In the primary market, lenders originate mortgage loans to borrowers to purchase homes. To evaluate the creditworthiness of a potential borrower (called underwriting), the lender considers the borrower’s credit scores and history, monthly debts including mortgage payments relative to income (debt-to-income ratio), and the amount of the mortgage loan relative to the home’s value (loan-to-value ratio). Borrowers with strong credit histories typically receive prime mortgages with the most competitive interest rates and terms. Lenders generally require borrowers to purchase private mortgage insurance when the loan-to-value ratio is higher than 80 percent. Some borrowers also may qualify for federal mortgage insurance programs (discussed later in this section). Mortgage lending creates certain risks: Credit risk is the risk that the borrower will default on the mortgage by failing to make timely payments. Prepayment risk is the risk that borrowers will pay off the principal of the loan before the mortgage term ends. Prepayment reduces or eliminates future interest payments. The lender must relend or reinvest the prepaid amount and may have only lower-interest options available for lending or investing the funds if interest rates have decreased. Interest rate risk is the risk that an increase in interest rates will reduce the value of a loan for the lender. For example, a lender might fund mortgage lending through short-term deposits. If interest rates rise and the lender previously made a long-term fixed-rate mortgage at a lower rate, the difference between the interest payments the lender receives from the mortgage and the interest the lender has to pay to its depositors decreases. Liquidity risk is the risk that an institution will be unable to meet its financial obligations as they come due without incurring unacceptable losses. For example, firms can be exposed to liquidity risk by funding longer-term asset purchases with shorter-term debt obligations. After origination, mortgages are serviced until they are paid in full or closed due to nonpayment. Servicers can provide borrowers with account statements, respond to customer service questions, and collect monthly payments, among other duties. The servicer can be the same institution that originated the loan or the servicer can change as institutions sell servicing rights. Lenders hold mortgage loans in their portfolios or sell them to institutions in the secondary market (see fig. 1). Lenders sell their loans to transfer risk (such as interest rate risk in the case of fixed-rate mortgages) or to increase liquidity. Secondary market institutions can hold the mortgages in their portfolios or pool them into MBS that are sold to investors. Participants in the secondary market include federal entities, issuers of private-label MBS, and investors. Private institutions, primarily investment banks, may issue MBS (known as private-label securities) which are backed by mortgages that are not federally insured and do not conform to the enterprises’ requirements. The federal government participates in the primary and secondary mortgage markets as both an actor and a regulator. In the primary market, the federal government operates mortgage guarantee and insurance programs to promote homeownership for certain types of borrowers. For example, the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), Department of Agriculture’s Rural Housing Service, and HUD’s Office of Public and Indian Housing offer programs that insure mortgages against default or guarantee lenders payment of principal and interest. In the secondary market, the federal government facilitates mortgage lending through the enterprises (discussed below) and the Government National Mortgage Association (Ginnie Mae). Ginnie Mae is a federally owned corporation within HUD that guarantees the timely payment of principal and interest to investors in securities issued through its MBS program. Ginnie Mae-guaranteed MBS consist entirely of mortgages insured or guaranteed by federal agencies (such as FHA) and are issued by financial institutions it approves. The federal government also regulates the housing finance system through FHFA, which oversees the enterprises; the Bureau of Consumer Financial Protection, also known as the Consumer Financial Protection Bureau (CFPB); and the federal banking regulators, which enforce regulatory standards for mortgage lending. Congress chartered Fannie Mae and Freddie Mac as for-profit, shareholder-owned corporations in 1968 and 1989, respectively. They share a primary mission to enhance the liquidity, stability, and affordability of mortgage credit. The enterprises generally purchase mortgages that meet certain criteria for size, features, and underwriting standards (known as conforming loans) and hold the loans in their own portfolios or pool them into MBS that are sold to investors. In exchange for a fee, the enterprises guarantee the timely payment of interest and principal on MBS that they issue. The enterprises also have obligations to support housing for certain groups. Following the enactment of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, the enterprises have been required to meet specific goals for the purchase of mortgages supporting underserved groups (such as low- and moderate-income families) or certain geographic areas. In 2008, the Housing and Economic Recovery Act (HERA) tasked the enterprises to fund new affordable housing programs, including the Housing Trust Fund and the Capital Magnet Fund. The enterprises fund these programs with a dollar amount based on their unpaid balance of new business, purchases, and the funds distribute the money to states and housing organizations to support affordable housing. HERA established authorities for providing capital support to the enterprises and established FHFA as an independent regulatory agency for the enterprises. HERA also authorized the Director of FHFA to appoint FHFA as a conservator or receiver for the enterprises. FHFA put the enterprises into conservatorship in September 2008. FHFA has a statutory responsibility to ensure that the enterprises operate in a safe and sound manner and that their operations and actions of each regulated entity foster a liquid, efficient, competitive, and resilient national housing finance market. FHFA sets strategic goals for its conservatorship of the enterprises. According to FHFA, the enterprises’ boards of directors oversee day-to-day operations, but certain matters are subject to FHFA review and approval. For example, FHFA officials told us that FHFA reviews and approves some pilot programs. Fannie Mae and Freddie Mac retain their government charters and continue to operate legally as business corporations. Using authority provided in HERA, Treasury has committed to providing up to $445.6 billion in capital support to Fannie Mae and Freddie Mac while they are in conservatorship through the senior preferred stock purchase agreements. If Fannie Mae or Freddie Mac has a net worth deficit at the end of a financial quarter, Treasury will provide funds to eliminate the deficit. Under the most recent agreement in December 2017, the enterprises must pay Treasury a dividend of all their quarterly net income above a $3 billion capital reserve that each enterprise is allowed to retain. Since the 2007–2009 financial crisis, Congress has taken steps to improve regulation and consumer protection related to the housing finance system. For example, to address challenges related to limitations on mortgage information, HERA requires FHFA to collect market data. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd- Frank Act) created CFPB, which has undertaken a number of consumer protection initiatives related to mortgage lending and servicing. The Dodd-Frank Act also updated the Truth in Lending Act to prohibit lenders from making certain mortgage loans without regard to a consumer’s ability to repay the loan (known as the ability-to-pay rule). A lender is presumed to have met the ability-to-repay requirement when it originates a qualified mortgage—a category of loans that have certain more stable features that make it more likely a borrower will repay the loan. Congress also has considered proposals to make significant changes to the housing finance system. During the 113th Congress (January 2013– January 2015), three proposals—the Housing Finance Reform and Taxpayer Protection Act of 2014, S. 1217; the FHA Solvency Act of 2013, S. 1376; and the Protecting American Taxpayers and Homeowners Act of 2013, H.R. 2767—were reported out of committee but no further action was taken. In September 2018, the Protecting American Taxpayers and Homeowners Act of 2018 (H.R. 6746) was reintroduced in the 115th Congress and referred to committee. As of the end of the 115th Congressional session, no further action had been taken. Industry groups and think tanks also have published reform proposals. We discuss reform proposals made since 2014 in more detail later in this report. Federal agencies also have commented on housing finance reform. In early 2018, the Director of FHFA sent a letter to the Chairman and Ranking Member of the Senate Committee on Banking, Housing, and Urban Affairs stating that conservatorship is not sustainable and needs to end, and provided suggestions on how the enterprises could be reformed. For example, the letter states that the housing finance system should preserve 30-year fixed-rate mortgages, end taxpayer bailouts for failing firms, maintain liquidity, and provide a level playing field for lenders of all sizes. It also states that secondary market activities should be managed by shareholder-owned firms chartered by a regulator and operating as utilities with an explicit paid-for federal guarantee on MBS issued by regulated firms. In June 2018, the Office of Management and Budget released recommendations to reform the federal government in a number of areas, including housing finance. The recommendations propose privatizing the enterprises, allowing new private entities to enter the market, and providing an explicit federal guarantee on MBS that could only be accessed in limited, exigent circumstances. In a 2014 report, we outlined a framework composed of nine elements we consider to be critically important to help policymakers assess or craft proposals to change the housing finance system (see table 1). The housing market has recovered since the financial crisis, with significant federal support. Indicators of recovery include rising house prices and declining mortgage delinquency rates. However, the federal government has continued to support the housing market with guarantees on more than two-thirds of new mortgages each year since 2008, either through government-insured originations or by guaranteeing timely payment to investors on mortgage loans purchased and securitized by the enterprises. The government also has continued to play a very substantial role in the secondary market, guaranteeing around 95 percent or more of all MBS issued annually since 2008. But recent trends—some loosening of underwriting standards, the rise of nonbank mortgage lenders and servicers, and less access to affordable housing and homeownership—may pose additional risks and challenges to the housing market and participants, including the enterprises. Several indicators demonstrate that the housing market has recovered since the financial crisis of 2007–2009. For example, real national average house prices have consistently risen each year since 2012 (see fig. 2). The rise in house prices also has been complemented by consistent economic growth, declining unemployment, and low mortgage rates since 2009. Higher house prices have some positive implications for the financial soundness of the enterprises: higher prices can reduce the enterprises’ potential losses due to defaulted loans because the enterprises can recover more value from properties securing the loans. Serious delinquency rates (90 or more days delinquent) for mortgages purchased by Fannie Mae and Freddie Mac have declined steadily and since 2014 have remained between 1 and 2 percent for both enterprises (see fig. 3). Examining delinquency rates for mortgages by origination year reveals significant differences for mortgages originated before and after the financial crisis. According to Fannie Mae and Freddie Mac reports, mortgages originated since 2009 have had lower delinquency rates than those originated before 2009. For example, in 2017, Fannie Mae’s serious delinquency rate was 6.6 percent for mortgages originated in 2005–2008, compared to 0.5 percent for mortgages originated since 2009. As of October 2018, mortgages originated since 2009 represented more than 90 percent of Fannie Mae’s and 80 percent of Freddie Mac’s outstanding held loans and guaranteed MBS. Serious delinquency rates for mortgages insured by FHA are higher on average than those purchased by the enterprises but generally have followed similar trends. Compared to pre-2007 levels, trends in mortgage originations indicate a smaller-volume market largely composed of prime conforming and government-insured mortgages, as shown in figure 4. During 2008–2017, total mortgage origination volume—the dollar value of mortgage loans— remained below pre-crisis levels. Much of the decrease in volume resulted from large declines in prime jumbo and nonprime originations since 2008. Prime jumbo and nonprime originations represented a significant share of originations (market share) before 2007 but declined sharply since 2008. Prime jumbo market share recovered somewhat, increasing from a low of 6 percent in 2009 to approximately 18 percent of originations each year since 2014. Riskier nonprime originations remain very low compared to their pre-crisis levels. Meanwhile, federally insured mortgages (such as those insured by FHA or guaranteed by VA) grew significantly in 2008 and retained a market share between 19 and 25 percent in 2008–2017. Finally, prime conforming origination volume varied year-to-year but these mortgages have represented the majority of originations since 2007. Federally insured and prime conforming mortgages represented 80 percent or more of originations every year since 2008. The federal government has continued to support a significant share of the mortgage markets since the financial crisis. For instance, while down from the peak in 2009, the federal government has guaranteed more than two-thirds of new mortgages since 2014, either by insuring mortgages or by guaranteeing timely payment to investors on loans purchased and securitized by the enterprises (see fig. 5). Government-insured mortgages declined leading up to the financial crisis, largely due to the availability of nonprime mortgages and securitization by fully private institutions. But when the availability of these products declined sharply, government agencies such as FHA and VA insured or guaranteed significantly higher volumes of mortgages. For instance, the share of mortgages insured or guaranteed by federal agencies grew from 6 percent ($134 billion) in 2007 to more than 20 percent ($328 billion) in 2008. As of 2017, federally insured mortgages were 25 percent ($444 billion) of total originations. Similarly, as the share of conventional mortgages held in banks’ portfolios declined during the financial crisis, the enterprises purchased and securitized large volumes of these mortgages. The share of mortgage originations purchased by the enterprises peaked at 65 percent in 2008 and still accounted for nearly half of new mortgages in 2017. The federal government also has maintained a very substantial role in the secondary mortgage market since the financial crisis. The enterprises and Ginnie Mae guaranteed around 95 percent or more of all MBS issued each year since 2008, despite a nearly decade-long economic expansion. In line with the rise in federally insured originations, Ginnie Mae’s market share increased substantially, from 5 percent ($110 billion) in 2007 to 22 percent ($301 billion) in 2008, and about 33 percent ($455 billion) in 2017 (see fig. 6). Conversely, private-label MBS issuance since 2008 has been minimal, as many private-label issuers left the market and nonprime originations declined. The growth in the market share of Ginnie Mae and the enterprises resulted in part from actions by Congress and the Board of Governors of the Federal Reserve System (Federal Reserve). Congress increased the loan limits for FHA-insured loans and loans eligible for securitization by the enterprises. The federal government also made its backing of securities issued by the enterprises explicit by committing to provide them financial assistance, and Ginnie Mae continued to provide guarantees for securities backed by federally insured mortgages. According to several mortgage originators, securitizers, investors, and researchers with whom we spoke, the enterprises will continue to dominate the MBS market because the federal guarantee through conservatorship offers a competitive advantage over other participants without such a guarantee. In response to the financial crisis, the Federal Reserve provided additional support for the mortgage market, becoming one of the largest purchasers of MBS issued by the enterprises and guaranteed by Ginnie Mae. Among other impacts, this action made these securities somewhat more attractive to secondary market participants. In June 2017, when the Federal Reserve’s MBS holdings had peaked at $1.78 trillion, it announced plans to gradually reduce its MBS holdings as part of its efforts to reduce the size of its balance sheet. As of November 2018, the Federal Reserve had $1.66 trillion in MBS holdings. Recent trends—particularly changes in underwriting standards and borrowers’ credit risk profiles, the rise of nonbank mortgage lenders and servicers, and limited access to affordable housing and homeownership— pose risks and challenges to the housing market and participants, including the enterprises. Indicators of borrower credit risk and surveys of loan officers indicate a loosening of underwriting standards in recent years. More specifically, indicators of borrower credit risk for mortgages the enterprises purchased suggest underwriting standards tightened in 2008 but loosened slightly since 2012, which could pose increased risk to the enterprises. Specifically, average combined loan-to-value ratios (for all loans on the property) and debt-to-income ratios have increased, while average borrower credit scores have declined. The enterprises and FHA include assessments of these measures in setting their underwriting standards. As discussed earlier in the report, mortgages originated since 2009 have performed much better than those originated before 2008, but remain untested by a large-scale stressful economic event. Furthermore, mortgages to refinance an existing mortgage (as opposed to mortgages for purchasing a home) declined since 2012. According to FHFA officials, credit scores, loan-to-value ratios, and debt-to-income ratios tend to be stronger for refinance mortgages than purchase mortgages. FHFA and HUD officials also told us that reduced refinancing volume due to rising interest rates may put additional pressure on lenders to maintain volume and profitability by offering more relaxed credit terms to borrowers. Average combined loan-to-value ratios for mortgages purchased by the enterprises peaked in 2014 and have remained roughly similar to pre- crisis levels (see fig.7). In December 2014, FHFA began allowing the enterprises to purchase mortgages with loan-to-value ratios up to 97 percent. In the first three quarters of 2018, 22 percent of mortgages Fannie Mae purchased included a loan-to-value ratio over 90 percent, which is higher than shares in 2005–2008. FHA’s loan-to-value ratio is limited to 96.5 percent, and the average among borrowers has remained relatively consistent around 93 percent since 2008. The higher the loan- to-value ratio when a loan is originated, the less equity borrowers will have in their homes and the more likely they are to default on mortgage obligations, especially during times of financial stress or falling home values. Additionally, house price valuation—measured by the price-to- rent ratio—has increased substantially since 2012 to levels last seen in 2004. Higher valuations could increase the risk of future price decreases—which would reduce collateral values that protect the enterprises against losses in the event of default—or more modest price increases. This could signal increased risk when associated with higher loan-to-value ratios. Average credit scores for enterprise-purchased loans rose significantly from their pre-crisis lows and remained historically high through 2012 but have since slightly declined (see fig. 8). The average credit score of FHA-insured borrowers, while lower than those for loans purchased by the enterprises, followed a trend similar to those of the enterprises. Generally, a higher score indicates a greater credit quality and potentially lower likelihood of default. Lenders continue to use credit scores as a primary means of assessing whether to originate a loan to a borrower. Average debt-to-income ratios for mortgages purchased by the enterprises remained below their pre-crisis levels but have deteriorated since 2012, and the share of high debt-to-income mortgages rose. Additionally, according to Fannie Mae financial reports, in the first three quarters of 2018, roughly 25 percent of mortgages it purchased included a borrower debt-to-income ratio over 45 percent, up from roughly 7 percent of mortgages in the first three quarters of 2017. The share of high debt-to-income ratios for FHA-insured borrowers also has risen significantly. For example, nearly half (49 percent) of FHA- insured borrowers in fiscal year 2017 had high debt-to-income ratios, surpassing the previous high of 45 percent of borrowers in 2009. According to FHA, as of March 2018, about 24 percent of mortgages included debt-to-income ratios above 50 percent, up from 20 percent of mortgages in March 2017. The Dodd-Frank Act requires mortgage lenders to make “a reasonable, good faith determination” of a borrower’s ability to repay the loan. A lender that originates a “qualified mortgage” is presumed to have met this requirement. All qualified mortgages must meet mandatory requirements including restrictions on points and fees, and loan structure. In addition, the borrower’s debt-to-income ratio must be 43 percent or less; however, loans eligible for purchase by the enterprises or to be insured by the FHA, VA or USDA are not subject to a specific debt-to-income ratio. Additionally, according to results from the October 2018 Senior Loan Officer Opinion Survey on Bank Lending Practices, more loan officers reported loosening than tightening their underwriting standards for enterprise-eligible mortgages every quarter from 2015 through the second quarter of 2018. More officers reported loosening their standards for government-insured mortgages during 12 of the last 16 quarters. Our review found that the increased role of nonbank mortgage lenders and servicers in recent years has helped provide liquidity and access to mortgage credit but also presented additional liquidity risks. FHFA and HUD officials reported that the share of nonbanks mortgage originators and servicers grew since the financial crisis. According to data from Inside Mortgage Finance, nonbanks originated roughly half of all mortgages sold to the enterprises in 2017 and the first three quarters of 2018. Of the top 10 mortgage sellers to the enterprises in the first three quarters of 2018, six were nonbanks that originated more than 20 percent of all enterprise purchases during that period. Nonbank servicers of loans backing enterprise MBS have grown from 25 percent in 2014 to 38 percent as of the third quarter of 2018. For FHA-insured mortgages, nonbank originations represented 74 percent in 2003, declined to 56 percent in 2010, and then increased to 86 percent in fiscal year 2017. While FHFA and HUD officials told us nonbanks have helped provide access to mortgage credit, several stakeholders and experts in all four of our panels identified the increased presence of nonbank lenders as a current risk in the housing finance system. A 2018 paper published by the Brookings Institution cited that nonbanks are exposed to significant liquidity risks in their funding of mortgage originations and servicing of mortgages, because nonbank lenders rely more on credit lines provided mostly by banks, securitizations involving multiple players, and more frequent trading of mortgage servicing rights than banks. For instance, during times of financial stress, lenders to nonbanks have the right to quickly pull their lines of credit and seize and sell the underlying collateral if nonbanks do not maintain certain levels of net worth. HUD officials identified similar risks and added that this may reduce borrower access to credit in the event of financial stress or a liquidity crisis. Additionally, while nonbanks are subject to some federal and state oversight, they are not federally regulated for safety and soundness. State regulators may require nonbanks to be licensed and may examine their financial soundness and compliance with relevant state laws, but there are no such federal regulations, unlike with banks. The Conference of State Bank Supervisors has a series of initiatives with the goal of all state regulators adopting a nationwide nonbank licensing and supervisory system by 2020. CFPB oversees nonbank issuers for compliance with consumer financial protection laws but not for financial safety and soundness. We reported in 2016 that incomplete information on the identity of nonbank servicers may hinder those responsible for their oversight. The lack of federal safety and soundness oversight of nonbank lenders and servicers may pose risks for the enterprises and federal housing finance entities. The enterprises conduct financial and operational reviews of their counterparties in accordance with FHFA guidance. But, as we reported in 2016, FHFA does not have the authority to independently evaluate the safety and soundness of entities that conduct business with the enterprises. In 2014, the FHFA Office of Inspector General found that nonbank lenders may have limited financial capacity and are not subject to federal safety and soundness oversight, creating an increased risk that these counterparties could default on their financial obligations. They also found that rapid business growth among specialty servicers could put stress on their operational capacity or overrun their quality control procedures, potentially increasing representation and warranty claims and credit losses on mortgages they sell to the enterprises. Representation and warranty claims allow the enterprises and other federal entities to recover some losses from lenders in the event of misrepresentation by the seller. From 2009 through 2013, the enterprises received $98.5 billion through repurchase requests to sellers (that is, they required sellers to repurchase the enterprises’ interests in the loans). According to the FHFA Office of Inspector General, due to lower capital levels, nonbanks may be less able to honor these representation and warranty commitments. FHFA and HUD officials also told us nonbanks have helped increase servicing capacity. We previously reported that nonbank servicers provide benefits to the housing market through increased capacity to service delinquent loans and contribute to liquidity by broadening participation in the market for mortgage servicing rights. In particular, larger numbers of individual servicers also can reduce market concentration, suggesting that servicers may be more likely to behave competitively and can, for instance, increase innovation. Furthermore, large nonbanks are generally not as interconnected with the financial system as large banks, potentially limiting broader market effects in the event of the failure of a single large nonbank servicer. But the enterprises and Ginnie Mae likely would incur costs in the event of a failure of a large nonbank servicer whose portfolio cannot be easily absorbed by others. Mortgage servicers must continue making payments to investors when borrowers do not make payments. For mortgages backed by the enterprises, servicers can be reimbursed for principal and interest and certain other expenses, but they must finance them in the interim. Servicers of mortgage pools guaranteed by the enterprises must advance payments until the borrower is 120 days delinquent on the loan. Servicers of Ginnie Mae-guaranteed pools are not limited in how long they must advance principal and interest on delinquent loans, and they additionally may be required to absorb losses not covered by FHA insurance or VA guarantees. In the event of a failure of a large nonbank servicer with a not readily absorbable portfolio, Ginnie Mae and the enterprises likely would bear most of the associated costs, and consumers also likely would see some effects, such as service interruptions. In 2015, FHFA and Ginnie Mae raised their minimum financial eligibility requirements for sellers and servicers (including for net worth, capital ratio, and liquidity criteria for counterparties), but these requirements may not fully account for the high interest rate and default risks that nonbanks face. Challenges related to affordable housing and access to homeownership also remain. Fannie Mae and Freddie Mac are subject to affordable housing goals for their purchases of single-family and multifamily mortgages that benefit families with lower incomes. However, a number of factors affect the development of affordable housing and access to homeownership. For example, according to a 2018 study on the state of the nation’s housing, competition for the historically low supply of existing homes on the market has pushed up home prices in most metropolitan areas, raising concerns about affordability. The study also noted that although better housing quality accounts for some of the increase in housing prices, sharply higher costs for building materials and labor, among other factors, have made housing construction considerably more expensive. Land prices also increased as population growth in metropolitan areas increased demand for well-located sites. Along with rising housing costs, the study also reported that weak income growth among low- and moderate-income households contributed to affordability pressures. As homeownership becomes less affordable with house price increases, the enterprises’ affordable housing goals become more difficult to achieve. For example, for calendar year 2016, Freddie Mac met all of its affordable housing goals, and Fannie Mae met most of its affordable housing goals, but failed to meet its goal for the single-family home purchase, very-low income category. For calendar year 2017, based on FHFA’s preliminary determinations, Fannie Mae met all of its affordable housing goals, but Freddie Mac missed its single-family home purchase goals for both the very low-income and low-income categories. Experts and stakeholders we interviewed identified other contributing challenges. For example, a few experts and stakeholders cited lower levels of lending in minority communities and to low- and moderate- income borrowers, which are typically most in need of affordable housing, as contributing challenges. A few other experts and stakeholders stated that borrowers increasingly have been holding other types of debt, such as student loan debt, which makes it more difficult for them to obtain an affordable mortgage. Lastly, the qualified mortgage rule exception, which may have helped some borrowers with a debt-to-income ratio above 43 percent to obtain a mortgage, expires in 2021 or earlier if conservatorship of the enterprises ends before then. When this happens, this could also hinder the ability of certain borrowers with a debt-to-income ratio higher than 43 percent to obtain mortgages. Fannie Mae and Freddie Mac have taken actions in recent years that could further increase the scope of their activities and present challenges or barriers to entry for other market participants. Both enterprises have recently introduced pilot programs that affect mortgage insurance decisions and terms typically made by lenders. In 2018, Fannie Mae introduced a pilot program to offer an enterprise-paid mortgage insurance option—an alternative to the borrower-paid and lender-paid options currently available. Under the program’s structure, Fannie Mae is the entity responsible for purchasing mortgage insurance on loans with high loan-to-value ratios. To do so, Fannie Mae secures an insurance arrangement from a qualified insurer, which in turn transfers the risk to a panel of approved reinsurers. Fannie Mae pays the mortgage insurance premiums, while the lender is responsible for paying an additional, loan-level price adjustment. Freddie Mac launched a similar pilot program earlier in 2018 known as the Integrated Mortgage Insurance program. Under this program, simultaneous with purchasing single-family mortgages, Freddie Mac purchases mortgage insurance from a panel of pre-approved reinsurance companies that it has allocated risk among. In addition, the reinsurers post collateral to provide further assurance that claims will be paid, and they cannot deny or rescind coverage. According to Fannie Mae and Freddie Mac documents, these pilot programs allow the enterprises to better manage their counterparty risk and streamline the operational requirements of participating lenders. For example, each participating reinsurer undergoes a thorough counterparty review in order to be approved for participation in the programs. Additionally, under the programs, lenders are not required to purchase mortgage insurance for loans with loan-to-value ratios above 80 percent, which would simplify the process of selling loans to the enterprises. However, according to several experts and stakeholders with whom we spoke, by allowing the enterprises to play a role in selecting the mortgage insurer, these pilot programs widen the scope of activities of the enterprises. They also allow them to become more dominant by potentially growing their role beyond the secondary market and into the primary market. They explained that these programs promote greater vertical integration of private-sector activities into the enterprises, and create challenges for market participants. For example, they stated that they promote an uneven playing field in the private market by allowing for different terms and standards for enterprise-paid mortgage insurance versus other sources of private capital. Experts and stakeholders also identified other enterprise pilot programs or activities, such as Freddie Mac’s financing of nonbank mortgage servicers and the enterprises’ standardization efforts, as potential challenges. Freddie Mac’s Mortgage Servicing Rights pilot program provides financing to nonbank servicers, with some limitations, secured by the servicers’ mortgage servicing rights. The program is intended to address impediments nonbank mortgage servicers face in obtaining financing and extends credit to nonbank mortgage servicers when they need access to cash. However several experts and stakeholders with whom we spoke stated that this could lead to certain servicers having a competitive advantage. For example, they stated that under this program, Freddie Mac may target its financing at the biggest servicers and charge comparatively low interest rates, putting small lenders and servicers at a disadvantage. The enterprises also have efforts to standardize appraisal data, loan applications, and closing disclosures. While these efforts are intended to streamline and standardize aspects of the mortgage process, several experts and stakeholders explained that the results of these activities can be costly to smaller lenders and servicers who have to bear the costs of adapting their systems to enterprise requirements. They also indicated that participants in the primary market have become reliant on the enterprises for standards and innovation. Several experts and stakeholders also stated that the cost for market participants to adopt new programs or standards set by the enterprises can be high and could inhibit other participants from entering the housing finance market. In addition, the enterprises are currently developing a common securitization platform to support the issuance of a common single mortgage-backed security by both enterprises. The platform will support the enterprises’ single-family mortgage securitization activities, including issuance by both enterprises of a common mortgage-backed security to be known as the uniform mortgage-backed security. FHFA expects the issuance of the uniform mortgage-backed security to improve the overall liquidity of the enterprises’ securities and promote liquidity of the nation’s housing finance markets. The common securitization platform also would integrate the various securitization infrastructure systems within each enterprise, which is expected to lower costs and increase efficiency. However, several stakeholders we interviewed explained that the platform presents concerns. For example, mortgage securitizers and investor stakeholders who participated on our panels expressed concern about the platform and its availability to other market participants. Specifically, they stated that the goal of the project has, at times, been unclear and that it has been difficult to tell to what extent or when the platform will be accessible to other secondary market participants. They also stated that if the platform would not be accessible to other secondary market participants, it would take away opportunities from participants willing and able to pool eligible securities. FHFA officials told us the platform currently is intended for use only by Fannie Mae and Freddie Mac, but that the agency is aware that potential reforms to the housing finance system may bring about the inclusion of other guarantors. As such, the platform is being designed to be adaptable for use by other participants in the secondary market in the future. (We discuss recent proposals to reform the housing finance system in detail later in this report.) FHFA-directed actions (including retained mortgage portfolio reductions, credit risk transfer, and foreclosure prevention) have improved the condition of the enterprises by mitigating some of the enterprises’ exposures to potential losses. Treasury’s remaining funding commitment through the senior preferred stock purchase agreements leaves taxpayers exposed to risk, especially in the event of adverse market or other external conditions and considering the recent growth in the enterprises’ guarantee business. Total MBS outstanding guaranteed by the enterprises and held by external investors has increased each year since 2012. As of the end of 2017, the enterprises’ combined MBS outstanding held by external investors peaked at $4.8 trillion (see fig. 12). Under the terms of the senior preferred stock purchase agreements with Treasury, Fannie Mae and Freddie Mac do not maintain a capital cushion—as a private financial institution would—to guard against the risk of unexpected losses such as those that might occur during a recession or downturn in the housing market. Instead, Treasury, through taxpayer funds, committed $445.6 billion of financial support to the enterprises. As of August 2018, Treasury had provided the enterprises with $191.4 billion of the total amount since they were placed under conservatorship in 2008, leaving $254.1 billion in potential taxpayer exposure should Treasury need to provide additional support. In return, the enterprises must pay to Treasury as dividends all of their quarterly positive net worth amount (if any) over $3 billion. Thus, any losses on this amount not recovered through loss-mitigation efforts or covered by private investors or insurers would be borne by taxpayers through additional financial support from Treasury. While private institutions could absorb a share of losses on mortgages covered by credit risk transfer and private mortgage insurance (discussed earlier in this section), any additional losses would come from Treasury’s remaining funding commitment through the senior preferred stock purchase agreements. Because of this arrangement, credit rating agencies have linked the enterprises’ strong long-term credit ratings directly to that of the U.S. government and their equity to Treasury’s remaining funding commitment. Since the second quarter of 2012, Fannie Mae and Freddie Mac have not required additional support from Treasury, with the exception of the first quarter of 2018, when both enterprises required Treasury support due to devaluation of their deferred tax assets as a result of changes to the tax code. As of the end of September 2018, the enterprises had cumulatively returned $285.8 billion to Treasury through senior preferred stock agreement dividend payments. However, in addition to economic circumstances, changes in market conditions or other external factors— such as changes in interest rates, house prices, accounting standards, or events such as natural disasters—could lead to volatility in the enterprises’ quarterly financial results, potentially requiring additional taxpayer support. The extended duration of the conservatorships continues to create uncertainty about the goals and future role of the enterprises. We previously reported that FHFA’s priorities can shift, sometimes due to changes in leadership. For example, FHFA initially outlined its understanding of its conservatorship obligations and how it planned to fulfill those obligations in a 2010 letter to Congress. In February 2012, FHFA sent Congress a strategic plan that set three strategic goals for conservatorship and elaborated on how FHFA planned to meet its conservatorship obligations. However, under a new Director in 2014, FHFA issued an updated strategic plan that reformulated its three strategic goals. This same Director’s term expired in early January 2019, and the process is underway for a new, permanent Director to be confirmed. The upcoming change in leadership could shift priorities for the conservatorships again and change enterprise goals. Continuing conservatorship also presents challenges to FHFA, as it has to balance its role as conservator with its role as regulator. FHFA must follow the mandates assigned to it by statute and the missions assigned to the enterprises by their charter. This entails consistently balancing governing of the enterprises, ensuring they employ sound risk-management practices, and ensuring they continue to serve as a reliable source of liquidity and funding for housing finance. In our interviews with experts and stakeholders, at least one expert or stakeholder from each of the groups (mortgage originators, mortgage securitizers and investors, academics and researchers, and consumer advocates) also identified the duration of the conservatorships as a challenge. For example, they said that the duration of the conservatorship has led to a more substantial role for the enterprises than envisioned when they were placed under conservatorship, which could make potential changes to their structure more difficult to implement. The duration of the conservatorships also has led to uncertainties in the housing finance market. As we previously reported, under conservatorship, the enterprises are subject to agency policy decisions and are insulated from competition and other market forces. As a result, according to several mortgage originators and securitizers, and consumer groups with which we spoke, uncertainty about the future of the enterprises also makes it challenging for them to develop their own strategic plans and goals. They explained that they hesitate to make longer-term strategic plans and goals due to potential housing finance reform changes, particularly to the enterprises, that could markedly affect their industries. Additionally, the dominant role of the federal government in guaranteeing MBS since the crisis has continued, and private capital generally has not been positioned to absorb losses in the secondary mortgage market during a potential economic downturn. The current structure of the secondary mortgage market will continue to leave taxpayers at risk to potential losses. The significant federal role in the housing market likely will continue if the enterprises remain under conservatorship and without a defined future role. We assessed 14 proposals for housing finance reform against our framework to assess potential changes to the housing finance system. The framework consists of nine elements we determined to be critically important, such as recognition and control of federal fiscal exposure, protections for investors and borrowers, and clear goals (see the Background for more information). We found that the proposals generally aim to manage fiscal exposure—the risk the housing finance system poses to the federal government and taxpayers—but only six have clear goals and only seven consider other federal housing finance entities, such as FHA or Ginnie Mae, in addition to the enterprises. Reform proposals we reviewed generally fit into four different models: (1) reconstituted enterprises, (2) multiple guarantor, (3) government corporation, or (4) privatization (termination of the enterprises). Based on our review of the proposals, relevant literature, and expert interviews, each model has potential strengths and limitations. Four proposals we reviewed call for the enterprises to be recapitalized and then released from conservatorship, retaining their federal charters. Under these proposals, the enterprises would be regulated by an independent regulator that would oversee their safety and soundness. These proposals also recommend a federal guarantee on MBS under the senior preferred stock purchase agreement or by legislation. To mitigate fiscal exposure from the enterprises, the proposals include the continuation of credit risk transfer programs, and also require the enterprises to have risk-based capital reserves. In its report analyzing alternative housing finance market structures, CBO reported that under this model, taxpayers would have a higher exposure to risk compared with the multiple-guarantor and privatization models. According to industry stakeholders, potential strengths of this model include feasibility, minimal market disruption, and the continuation of policies familiar to key stakeholders. For example, one proposal argues that its reforms could be completed under existing legal authority, with no new legislation required. Five primary market stakeholders in our panels also stated that they would prefer a system similar to the current model with minor reforms because larger changes might disrupt the market and have unforeseen consequences. Industry stakeholders that rely on specific policies of the enterprises also generally support a recapitalization and release model. For example, four associations of small lenders have released statements in support of reconstituting the enterprises to ensure the continuation of the cash window. In addition, groups that advocate for financial inclusion and civil rights also have expressed support for reconstituting the enterprises to ensure the continuation of the affordable housing goals and other policies to help low-income borrowers. However, this model may not include sufficient safeguards to mitigate the risk that the enterprises—even in a reconstituted form—could pose to the stability of the mortgage market. As previously discussed, as of 2017, the enterprises issue more than half of new MBS and, in our panels, two participants from industry groups criticized the enterprises for their expansion into other areas of the housing market. In 2018, a former FHFA director stated in Congressional testimony that the enterprises were more entrenched in the market than ever before, the market depended entirely on them, and any weaknesses in their risk management could disrupt the entire housing market. If the enterprises were recapitalized without sufficient safeguards, shareholders again might have incentive to take on excessive risk. To mitigate these concerns, two of the four proposals recommend that the reconstituted enterprises operate as utilities. Utilities have a regulated rate of return, which supporters say would limit profit-maximizing motivations and encourage more prudential behavior and underwriting standards. The utility model is traditionally used in industries that tend to operate as monopolies or near monopolies, such as the electric power industry. Some industry experts believe that the securitization market operates similarly to a monopoly. Three industry stakeholders, two researchers, and one participant from a consumer protection group we interviewed also supported restructuring the enterprises as utilities. Additionally, three industry groups representing small lenders endorsed turning the enterprises into utilities. Six of the proposals we reviewed recommend transitioning to a system with multiple guarantors operating in the secondary market. Under this model, multiple private-sector firms would purchase eligible mortgages and aggregate them into MBS. The MBS would be eligible for an explicit federal guarantee if the guarantor arranged for private credit enhancements to absorb a certain amount of loss and if it met certain regulatory criteria, such as securitizing mortgages that comply with all qualified mortgage standards. A federal agency—FHFA or a successor— would charge and collect guarantee fees from the guarantors and set capital requirements. The six proposals use the guarantee fees to fund a mortgage insurance fund that would provide the federal guarantee. According to CBO’s analysis, under this model, taxpayers would have less exposure to risk compared with models for reconstituted enterprises or a government corporation, but more than under a fully private market. Proposals within this model vary in a few key ways: Enterprises: Four of the six proposals call for the enterprises to become guarantors in the new system, while two call for them to be put into receivership and replaced with successor entities. One of the proposals that would keep the enterprises recommends that they and other guarantors operate as utilities and another suggests the enterprises remain in the new system but transition to be mutually owned by lenders instead of shareholders. Securitization: Three of the six proposals would retain the common securitization platform, while one proposal would rely on Ginnie Mae- approved issuers, allowing them to issue securities including mortgages that obtained credit enhancement from a private guarantor (instead of just federal programs). One proposal that retains the common securitization platform would convert the platform into a government corporation that issues securities from any regulator- approved entity. The fifth proposal would rely on both Ginnie Mae issuers and the common securitization platform to issue securities. The sixth proposal does not specify an entity to issue securities. Number of guarantors: Proposals vary in the number of guarantors needed in the new system. For example, the Mortgage Bankers Association’s proposal suggests having more than two guarantors, while Moody’s Chief Economist said in a congressional testimony that from five to seven would be feasible (using the private mortgage insurance industry as a guide). The potential strengths of this model include the benefits arising from competition and replacing reliance on two large firms with multiple smaller guarantors. The Mortgage Bankers Association’s proposal stated that, while subject to strong regulations, guarantors can compete on price, products, and service. Multiple guarantors could provide lenders with a variety of options to sell their loans, instead of just the enterprises. More competition also could encourage innovation in the secondary market. The secondary mortgage market also might reduce its reliance on two “too-big-to-fail” entities with multiple guarantors. Because credit risk would be more dispersed across a number of entities, the failure of one firm would be less likely to disrupt the broader system, thus reducing the likelihood the government would have to rescue a struggling firm. According to four representatives of investor groups and a former HUD official we interviewed, a potential limitation of the multiple-guarantor model is that it could be difficult for new firms to enter the market and compete with the enterprises. One proposal addresses this concern by terminating the enterprises. However, if there are only a few guarantors, the failure of any one firm could pose a systemic risk and might require federal assistance. In addition, two researchers we interviewed said that because the guarantors would operate in the same market and thus would face the same market trends, having multiple guarantors might not diversify risk. For example, in a financial crisis, it is possible that all the guarantors would struggle and in such a scenario, the government would have to assist many firms. Some industry experts expressed concern that competition could have negative consequences. We previously reported that leading up to the financial crisis, the enterprises faced new competition from private-label securitizers and, in the absence of strong federal oversight, they relaxed their underwriting standards to regain market share. Thus, two researchers, four primary market stakeholders, and a former HUD official we interviewed warned that a system dependent on competing entities could face similar risks, particularly if oversight and regulation were not strong. Five of the proposals we reviewed would require all guaranteed securitized mortgages to meet qualified mortgage standards, limiting potential reductions in underwriting standards, and one of the five also would address this concern by regulating the guarantors as utilities. Two proposals would replace Fannie Mae and Freddie Mac with a single government corporation that would issue MBS. For example, in one proposal we reviewed, lenders would sell loans meeting certain requirements (such as qualified mortgages) to the corporation, which would operate the common securitization platform to issue MBS with a federal guarantee. The government corporation would manage fiscal exposure by transferring credit risk to the private sector and through capital requirements set by an independent regulator. The two proposals also would use guarantee fees to fund a mortgage insurance fund that would add an additional level of taxpayer protection. Based on its analysis, CBO reported that under this model, taxpayers would have more exposure to financial risk than under the multiple guarantor or privatization models. The potential benefits of a government corporation include stable lending during financial crises, equitable lender access, and better targeting of underserved groups. According to CBO, a government agency is more likely than private actors to promote stable mortgage lending during financial crises due to federal support. Additionally, according to a proposal by a think tank, a government corporation could provide lenders of all sizes with equal access to securitization, potentially reducing barriers to entry for new firms in the primary market. We previously reported that compared with other models, a government corporation would be well-positioned to facilitate lending to targeted groups because it does not have potentially conflicting priorities, such as maximizing shareholder value. Finally, a key benefit of creating a government corporation would be to mitigate the potential challenges posed by relying on private-sector entities (reconstituted enterprises, multiple guarantors, or a fully private market). For example, we previously reported that as for-profit corporations with government sponsorship, the enterprises had an incentive to engage in potentially profitable but risky business practices, in part because of the perception of an implied federal guarantee. In contrast, a government corporation would not be motivated by profit and thus should have less incentive to engage in potentially risky actions. The government corporation also could end reliance on a few large private firms by transferring securitization to a single entity in the public sector. There are potential limitations to relying on a government agency to support the secondary market. According to CBO, under this model, the government would still retain most credit risk and thus originators might not have a strong incentive to thoroughly vet borrowers’ credit risk, which could lead to potential losses. We also reported in 2009 that because of the limitations on government entities relative to private firms, a government corporation might have more difficulty in attracting and retaining capable staff, responding to market developments, or promoting innovation. If unaddressed, these issues could pose safety and soundness concerns because the agency might not have the skills and capabilities to assess risks and manage a complex industry. Two proposals we reviewed would terminate the enterprises and completely privatize the housing finance industry, with no federal guarantee on MBS. Under these proposals, the enterprises’ charters would be revoked and the enterprises would be wound down over a multiyear transition period during which their guarantee fees would increase and their loan limits decrease until they no longer guaranteed new mortgages. One proposal would keep the common securitization platform and make it available to all market participants, but it would operate as a nongovernmental entity and would be prohibited from guaranteeing MBS. The main benefit of this model would be to minimize fiscal exposure by having private firms form the secondary market for mortgages that are not federally insured, similar to the private-label MBS sector before the crisis. CBO noted that private actors should have a stronger incentive to control lending risk without a government backstop. Additionally, if a number of firms replaced the enterprises, then a largely private market likely would reduce the systemic risk of relying on a few large firms. However, a fully privatized market has some potential limitations related to an implied federal guarantee, and credit availability. CBO reported that although taxpayers’ would have less explicit exposure to risk compared to the other models, risk exposure could be very high even without an explicit guarantee. That is, the government likely would assist or prevent the failure of private firms in an economic downturn to ensure financial stability (also known as an implicit federal guarantee). We previously reported that private-sector actors may benefit from an implicit guarantee and this may incentivize firms to engage in potentially risky actions and expose the government to potential losses. Additionally, privatizing the market could increase fiscal exposure through FHA. The CBO report noted that a privatized model could reduce the availability of credit to marginal borrowers, and predicted it would lead to a large increase in FHA-insured loans. A largely private market also might not sustain mortgage lending during periods of economic stress. For example, the private-label market largely disappeared after the 2007–2009 financial crisis and has yet to recover, as previously discussed. Finally, CBO reported that during a financial crisis, there could be large increases in mortgage interest rates, large declines in house prices, and limited availability of 30-year fixed-rate mortgages. The 14 proposals we reviewed generally meet the following elements of our housing finance reform framework: recognizing and controlling federal fiscal exposure, protecting mortgage investors, adhering to an appropriate regulatory framework with government entities that have the capacity to manage risks, emphasizing the implications of the transition to a new housing finance system, protecting mortgage borrowers and addressing market barriers, and considering market cyclicality and impacts on financial stability. Legislative proposals and those from other sources generally address these elements in similar ways. Every reform proposal we reviewed attempts to recognize and control federal fiscal exposure—the risk that the federal government and taxpayers will have to provide financial support to the housing finance system. Twelve of the 14 proposals we reviewed support an explicit government guarantee on MBS. Some supporters of a federal guarantee maintain that if the government were to support the mortgage industry in a crisis, then such support should be explicit, which will allow it to be priced and reflected in the federal budget. In addition, every expert with whom we spoke—including industry stakeholders, consumer advocates, researchers, and former agency officials—supported an explicit government guarantee on MBS. In 11 proposals, the federal guarantee would be administered through a mortgage insurance fund managed by a federal regulator and funded through guarantee fees. To manage and limit fiscal exposure, the 12 proposals structure the federal guarantee so that it would only be accessed after a certain amount of private-sector loss. Private capital would be introduced through increased, risk-based capital requirements for the enterprises, successor entities, or new market entrants (such as guarantors). The proposals also would continue to transfer credit risk to the private sector. These proposals vary in how much private capital would be required ahead of the government guarantee. For example, one proposal would require 10 percent but another proposal would require 5 percent. In its proposed rule for enterprise capital requirements, FHFA reported that capital reserves of about 5.5 percent would have covered the enterprises’ losses during the financial crisis. However, according to CBO, the initial increases in capital requirements could increase mortgage interest rates. The two proposals without an explicit federal guarantee aim to address fiscal exposure by eliminating the enterprises and relying entirely on the private sector. However, some industry experts have asserted that there likely will always be an implied federal guarantee for the housing finance market (even without the enterprises) as the federal government will not allow the market to fail. These experts stated that they believe that this guarantee should be explicitly recognized and accounted for in the federal budget. Thirteen of 14 proposals fully meet the element of providing protections for mortgage securities investors. We previously reported that investors need to receive consistent, useful information to assess risks. We also reported that prior to the crisis, MBS investors may have lacked reliable information to accurately assess the credit risk of their investments. Twelve reform proposals we reviewed attempt to remedy these weaknesses by first providing an explicit federal guarantee on MBS. In a 2017 testimony, a former FHFA Director said that a federal guarantee signaled to MBS investors that they were protected from credit risk and a meaningful segment of investors would not continue to invest in this market without the guarantee. In addition to the federal guarantee, proposals would aim to protect investors in the following ways: Increased transparency: Proposals recommend providing investors with more information on the mortgages underlying MBS. If investors had more information about asset quality, it would help them to more accurately price risk. For example, one proposal would require market participants to make available to investors all documents (including servicing reports) related to the mortgage loans collateralizing the security. Standard securitization platform: Currently, the enterprises each have their own platforms to issue MBS and different rules governing their MBS. To improve investor protections, FHFA and others recommend a standard platform for issuing securities. As previously discussed, FHFA has been developing such a platform, which will result in a both enterprises issuing a uniform security. Twelve of 14 proposals emphasize an appropriate regulatory framework with federal regulators that have the capacity to manage risk. Proposals generally recommend that an independent federal agency, such as FHFA or a successor, regulate housing finance market participants. The regulator also may oversee the securitization platform. Three proposals that would expand Ginnie Mae recommend that Ginnie Mae become an independent agency to strengthen its counterparty oversight capabilities. The proposals also generally recommend that the regulator have risk- management capabilities to determine market participants’ capital requirements. The regulator also would be able to adjust these and other requirements, such as credit risk transfer targets, based on market circumstances. In 11 proposals, the regulator would set and collect guarantee fees and use these fees to create a fund for mortgage insurance that would act as the federal guarantee on MBS. However, we previously noted that federal agencies sometimes have faced challenges in accurately pricing risk in other insurance programs, such as deposit or flood insurance. Eleven of the 14 proposals we reviewed fully consider the implications of transitioning to a new system and mitigating potential disruptions. Because transitioning to a new system could disrupt market operations and consumers’ access to mortgage credit, we previously noted the importance of a deliberate, well-defined transition. In our expert panels, participants from investor groups noted that unless there is a clear transition plan (particularly one that addresses any changes to the enterprises), it would be difficult for new market entrants and investors to plan accordingly. The 11 proposals that meet this element include multiyear transitions to help minimize disruption. For example, one proposal that would eliminate the enterprises would allow for a 10-year transition to a new fully privatized system and create a temporary federal entity to oversee the transition. Five primary market stakeholders and a representative from a consumer advocacy group we interviewed emphasized the importance of minimizing market disruption and maintaining market liquidity. These industry experts noted that some parts of the system currently work well, and these aspects should be maintained and transitioned in reform. The 11 proposals would transition the enterprises to the new market structure or transition their personnel and facilities to successor entities. One proposal that does not meet this element does not discuss transition plans. Two other proposals do not fully meet this element because they do not address what would happen to the enterprises’ current assets, human capital, and intellectual property. Nine of 14 reform proposals explicitly address protections for mortgage borrowers. The relevant policy mechanisms to protect mortgage borrowers include maintaining CFPB’s qualified mortgage and ability-to- repay rules, as well as additional services to support borrowers. For example, one proposal would increase support for programs that help prepare renters to become homeowners. Another proposal recommends modifying servicing guidelines for nonperforming loans to ensure consumers are treated fairly and would establish consistent procedures for servicers. The five proposals that do not fully meet this element do not address it at all or do not describe specific programs or policies. Eleven of 14 proposals explicitly address barriers to accessing the mortgage market. For example, eight proposals aim to maintain access to 30-year fixed-rate mortgages, a key instrument for promoting access to homeownership. Eleven proposals would support funds dedicated to affordable housing, such as the Housing Trust Fund and Capital Magnet Fund, through fees on securitized loans. Five proposals also would collect fees for a new Market Access Fund dedicated to increasing the number of families able to achieve homeownership and access credit. However, two proposals would eliminate the Housing Trust Fund. Proposals vary in their support of the enterprises’ affordable housing goals. Eight proposals call for the affordable housing goals to be eliminated and eight industry stakeholders we interviewed doubted the effectiveness of such goals, stating that homeownership should not be addressed through the secondary market. In 2009, we reported that there was limited evidence to support the effectiveness of the enterprises’ affordable housing goals in supporting homeownership for the targeted groups. However, affordable housing and consumer advocates we interviewed stated that they want to maintain the goals because they believe that the goals improved access to credit for minority and low- to moderate-income borrowers. Regardless of their position on the affordable housing goals, we found that proposals with a federal guarantee generally would require market participants to serve all eligible borrowers in all markets to receive the guarantee. Thirteen proposals also recommend policies that would promote small lender access to the market, such as maintaining the enterprises’ cash windows or creating a similar structure in their successors. Through the cash windows, lenders can sell individual loans directly to the enterprises and retain servicing rights. According to the Center for Responsible Lending, keeping loan servicing within community-based financial institutions often results in better loan performance and customer service outcomes. One former HUD official we interviewed stated that minority communities are often served by smaller lenders and these lenders need the cash window as a way to continue making affordable loans. Ten experts in our panels—including housing advocates, primary and secondary market participants, and researchers—said that reform plans should give fair treatment to all lenders, regardless of size. Nine of 14 reform proposals fully meet the element relating to consideration of the cyclical nature of the housing finance market and its impact on financial stability. We previously reported that the housing finance market is characterized by cyclical fluctuations and its market cycles may pose risks to overall financial and economic stability because housing is a significant part of the economy. The five proposals that do not fully meet this element do not address how the reformed system would attempt to mitigate market cycles. We previously reported that financial regulatory action or inaction can exacerbate housing finance cycles, and thus reform proposals should consider the potential impact of new regulations on market cyclicality. To mitigate market cycles, the nine proposals that meet this element generally include policies that would allow the regulator to adjust regulations based on market cycles. In one proposal, the regulator would establish risk-based capital requirements for the enterprises or successor entities and could adjust the requirements temporarily based on market cycles. One proposal that would create a government corporation also would allow the corporation to maintain a small portfolio to manage distressed loans. Eight of the proposals we reviewed do not have clearly defined goals and seven do not fully consider other entities in the housing finance system— two key elements in our housing finance reform framework. Eight of 14 proposals we reviewed do not have clearly defined goals for the housing finance system, including four legislative proposals. Additionally, none of the proposals prioritize their goals. Among the six proposals with clearly defined goals, we identified some common goals, such as minimizing the risk of taxpayer-funded bailouts, supporting market liquidity, and maintaining a level playing field for lenders of all sizes. We also identified different goals among the proposals, reflecting differences in reform models. For example, proposals similar to the multiple-guarantor model explicitly include market competition as a goal, while a proposal for reconstituting the enterprises includes stable transition as a goal. As we reported in 2015, clearly defined and prioritized goals are a key element to consider when assessing changes to the housing finance system. Clear goals help guide agencies’ activities and establish accountability. Experts with whom we spoke also emphasized the importance of clearly defined goals in housing finance reform proposals. For example, one researcher said it would be difficult to discuss any necessary policy changes until the government clearly articulated goals for its role in the housing finance system. Furthermore, prioritizing goals can help guide agencies’ actions and provide clarity to market participants, particularly if there are conflicting goals. For example, three proposals we reviewed include the goals of both minimizing risks to taxpayers and promoting affordable homeownership, but there is a trade-off between these goals—promoting homeownership may mean encouraging lending to riskier borrowers. As of early January 2019, Congress had not enacted legislation that establishes clear and prioritized objectives for the future federal role in housing finance. The lack of such goals in many of the proposals we reviewed raises questions as to whether the proposals that Congress may consider in the future will give adequate attention to these critical elements of housing finance reform. Without clearly defined and prioritized goals, agencies’ housing finance activities may lack focus and consistency. We previously reported that because Congress did not provide clearly defined and prioritized goals to FHFA for conservatorship, each FHFA director has been able to shift agency priorities within statutory requirements. For instance, the first FHFA director raised guarantee fees to encourage the return of private capital to the MBS market, while the next director stopped the increase out of concern for its effect on credit availability. Additionally, we reported that FHFA’s shifting priorities for conservatorship contributed to uncertainty among market participants. Therefore, by identifying a primary objective for housing finance reform, Congress would be better positioned to determine appropriate steps and policies and provide clarity to market participants. Seven of 14 proposals we reviewed—including proposed legislation—do not consider if and how they would affect other federal entities in the housing finance system, such as FHA and Ginnie Mae. The proposals that consider other federal entities include policies to help them manage the effects of reform and ensure agencies’ policies are consistent with overarching goals. For example, proposals that would expand Ginnie Mae’s guarantee to include the enterprises’ market also recommend that Ginnie Mae become an independent agency to better manage its expanded role. Another proposal with the broad goal of reducing the federal role in the mortgage market by terminating the enterprises also aims to manage fiscal exposure through FHA by increasing its capital reserve ratio from 2 to 4 percent. Finally, one proposal with a goal of promoting market liquidity recommends that FHA should become an independent agency to buttress its countercyclical role (that is, its ability to provide credit availability across market cycles). We previously reported that aligning policies and mechanisms with goals is a key element of housing finance reform, and that reform should have a comprehensive approach that considers all relevant entities. A comprehensive approach would help to promote consistency, transparency, and reduce unnecessary overlap and duplication between the enterprises and other federal entities. As of early January 2019, Congress had not enacted legislation with a system-wide approach to housing finance reform that considers the enterprises and other federal entities. The lack of a comprehensive approach in half of the proposals we reviewed highlights the need for policymakers to consider these key elements when reforming the housing finance system. Housing finance reform that does not consider all federal entities or participants may not account for how changes in the enterprises’ activities could affect risk exposure of other federal entities. For example, CBO reported that transitioning to a fully private market likely would lead to large increases in the volumes of loans insured by FHA. Industry experts with whom we spoke—including stakeholders from the primary and secondary markets, researchers, and former agency officials—also stated that any reforms to the enterprises must consider FHA too. Thus, considering the impacts of potential reforms on other federal entities would help ensure consistency and avoid unintended consequences. The enterprises have remained in conservatorship since 2008 (over 10 years), perpetuating uncertainty about their future and the federal role in the housing finance market. Determining those future roles and the enterprises’ structures has become both more urgent and more challenging as federal fiscal exposures have grown and new risks emerged in the housing finance markets (such as the growing role of nonbank lenders and servicers). Congress and industry stakeholders have introduced a number of proposals to reform the housing finance system, including addressing the prolonged conservatorship of the enterprises, but several proposals lack clearly defined and prioritized goals or do not consider all relevant federal entities in the housing finance system. By incorporating these key elements in future reform efforts, Congress could facilitate a more focused and comprehensive transition to a new housing finance system. Moreover, reform efforts that are both focused and comprehensive could allow market participants to confidently engage in long-term planning and help increase private-sector participation in the markets. Congress should consider legislation for the future federal role in housing finance that addresses the structure of the enterprises, establishes clear, specific, and prioritized goals and considers all relevant federal entities, such as FHA and Ginnie Mae. (Matter for Consideration 1) We provided a draft of this report to FHFA, Treasury, and HUD for review and comment. FHFA provided a technical comment that we incorporated. We also received technical comments from HUD and Treasury on sections of the draft report, which we incorporated as appropriate. Further comments on the full draft report from HUD and Treasury were not available due to the partial government shutdown. We are sending copies of this report to the appropriate congressional committees and FHFA, Treasury, and HUD. This report will also be available at no charge on our website at http://www.gao.gov. Should you or your staff have questions concerning this report, please contact me at (202) 512-8678 or garciadiazd@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix III. Our objectives in this report were to examine (1) recent developments in the housing and financial markets that could affect the safety and soundness of Fannie Mae and Freddie Mac, two government-sponsored enterprises (enterprises); (2) risks and challenges that the ongoing conservatorships pose to the status and operations of the enterprises and other aspects of the housing finance system, and (3) housing finance reform options that have been proposed and their relative strengths and limitations. To examine trends in the housing market and assess related risks, we reviewed and analyzed data that we considered relevant to various aspects of risk and developments in the housing market. Specifically, we reviewed and analyzed: house prices from the Federal Housing Finance Agency (FHFA) and Standard and Poor’s (a financial services company); mortgage delinquency rates from FHFA; the Board of Governors of the Federal Reserve System (Federal Reserve); the Bureau of Consumer Financial Protection, also known as the Consumer Financial Protection Bureau (CFPB); and Inside Mortgage Finance (a housing market data provider); mortgage origination and securitization data from Inside Mortgage Finance, FHFA, the Mortgage Bankers Association, and the Securities Industry and Financial Markets Association; and measures of underwriting standards from Fannie Mae, Freddie Mac, the Department of Housing and Urban Development (HUD), and the Senior Loan Officer Opinion Survey on Bank Lending Practices (conducted by the Federal Reserve). We adjusted house prices for inflation using the Bureau of Labor Statistics’ Consumer Price Index and mortgage origination and securitization volume using the Bureau of Economic Analysis’s Implicit Price Deflator for gross domestic product to make dollar amounts reflective of real 2017 dollars. To further inform our assessment of these developments and risks, we reviewed prior GAO work on these issues. Specifically, we reviewed prior GAO work that identified and analyzed key national housing market indicators, including house prices and loan performance, since the 2007– 2009 financial crisis. To examine risks and challenges that conservatorship poses to the status of the enterprises and other aspects of the housing finance system, we reviewed FHFA reports and Fannie Mae and Freddie Mac financial statements. Specifically, we reviewed progress reports and program updates from FHFA regarding its credit risk transfer and foreclosure prevention actions, and reviewed FHFA’s scorecard progress and other FHFA reports (such as the 2017 Report to Congress), strategic plans, and FHFA Office of Inspector General reports. For financial information on Fannie Mae and Freddie Mac, we reviewed filings with the Securities and Exchange Commission, quarterly financial supplements, and reports from credit rating agencies. We also reviewed selected academic literature that reported on risks and challenges identified in these sources and the potential effectiveness of risk-mitigation efforts. We also reviewed our prior work on the enterprises’ instability during the financial crisis. We took a number of steps to assess the reliability of the data, including interviewing agency officials; corroborating trends across data from multiple sources that we analyzed for these two objectives; reviewing related documentation; and reviewing relevant, prior GAO work. We used data that had been collected for prior GAO 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 actions, we determined the data were sufficiently reliable to report on recent trends in the housing market and developments under the conservatorships of the enterprises. To address our third objective, we reviewed 14 proposals proposed by Congress, federal agencies, industry groups, or think tanks for reforming the single-family housing finance system. We selected proposals for review based on the following criteria: Time frame: We selected proposals that were released from 2014 through 2018. Source of proposal: We selected proposals from the following sources: (1) Congress (either proposed legislation or discussion drafts by members), (2) federal agencies, and (3) industry groups or think tanks (limited to those that were discussed in congressional hearings). We excluded some proposed legislation that only would modify certain aspects of the conservatorships of the enterprises and did not contain broader reforms. For example, three proposed legislative acts would have amended the terms of the senior preferred stock purchase agreements but did not address other aspects of housing finance and thus we excluded them from our review. We also excluded documents that outlined principles and objectives for reform but did not include specific policies, such as reform principles documents that some industry and advocacy groups released. We used elements of GAO’s framework for assessing potential changes to the housing finance system to analyze the content and assess the potential strengths and limitations of the reform proposals. For each element, we defined a series of responses to determine if the proposal fully, partially, or did not meet the element and provided examples of relevant policies for each element. Generally, a proposal fully met an element if it described specific policies and programs relevant to that element, partially met an element if it the element was addressed but the proposal did not describe specific policies or programs relevant to it, or did not meet an element if it did not address it at all. We also gathered descriptive information on the policies and programs on which the proposals relied. We used the information we collected from the proposals to determine the potential strengths and limitations of the proposals. We generally considered a proposal’s strengths to be the elements it fully met and its limitations to be elements that were partially met or not met. We did not make an individual, overall determination about each proposal, but instead examined whether each proposal fully considered key elements of housing finance reform. For example, a proposal could have useful ideas for reform but had yet to consider some key elements. Using this information, we used the number of proposals that fully met each element to determine which elements were most frequently met. We noted which elements were met least often to determine the gaps in the reform proposals as a whole. We also grouped the individual proposals into the different reform models. We determined the main reform models and their potential strengths and weaknesses based on our review of the proposals, prior GAO reports, Congressional Budget Office reports, industry stakeholder reports, and information we obtained during panels and interviews we conducted. To address all three objectives, we convened four, 2-hour panels of experts and stakeholders representing (1) mortgage originators and insurers, (2) securitizers and investors, (3) consumer and affordable housing advocates, and (4) researchers. We selected the experts and stakeholders based on the extent to which they developed reform proposals, testified before Congress on housing finance reform, or had participated in prior GAO studies of housing finance issues. Each panel had from three to five participants. In cases in which key experts or stakeholders could not attend our discussion panels, we interviewed them separately. We also interviewed officials at FHFA, HUD, and the Department of the Treasury. We conducted this performance audit from March 2018 to January 2019 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. For this report, we reviewed the following housing finance reform proposals released between 2014 and September 2018 (see appendix I for more information about how we selected the proposals): Bipartisan Housing Finance Reform Act of 2018 (discussion draft). Released by House Financial Services Chairman Jeb Hensarling, Representative John Delaney, and Representative Jim Hines on September 6, 2018. Housing Finance Reform and Taxpayer Protection Act of 2014 (S. 1217). Released by Senate Banking Committee Chairman Tim Johnson and Ranking Member Michael Crapo on March 16, 2014. Housing Opportunities Move the Economy (HOME) Forward Act of 2014 (discussion draft). Released by House Financial Services Committee Ranking Member Maxine Waters on March 27, 2014. Mortgage Finance Act of 2015 (S. 495). Introduced by Sen. Johnny Isakson on February 12, 2015. Partnership to Strengthen Homeownership Act of 2014 (H.R. 5055). Introduced by Representative John Delaney on July 10, 2014. Protecting American Taxpayers and Homeowners Act of 2018 (H.R. 6746). Introduced by House Financial Services Chairman Jeb Hensarling on September 7, 2018 (originally introduced on July 22, 2013). Bright, Michael, and Ed DeMarco. Toward a New Secondary Mortgage Market. Washington, D.C.: Milken Institute, September 2016. Federal Housing Finance Agency. Perspectives on Housing Finance Reform. Washington, D.C.: January 2018. Independent Community Bankers of America. ICBA Principles for GSE Reform and a Way Forward. Washington, D.C.: 2017. Moelis & Company LLC. Blueprint for Restoring Safety and Soundness to the GSEs. June 2017. Mortgage Bankers Association. GSE Reform: Creating a Sustainable, More Vibrant Secondary Market. Washington, D.C.: April 2017. National Association of Home Builders. Why Housing Matters: A Comprehensive Framework for Reforming the Housing Finance System. Washington, D.C.: September 2015. Office of Management and Budget. Delivering Government Solutions in the 21st Century: Reform Plan and Reorganization Recommendations. Washington, D.C.: June 2018. Parrott, Jim, Lewis Ranieri, Gene Spalding, Mark Zandi, and Barry Zigas. A More Promising Road to GSE Reform. Washington, D.C.: Urban Institute, March 2016. In addition to the contact named above, Karen Tremba (Assistant Director), Tarek Mahmassani (Analyst in Charge), Miranda Berry, M’Baye Diagne, Michael Hoffman, Risto Laboski, Melanie Magnotto, Marc Molino, Matthew Rabe, Barbara Roesmann, Jessica Sandler, and Andrew Stavisky made significant contributions to this report.

Summary: Since 2008, the federal government has greatly increased its role in financially supporting housing markets. In September 2008, FHFA placed Fannie Mae and Freddie Mac under conservatorship, which created an explicit fiscal exposure for the federal government. As of October 2018, the dollar amounts of their outstanding MBS have grown by more than $800 billion since the end of 2008. Since 2013, GAO has designated the federal role in housing finance as a high-risk area. GAO examines (1) recent housing market developments, (2) risks and challenges posed by the current federal role, including ongoing conservatorship, and (3) housing finance reform proposals and their strengths and limitations. To address these issues, GAO reviewed housing finance data; FHFA and enterprise reports; and 14 housing finance reform proposals introduced in Congress or proposed by industry stakeholders since 2014. GAO also convened panels with housing finance experts and stakeholders (including consumer advocates, mortgage originators, insurers, and investors), who developed reform proposals, testified before Congress, or participated in prior GAO studies. Federal support of the housing finance market remains significant even though the market has largely recovered since the 2007–2009 financial crisis. While down from the peak in 2009, in 2017, the federal government directly or indirectly guaranteed about 70 percent of single-family mortgage originations. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)—two government-sponsored enterprises (enterprises) that purchase and securitize mortgages into mortgage-backed securities (MBS)—securitized and guaranteed about 46 percent of mortgage originations in 2017. In 2017, federal programs, such as those offered by the Federal Housing Administration (FHA), insured about 25 percent of mortgage originations. Together, the enterprises and the Government National Mortgage Association (Ginnie Mae)—a federally owned corporation that guarantees MBS backed by federally insured mortgages—have issued or guaranteed 95 percent or more of all MBS issued annually since 2008 (see figure). However, recent market trends pose risks to these entities and the housing finance system. For example, mortgage lending standards have loosened slightly in recent years, which could increase the risk of borrower default—especially in a recession or downturn in the housing market—and losses to federal entities. Nonbanks have increased their presence in mortgage lending and servicing, which involves collecting monthly mortgage payments, among other duties. For instance, the share of nonbank originations of FHA-insured mortgages increased from 56 percent in fiscal year 2010 to 86 percent in 2017. The share of nonbank servicers of mortgages in enterprise MBS also grew from 25 percent in 2014 to 38 percent as of the third quarter of 2018. While nonbank lenders and servicers have helped provide access to mortgage credit, they are not subject to federal safety and soundness regulations. The Federal Housing Finance Agency (FHFA) has taken actions to lessen some of Fannie Mae and Freddie Mac's risk exposure. For example, under FHFA's direction, the enterprises have reduced the size of their riskier retained mortgage portfolios which hold assets that expose them to considerable interest rate and other risks from a combined $1.6 trillion in 2008 to $484 billion in 2017. Since 2013, the enterprises also have transferred increasing amounts of risk on their guaranteed MBS to private investors and insurers through credit risk transfer programs. However, federal fiscal exposure remains significant. The Department of the Treasury's remaining funding commitment through the senior preferred stock purchase agreements—which provide financial support to the enterprises—leaves taxpayers exposed to risk, especially in the event of adverse market or other conditions and given the recent growth in the enterprises' guarantee business. The value of outstanding MBS on which the enterprises guarantee principal and interest payments to investors grew from about $2.1 trillion in 2003 to about $4.8 trillion in 2017. The long duration of the conservatorships also raises uncertainty among market participants. Several experts and stakeholders GAO interviewed said that they have hesitated to make longer-term strategic plans and goals due to potential housing finance reforms that could markedly affect their industries. The figure below shows 2003–2017 trends in the enterprises' guarantee business and retained mortgage portfolios. GAO reviewed 14 housing finance reform proposals from Congress, agencies, industry groups, and think tanks. The proposals generally fit into four different models: reconstituted enterprises, a multiple guarantor system with an explicit federal guarantee, a government corporation, and a completely privatized market without an explicit federal guarantee. The 14 proposals generally meet key elements of GAO's framework for assessing potential changes to the housing finance system, such as addressing fiscal exposure, protecting investors, and considering the implications of the transition to a new system. However, many proposals lack clearly defined and prioritized goals or do not address the role of other federal entities in the housing finance system, such as FHA and Ginnie Mae—two key elements in GAO's framework. By incorporating these elements, policymakers could facilitate a more focused and comprehensive transition to a new housing finance system and provide greater certainty to market participants. Congress should consider legislation for the future federal role in housing finance that addresses the structure of the enterprises, establishes clear and prioritized goals, and considers all relevant federal entities, such as FHA and Ginnie Mae.