percent. As the capital ratio declined, the insurance  fund’s condition also worsened from the federal budgetary perspective. In  recent years, FHA has taken several actions intended to strengthen its  financial position and minimize defaults, such as increasing down- payment requirements for certain loans in 2010 and raising premiums on  insured mortgages multiple times. (FHA proposed its most recent  premium increase in January 2013.) However, on September 27, 2013,  FHA notified Congress for the first time that the agency would require  $1.68 billion in Treasury funds to ensure that at the end of FY 2013, the  mutual mortgage insurance fund would have sufficient funds in its capital  reserve account to pay for all expected future losses.

section_title: Public Conservatorship of the Enterprises
paragraphs: Prior to the financial crisis, the enterprises made changes to their  practices that increased their risk. For example, in 2009 we noted that  during the late 1990s and early 2000s, we had raised concerns about the  rapid growth of the enterprises’ retained mortgage portfolios, which  reached about $1.6 trillion by 2005. We found that although increasing  the size of their mortgage portfolios may have been more profitable than  issuing MBS, it also exposed the enterprises to significant interest-rate  risk. Additionally, in 2004 and 2005, the enterprises embarked on  aggressive strategies to purchase mortgages and mortgage assets with  questionable underwriting standards. For example, they purchased a  large volume of Alt-A mortgages, which typically did not have  documentation of borrowers’ incomes and had higher loan-to-value ratio  or debt-to-income ratios. The enterprises also increased their purchases  of private-label MBS from 2003 through 2006. By the end of 2007, the  enterprises collectively held more than $313 billion in private-label MBS.  According to FHFA, while these questionable mortgage assets accounted  for less than 20 percent of the enterprises’ total assets, they represented  a disproportionate share of credit-related losses in 2007 and 2008.

During 2007 and the first half of 2008, Fannie Mae’s and Freddie Mac’s  financial condition deteriorated, which prompted congressional and  Executive Branch efforts to stabilize the enterprises and minimize  associated risks to the financial system. The enterprises incurred  substantial credit losses on their retained portfolios and their guarantees  on MBS. These credit losses resulted from pervasive declines in housing  prices, as well as specific enterprise actions such as their guarantees on  MBS collateralized by questionable mortgages (mortgages with limited or  no documentation of borrowers’ incomes), and investments in private- label MBS collateralized by subprime mortgages. According to FHFA and  Treasury officials, their ongoing financial analysis of the enterprises in  August and early September 2008, as well as continued investor  concerns about the financial condition of each enterprise, resulted in  FHFA’s imposition of the conservatorships on September 6, 2008, to help  ensure the enterprises’ viability, that the enterprises fulfill their housing  missions, and stabilize financial markets. Concurrently, Treasury made  investments in the enterprises’ senior preferred stock and MBS through  authorities provided in HERA in an effort to ensure that the enterprises  could maintain a positive net worth. The Senior Preferred Stock Purchase  Agreements that Treasury entered into with the enterprises initially  entitled Treasury to 10 percent dividend payments on its senior preferred  stock investments. The agreements were subsequently amended, and  since January 2013, the enterprises’ required dividend payments are  equal to their positive net worth, if any, above required capital levels.

section_title: Appendix III: Legislative Proposals to Change the Housing Finance System-March 2013 to July 2014
paragraphs: This appendix discusses the legislative proposals that were introduced in  the U.S. Senate and the House of Representatives between March 2013  and July 2014. These proposals are discussed accordingly from the most  recent to those introduced earlier in the period.
subsections: section_title: Senate Bills
paragraphs: Housing Finance Reform and Taxpayer Protection Act of 2014,  S.1217 (Johnson-Crapo Bill), a draft of the bill was released by Senate  Banking Committee Chairman and Ranking Member on March 16,  2014.The Senate Banking Committee approved the bill with amendments  on May 15, 2014. The proposed legislation addresses secondary market  reform by winding down the enterprises and creating a federal mortgage  insurer to protect mortgage backed securities (MBS) investors against  catastrophic loss, establishing a regulatory structure to oversee the  secondary market, and imposing secondary market fees that would  provide a funding stream to address low-to-moderate homeownership  and rental housing needs.

Structure – The Federal Housing Finance Agency (FHFA) would  become an independent office in the Federal Mortgage Insurance  Corporation (FMIC), and FHFA would continue to be responsible for  supervision and regulation of the Federal Home Loan Banks and the  enterprises as they wind down. The enterprises would be dissolved  over a five-year transition period with flexibility allowing for extensions  if necessary to prevent market disruptions and increases in borrowing  costs. FMIC is to maintain a re-insurance fund, the Mortgage  Insurance Fund (MIF), to fund insurance claims on the principal and  interest of FMIC-backed securities in certain circumstances. FMIC  would have a 5-member bipartisan board of directors. The proposal  would create an advisory committee with diverse housing finance  expertise to facilitate housing finance system stakeholder interaction  with the board of directors.

Activities – FMIC is to establish a securitization platform to develop  standardized securitization documents for all FMIC-guaranteed  securities. MIF would fund claims on the principal and interest of  FMIC-backed securities if losses exceed a required private market  first loss position. The MIF would be funded initially by assessments  on the enterprises and sustained in the future by fees on FMIC- backed securities. FMIC is to impose user fees to fund affordable  homeownership and rental housing through the Housing Trust Fund,  Capital Magnet Fund, and the proposed Market Access Fund. The  MIF is to have a capital reserve ratio of 1.25 percent of the  outstanding principal balance of FMIC-backed securities within 5  years, and 2.5 percent within 10 years and thereafter. FMIC must  establish underwriting standards to mirror the definition of “qualified  mortgage,” and the bill sets the down payment requirement at 3.5  percent for first-time homebuyers and at 5.0 percent for other  homebuyers (this rate is established after a phase-in period). FMIC is  authorized to establish and capitalize a mutually owned company to  facilitate access to the secondary market by smaller lenders.

Once the new mortgage finance system is fully operational, FMIC is  required to submit annual reports to Congress with detailed  information including, among other things, a report on MIF’s financial  condition, the exposure of the MIF to economic conditions, and an  estimate of the resources needed for the MIF to operate. The bill also  establishes an Office of the Inspector General of FMIC and requires  GAO to submit a report on the transition within 18 months of the  system becoming fully operational and, within 8 years after the date of  enactment, and a report on the feasibility of transitioning to and  creating a fully privatized secondary mortgage market.

FHA Solvency Act of 2013, S.1376, introduced by the Senate Banking  Committee, which addresses primary market reform—in particular, the  Federal Housing Administration (FHA). The bill was reported out by the  Senate Banking Committee on July 31, 2013. The bill makes several  changes to current law aimed at improving the financial safety and  soundness of FHA’s Mutual Mortgage Insurance Fund.

Structure – The bill would maintain FHA’s current structure as part of  HUD. The bill includes a statutory requirement for a Deputy Assistant  Secretary and Chief Risk Officer with specific duties, including an  annual report to Congress on the lowest performing loans.

Activities – FHA would be required to issue a single resource guide to  inform lenders and servicers of all policies, processes, and  procedures applicable to FHA mortgages and make it publicly  available on the Internet. The bill would require an increase in the  capital reserve ratio from 2 percent to 3 percent within 10 years. FHA  must conduct an annual review of mortgagees underwriting or  originating single family mortgages and FHA would have authority to  terminate approval of a mortgagee if it determines that the mortgage  loans originated by the mortgagee present an unacceptable risk to the  insurance fund. FHA is given authority to issue rules requiring an  underperforming servicer to contract with a specialty subservicer for a  single mortgage or any pool of mortgages. FHA is required to  evaluate and revise as necessary FHA’s underwriting standards using  criteria similar to the criteria used by CFPB for Qualified Mortgages.  FHA is required to develop an alternative stress test scenario to help  assess the financial status of the MMF. FHA would be required to  submit a capital restoration plan to Congress when the MMI Fund is  undercapitalized and to assess annual premium surcharges on new  business.

Housing Finance Reform and Taxpayer Protection Act of 2013,  S.1217 (Corker-Warner Bill), introduced by a bipartisan group of  Senators, including Senators Bob Corker (R-TN), Mark Warner (D-VA),  and some members of the Senate Banking Committee, on June 24, 2013.  The proposal addresses secondary mortgage market reform by winding  down the enterprises and creating a federal mortgage insurer to protect  MBS investors against catastrophic loss, establishing a regulatory  structure to oversee the secondary market, and imposing secondary  market fees that would provide a funding stream for to address low-to- moderate homeownership and rental housing needs.

Structure – The bill would create a new agency, the Federal Mortgage  Insurance Corporation (FMIC), transfer the functions of FHFA to the  new agency, and wind down the enterprises in no more than 5 years.  FMIC would have a five-member bipartisan board of directors  composed of individuals, each with expertise in a different area,  including asset management, insurance, community banking, and  multifamily housing. The bill would establish a Mortgage Insurance  Fund (MIF) to cover insured losses when losses exceed the first loss  position absorbed by private market holders. FMIC must create the  FMIC Mutual Securitization Company, to be owned by credit unions,  community and mid-size banks, and non-depository mortgage  originators, to securitize member mortgages. The bill would also  establish an Office of Federal Home Loan Bank Supervision within  FMIC to oversee the Federal Home Loan Banks and the Federal  Home Loan Bank System and would create an Office of Underwriting  within FMIC to ensure that mortgages that underlie FMIC-guaranteed  securities meet certain standards.

Activities – FMIC would be required to develop standard risk-sharing  mechanisms, products, and contracts within 5 years of enactment.  MIF insurance would have full-faith-and-credit government guarantee.  To be eligible for a guarantee by FMIC, the mortgage loan amount  would have to be below conforming loan limits set by the bill and the  mortgage would need to meet the requirements of the qualified  mortgage rule. The Housing Trust Fund in HUD and Capital Magnet  Fund in Treasury are to be funded with a 5-10 basis-point fee on MBS  insured by FMIC (80 percent to HUD/20 percent to Treasury). MIF  would be required to maintain at least a 2.5 percent capital ratio after  10 years.

The FMIC is to present reports to Congress on various topics,  including the MIF and the secondary mortgage market. The bill would  require GAO to conduct an annual financial audit of FMIC and to issue  a study on the feasibility of a fully privatized secondary market no later  than 8 years after the date of enactment. Six months later, the FMIC  director would be required to submit a report to Congress that  describes all the legislative, administrative, and regulatory actions  necessary to carry out a transition to a fully private secondary market.

section_title: House Bills
paragraphs: Partnership to Strengthen Homeownership Act of 2014, (H.R. 5055).  Introduced by Congressman Delaney and referred to the House  Committee on Financial Services on July 10, 2014. The bill addresses  secondary market reform by winding down the enterprises and creating a  federal mortgage insurer to protect mortgage-backed securities investors  against catastrophic loss, establishing a new regulatory structure to  oversee the secondary market, and imposing secondary market fees to  fund low-income housing initiatives.

Structure – Ginnie Mae is removed from HUD, established as an  independent entity, and replaces FHFA six months after enactment of  the act. All FHFA’s functions property and personnel are transferred to  Ginnie Mae, which would have supervisory and regulatory authority  over secondary market participants. Ginnie Mae is to establish a  securitization platform and reinsurance fund. The bill winds down the  enterprises over five years with 2-year extensions.

Activities – Ginnie Mae is to establish and oversee a securitization  platform and provide backstop insurance through the newly  established insurance fund with catastrophic government guarantees  for losses above 5 percent on MBS after private capital takes first loss  position. The new insurance fund is to have a capital reserve ratio of  1.25 percent of the outstanding principal balance of backed securities  within 5 years, and 2.5 percent within 10 years and thereafter. The bill  requires that the Ginnie Mae, through the platform, establish uniform  standards for MBS, including servicing and pooling requirements and  underwriting guidelines. The bill also requires that Ginnie Mae set  standards for secondary market participants, including credit rating  requirements, and capital and related solvency standards intended to  ensure safety and soundness of market participants and minimize risk  to the insurance fund. The bill proposes that FHLBanks maintain a  TBA market for small lenders. The bill requires the director of the new  regulatory agency to share information with other federal regulatory  agencies regarding the financial condition and risk management  practices of market participants. The bill also requires the new  regulator to avoid duplication with the regulatory activities of other  agencies, such as examination activities and reporting requirements.  The bill preserves the Housing Trust Fund and the Capital Magnet  Fund, and establishes a Market Access Fund to increase the supply  of affordable housing for extremely low-, and very low-, and low- income families.

Housing Opportunities Move the Economy (HOME) Forward Act of  2014. Released by House Financial Services Committee Ranking  Member Maxine Waters on March 27, 2014. The proposal addresses  secondary mortgage market reform by winding down the enterprises and  creating a new lender-owned issuer of government-guaranteed securities,  creating a federal mortgage insurer to protect MBS investors against  catastrophic loss, establishing a regulatory structure to oversee the  secondary market, and imposing secondary market fees that would  provide a funding stream for affordable rental housing.

Structure – The bill would establish the National Mortgage Finance  Administration (NMFA) to replace FHFA. The bill would also establish  the new lender-owned Mortgage Securities Cooperative (MSC) to  replace the enterprises, which would be wound-down over a five-year  period. The Secretary of the Treasury may extend the transition  period for no more than one year. The bill specifies that the director  shall serve on the Financial Stability Oversight Council. The proposal   establishes the Mortgage Insurance Fund (MIF), which would be  funded by private companies and modeled after the Deposit  Insurance Fund managed by FDIC.

Activities – NMFA would oversee the securitization platform  established by the GSEs and provide backstop insurance through the  MIF funded by private companies—catastrophic government  guarantees for losses above 5 percent on MBS after private capital  takes first loss position. The proposal gives the MIF up to 7 years to  reach a reserve of 1.25 percent of the outstanding principal balance of  guaranteed securities and 12 years to reach 2.25 percent capital  reserve ratio. The NMFA may reduce these percentages if a  determination is made that the level of reserves is adequate to cover  losses at least equal to any experienced in the housing markets over  the last 100 years. In addition to overseeing the MIF, NMFA would  have oversight responsibilities over the Federal Home Loan Banks  (FHLBank) and the FHLBank System and counterparties to the MSC.  The bill also would establish underwriting standards for mortgages to  be guaranteed by the MIF to mirror the definition of “qualified  mortgage,” and would set the down payment requirement at 3.5  percent for first-time homebuyers and at 5.0 percent for other  homebuyers. The draft bill preserves the Housing Trust Fund to  increase the supply of affordable housing for extremely low-,and very  low-, and low-income families in rural and urban areas. The draft bill  also preserves the Capital Magnet Fund at the Department of  Treasury to develop, rehabilitate, or purchase affordable housing for  these households and would establish a Market Access Fund to  promote innovation in housing finance and affordability.

The proposal also would establish an Inspector General with  responsibilities to evaluate the programs of the agency and report on  the adequacy of guarantee fees and the MIF, effectiveness of the  placement of credit risk and capital requirements, and the extent to  which the government is protected from loss. The NMFA Director  would be required to provide a report and testimony to Congress  annually. GAO would be required to conduct annual financial audits of  the agency.

Protecting American Taxpayers and Homeowners (PATH) Act, H.R.  2767, introduced by Rep. Scott Garrett. The bill was reported out of  committee with amendments on July 24, 2013. H.R. 2767 consists of four  separate titles, which, combined, address the primary and secondary  mortgage markets. Together, the legislation would move FHA out of HUD,  limit its activities, and increase its capital requirements; wind down the  enterprises; authorize FHFA to establish a charter for a national mortgage  market utility to be owned by the private sector; establish FHFA as the  regulator of the national mortgage market utility, and FHA and Rural  Housing Service (RHS) programs; establish regulation of covered bonds  by financial regulators and standards setting by Treasury.

GSE Bailout Elimination and Taxpayer Protection Act. This title  terminates enterprise conservatorship 5 years after enactment and  requires FHFA director to act as receiver of the enterprises after their  charters are revoked.

Structure – The bill would revoke the enterprises’ charters 5 years  after the date of enactment, unless the FHA director determines  that market conditions warrant a temporary extension; no new  business may be conducted thereafter.

Activities – The bill would impose limitations, requirements and  prohibitions on the enterprises’ activities until their charters are  repealed. The bill would reduce conforming loan limits in high-cost  areas, reduce the size of the enterprises’ retained portfolios, and  prohibit the purchase and guarantee of mortgages that do not  meet the criteria for qualified mortgages in the Dodd-Frank Act.

The bill repeals the enterprises’ affordable housing goals and the  Affordable Housing Trust Fund.

FHA Reform and Modernization Act of 2013. The bill would establish  FHA as an independent agency to provide single-family  homeownership to first-time homebuyers and rental housing  opportunities.

Structure – FHA would become an independent government  corporation with a nine-member board composed of the HUD  secretary, the Secretary of Agriculture and 5 individuals with  expertise in mortgage finance and 2 individuals with expertise in  affordable housing. The bill provides for a transition to  independence ending no sooner than 2 years after the date of  enactment or on the date FHA says it is ended, with OMB  agreement or after the expiration of 5 years from the date of  enactment. The bill would create positions for Chief Risk and  Technology Officers with specified powers and duties. FHA would  be required to use Generally Accepted Accounting Principles  applicable to the private sector.

Activities – The bill would limit mortgage insurance to first-time  and low- and moderate-income homebuyers and those  experiencing countercyclical markets or disasters. With some  delay, FHA would be required to establish credit risk-sharing on at  least 10 percent of new business—FHA insures part of a  mortgage and private insurers the rest. FHA insurance coverage  would be reduced over 5 years from 100 percent to 50 percent of  the original value of the loan. The agency would be required to  engage in research, development, and testing of new mortgage  products designed to make housing credit available to hard-to- serve markets. The director of FHFA would be required to  evaluate the safety and soundness of FHA and RHS. The  minimum capital adequacy ratio of the Mutual Mortgage Insurance  Fund would be raised from 2 percent to at least 4 percent of  outstanding insurance obligations with restrictions on new  insurance commitments when the ratio falls below certain  thresholds The director would be required to develop a risk-based  capital model and conduct stress tests to ensure capital adequacy  during periods of stress. However, upon a joint determination with  the Chief Risk Officer, the director may temporarily lower capital  ratios under certain stressful conditions. Lenders would be  required to repurchase mortgages that are more than 60 days  delinquent within the first two years of the loan, and borrowers  may not obtain FHA mortgage insurance within seven years of a  completed foreclosure.

National Mortgage Market Utility Act of 2013. The bill would require  the FHFA Director to charter the National Mortgage Market Utility  (Utility) to own and operate the securitization platform currently being  developed by the enterprises, and the Utility is to organize and  operate a national repository for mortgage data.

Structure – The Utility would be a not-for-profit entity and would be  governed by a board of directors. The FHFA director would  choose the Utility’s organizational form. Initial funding through  appropriations is to be repaid within 10 years out of user fees. The  Utility would be regulated by FHFA.

Activities – The Utility would operate a securitization platform for  private issuers of residential mortgage-backed securities (RMBS)  and establish standards for RMBS. The Utility would not be  permitted to originate, service, insure, or guarantee any mortgage  or financial instrument associated with a mortgage and may not  provide a government guarantee on MBS. All users of the platform  would be required to resolve all representations and warranties  disputes through mandatory arbitration. The FHLBanks would be  authorized to serve as loan aggregators to compile pools of  mortgages originated by any of their members for securitization  through the platform.

United States Covered Bond Act of 2013. The bill would create a  legislative framework for financial institutions to issue covered bonds,  which would be an alternative to securitization as a way to finance  mortgage lending. Eligible assets would include residential  mortgages; federal, state, and local government securities; and auto,  student, credit card, and Small Business Administration loans. The  amount of covered bonds issued would be limited to a percentage of  the issuer’s total assets. Treasury would be required to establish  standards for and registry of covered bond programs that would be  overseen by federal financial regulators.

FHA Emergency Fiscal Solvency Act of 2013, (H.R. 1145). Introduced  by House Financial Services Committee Ranking Member Maxine Waters  on March 13, 2013. The bill addresses primary market reform by directing  HUD to establish and collect annual mortgage insurance premiums  beyond current levels, expanding HUD’s indemnification authority over  mortgagees, and establishing a program to review the cause of early  delinquencies—defined as a mortgage that becomes 90 or more days  delinquent within 24 months of origination—on mortgages that are the  obligation of the Mutual Mortgage Insurance Fund (MMIF) and to report  on the financial impact on the MMIF of related indemnifications.

Structure –The bill maintains FHA’s current structure at HUD,  including the Mutual Mortgage Insurance Fund. The bill establishes a  Deputy Assistant Secretary for Risk Management and Regulatory  Affairs position at FHA and a Chief Risk Officer for Ginnie Mae.

Activities – The bill requires HUD to increase annual premium  payments from not more than 1.5 percent to between 0.55% to 2% of  the remaining insured principal balance for the first 11 years of HUD- insured mortgages, and to increase from 1.55 percent to 2.05 percent  the 30-year annual premium for an insured mortgage whose original  principal obligation exceeds 95% of the remaining principal balance.  The bill revises the conditions under which HUD would exercise its  indemnification authority to include instances where the mortgagee  knew, or should have known, of serious or material violations of  HUD’s mortgage requirements, irrespective of whether such violations  caused a mortgage default. HUD’s indemnification authority is also  revised to include fraud or misrepresentation with origination or  underwriting of which the mortgagee knew or should have known. The  bill directs HUD to establish an appeals process for mortgagees in  indemnification cases. The bill authorizes HUD to terminate the  approval of the mortgagee to originate or underwrite mortgages if the  mortgagee has an excessive rate of early defaults and claims.

The bill requires HUD to establish programmatic reviews and  reporting on early period delinquencies, defined as mortgages that  become 90 or more days delinquent within 24 months of origination.  The bill also requires HUD to estimate annual costs to the MMIF since  2008 resulting from mortgage servicers’ noncompliance with National  Housing Act guidelines governing loan servicing, loss mitigation, and  insurance claim submission. The bill would also add to HUD’s existing  obligation to conduct and report on an annual independent actuarial  study of the MMIF’s financial position a requirement that HUD conduct  and report on the study semiannually during periods of capital  depletion of the MMIF. The bill directs GAO to provide, within 60 days  of enactment, third-party review of the financial safety and soundness  of HUD mortgage insurance programs and funds and the extent of  their loan loss reserves and capital adequacy.

section_title: Appendix IV: List of Participants in Discussion Groups
paragraphs: This appendix includes a list of the government officials, researchers,  consumer advocates, and industry representatives who participated in our  discussion groups on a draft housing finance framework. We also spoke  with officials at the Credit Union National Association, the Council of  Federal Home Loan Banks, and Treasury who were unable to attend our  discussion groups about the draft framework. Researchers listed here  spoke for themselves rather than for the institutions with which they are  affiliated.

section_title: Appendix V: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact

section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Andrew Pauline (Assistant  Director), Nancy S. Barry (Analyst-in-Charge), Farah Angersola, Bethany  Benitez, Emily Chalmers, Jeremy Conley, John Karikari, Colleen Moffatt  Kimer, Jena Sinkfield, Andrew Stavisky, and Jim Vitarello made major  contributions to this report. Janet Eackloff, Paige Smith, and Heneng Yu  also contributed to this report.

section_title: Related GAO Products
paragraphs: Troubled Asset Relief Program: More Efforts Needed on Fair Lending  Controls and Access for Non-English Speakers in Housing Programs.  GAO-14-117. Washington, D.C.: February 6, 2014.

FHA Mortgage Insurance: Applicability of Industry Requirements Is  Limited, but Certain Features Could Enhance Oversight. GAO-13-722.  Washington, D.C.: September 9, 2013.

Federal Housing Administration: Analysis of Options for Modifying Its  Products, Market Presence, and Powers. GAO-13-682. Washington,  D.C.: September 9, 2013.

High-Risk Series: An Update. GAO-13-283. Washington, D.C.: February  14, 2013.

Housing Assistance: Opportunities Exist to Increase Collaboration and  Consider Consolidation. GAO-12-554. Washington, D.C.: August 16,  2012.

Financial Markets and Institutions: The Cooperative Model as a Potential  Component of Structural Reform Options for Fannie Mae and Freddie  Mac. GAO-11-33R. Washington, D.C.: November 15, 2010.

Federal Housing Administration: Improvements Needed in Risk  Assessment and Human Capital Management. GAO-12-15. Washington,  D.C.: November 7, 2011.

Homeownership Counseling: Although Research Suggests Some  Benefits, Implementation and Evaluation Challenges Exist.  GAO-11-925T. Washington, D.C.: September 14, 2011.

Mortgage Reform: Potential Impacts of Provisions of the Dodd-Frank Act.  GAO-11-656. Washington, D.C.: July 19, 2011.

Nonprime Mortgages: Analysis of Loan Performance, Factors Associated  with Defaults, and Data Sources. GAO-10-805. Washington, D.C.: August  24, 2010.

Fannie Mae and Freddie Mac: Analysis of Options for Revising the  Housing Enterprises’ Long-term Structures. GAO-09-782. Washington,  D.C.: September 10, 2009.

Fair Lending: Data Limitations and the Fragmented U.S. Financial  Regulatory Structure Challenge Federal Oversight and Enforcement  Efforts. GAO-09-704. Washington, D.C.: July 15, 2009.

Financial Regulation: A Framework for Crafting and Assessing Proposals  to Modernize the Outdated Financial Regulatory System. GAO-09-216.  Washington, D.C.: January 8, 2009.

Federal Housing Administration: Decline in the Agency’s Market Share  Was Associated with Product and Process Developments of Other  Mortgage Market Participants. GAO-07-645. Washington, D.C.: June 29,  2007.

Alternative Mortgage Products: Impact on Defaults Remains Unclear, but  Disclosure of Risks to Borrowers Could Be Improved. GAO-06-1021.  Washington, D.C.: September 19, 2006.

Consumer Protection: Federal and State Agencies Face Challenges  Combating Predatory Lending. GAO-04-280. Washington, D.C.: January  30, 2004.


Question-summary annotations: questions: question: How was the federal government providing support for mortgages?
answer: In 2013 the federal government was providing support either directly or indirectly for 81 percent of the value of all new mortgages.
child_questions: question: What did the Federal Reserve System and the Department of the Treasury start doing during the crisis?
answer: In addition, during the crisis, the Federal Reserve System and the Department of the Treasury began purchasing MBS issued by the enterprises.

question: What did the deral Reserve System start doing as a result?
answer: The Federal Reserve System began reducing these purchases in January 2014, and Treasury completed the sale of its MBS investments in fiscal year 2012.

questions: question: Why do some experts believe the US housing finance system warrants reform?
answer: In light of the substantial increase in federal support of the single-family housing finance system and weaknesses revealed during and after the financial crisis, some experts believe the U.S. housing finance system warrants reform.
child_questions: question: What important characteristic about housing finance has GAO identified?
answer: In addition, GAO has identified the federal role in housing finance as a high risk area.

question: What are the nine elements of the framework?
answer: This framework is comprised of nine elements (see table), and certain characteristics—transparency, accountability, aligned incentives, and efficiency and effectiveness—need to be addressed throughout the elements.
child_questions: question: What would the results of applying the elements of this framework be?
answer: Applying the elements of this framework should help reveal the relative strengths and weaknesses of any proposal for change and identify what are likely to be significant trade-offs among competing goals and policies.

questions: question: Which sector played a major role in the 2007-2009 financial crisis?
answer: Housing finance played a major role in the 2007-2009 financial crisis, and the housing sector continues to show considerable strains.

question: How has the federal government's role in the single-family housing finance system changed?
answer: The federal government's role in the single-family housing finance system has also grown substantially.
child_questions: question: What has this resulted from policymakers?
answer: As a result, policymakers and others have made proposals to change the system.

question: What are the main three things this report achieves?
answer: To help policymakers assess various proposals and consider ways to make it more effective and efficient, this report (1) describes market developments since 2000 that have led to changes in the federal government's role in the single-family housing finance system; (2) analyzes whether and how these market developments have challenged the housing finance system; and (3) presents an evaluation framework for assessing potential changes to the system.

questions: question: What has GAO reviewed literature on?
answer: GAO reviewed literature on housing finance and housing market developments as well as prior GAO reports presenting frameworks for reform in the financial sector and criteria for improving government performance.
child_questions: question: Where were the officials GAO met up with from?
answer: GAO also met with officials from a number of federal agencies.

question: Who did GAO share the draft framework with?
answer: Based on the literature review and interviews, GAO developed a draft framework that it shared with seven discussion groups composed of government officials, experts from academia and research organizations, and interested parties such as consumer advocates and industry representatives.

question: How did the discussants contribute?
answer: The discussants provided input on market developments and the framework.