These developments led to changes in  the government’s role throughout the period and ultimately to a significant  increase in that role. The share of the primary market insured or  guaranteed by the federal government grew and the share of mortgages  backing MBS securitized by the enterprises also grew, reaching highs in  2009 of about 25 and 67 percent, respectively. Specifically, the share of government-insured or - guaranteed mortgages—those directly supported by the government—fell  from 11 percent in 2000 to less than 3 percent of the value of all new  mortgage originations in 2006. The government’s role has also changed as a result of  placing the enterprises into conservatorship in 2008. Treasury had  completed the sale of its MBS investments in fiscal year 2012. Market Developments since 2000 Have Challenged the Single-Family Housing Finance System

Market developments since 2000 have challenged the single-family  housing finance system and revealed some key weaknesses in that  system, including misaligned incentives, an overall lack of reliable  information or transparency, and excessive risk taking. For example, prior to the financial crisis:
Originators’ incentives were not aligned with the long-term interests of  borrowers because originators did not retain credit risk. In addition, complex financial products  such as credit default swaps, which were designed to reduce the risk  associated with MBS for investors, spread risk throughout the financial  markets and contributed to the onset of the financial crisis. The rapid  growth of nonprime mortgage lending and private-label MBS in the  early part of the decade led to increased market competition among  private-label issuers and the enterprises. Representatives of market participants have said that they faced  uncertainties because some regulations had not been implemented and  that these uncertainties could limit the return of private capital to the  secondary market. A Framework for Assessing Potential Changes to the Housing Finance System

We have identified the role played by the federal government in the  housing finance system as a high-risk area for the government and have  also noted that the Dodd-Frank Act did not fully address weaknesses in  the housing finance system. We  sought the input of a broad range of government officials, experts from  academia and research organizations, consumer advocates, and industry  representatives on this framework and have included their comments  related to the nine elements as appropriate. Applying the elements of this framework  would help policymakers identify the relative strengths and weaknesses  of any proposals they are considering. In addition, proposals will need to take into  consideration certain characteristics—transparency, accountability,  aligned incentives, and efficiency and effectiveness—associated with  appropriate controls and high-quality government performance that run  through each element. Flexibility and  adaptability may be particularly important during a transition from the  current system to a new housing finance system. Proposals to change the housing finance system address capacity to  manage risk in a number of ways. As discussed earlier in this report,  misalignment of incentives in the securitization market occurred when, for  example, originators lowered underwriting standards but did not retain the  risk and passed on the risks of these mortgage loans to the secondary  market. Further, specifying goals and trade-offs is essential  to holding federal agencies and the private sector accountable. GAO staff who made major contributions to this report are  listed in appendix V.

Appendix I: Objectives, Scope, and Methodology

To help policymakers assess various proposals for changing the single- family housing finance system and consider ways in which it could be  made more effective and efficient, we prepared this report under the  authority of the Comptroller General. Specifically, this report (1) describes  market developments since 2000 that have led to changes in the federal  government’s role in single-family housing finance; (2) analyzes whether  and how these market developments have challenged the housing  finance system; and (3) presents an evaluation framework for assessing  potential changes to the housing finance system. To meet these objectives, we reviewed literature, including existing GAO  reports on housing finance and housing market developments, as well as  prior GAO reports presenting frameworks for reform in the financial sector  and reports that contain criteria for appropriate controls and high-quality  government performance. These agencies included the Board of Governors  of the Federal Reserve System (Federal Reserve), Bureau of Consumer  Financial Protection known as the Consumer Financial Protection Bureau,  Departments of Agriculture (USDA), Housing and Urban Development,  Treasury and Veterans Affairs (VA), Federal Deposit Insurance  Corporation, Federal Housing Finance Agency, Office of the Comptroller  of the Currency, and Securities and Exchange Commission. To describe changes in market participants and products in the primary  and secondary markets, we calculated the percentage of the dollar value  of mortgage originations supported by the Federal Housing  Administration, VA, and USDA and the percentage supported by Fannie  Mae and Freddie Mac from 2000 through 2013. To address our second objective, which describes weaknesses revealed  by developments in the housing finance market beginning in 2000, we  used information from our literature review and interviews. We then shared this  draft framework with government officials, researchers, and other relevant  parties at our discussion groups. Regulation of the Enterprises

During the 1990s the federal government continued to restructure the  enterprises and put in place a new regulatory structure for them. Response to Financial Crisis

The 2007-2009 financial crisis, which according to many researchers,  was triggered by losses in the mortgage market, led the federal  government to significantly increase the federal role in the housing  finance markets.
Why GAO Did This Study

Housing finance played a major role in the 2007-2009 financial crisis, and the housing sector continues to show considerable strains. The federal government's role in the single-family housing finance system has also grown substantially. As a result, policymakers and others have made proposals to change the system. To help policymakers assess various proposals and consider ways to make it more effective and efficient, this report (1) describes market developments since 2000 that have led to changes in the federal government's role in the single-family housing finance system; (2) analyzes whether and how these market developments have challenged the housing finance system; and (3) presents an evaluation framework for assessing potential changes to the system.
GAO reviewed literature on housing finance and housing market developments as well as prior GAO reports presenting frameworks for reform in the financial sector and criteria for improving government performance. GAO also met with officials from a number of federal agencies. Based on the literature review and interviews, GAO developed a draft framework that it shared with seven discussion groups composed of government officials, experts from academia and research organizations, and interested parties such as consumer advocates and industry representatives. The discussants provided input on market developments and the framework.

What GAO Found

Developments in the single-family housing finance market from 2000-2013 led to changes in the federal government's role in the housing finance system and ultimately to a significant increase in that role. For example,
Before the 2007-2009 financial crisis, the market share of nonprime mortgages—loans often made to borrowers with high-risk characteristics and funded by mortgage backed securities (MBS) issued by private institutions without a federal guarantee (private-label MBS)—grew but fell dramatically during the crisis.
As this market segment grew the share of new mortgage originations (refinances and purchase loans) insured by federal entities—the Federal Housing Administration and the Departments of Veterans Affairs and Agriculture—fell from 11 percent in 2000 to less than 3 percent of the value of new originations in 2006 but, with the onset of the crisis, the market share of these mortgages rose as high as 25 percent before declining to 20 percent of the market in 2013.
The market share of new mortgages backing MBS guaranteed by Fannie Mae and Freddie Mac (the enterprises) fell from 36 percent in 2000 to 27 percent in 2006 but stood at 61 percent in 2013.
In 2008, when the enterprises' weakened financial condition led to their being placed into conservatorship, the federal government's support for them became explicit .
In 2013 the federal government was providing support either directly or indirectly for 81 percent of the value of all new mortgages. In addition, during the crisis, the Federal Reserve System and the Department of the Treasury began purchasing MBS issued by the enterprises. The Federal Reserve System began reducing these purchases in January 2014, and Treasury completed the sale of its MBS investments in fiscal year 2012.
Developments in mortgage markets since 2000 have challenged the housing finance system and revealed or led to weaknesses in that system including misaligned incentives, an overall lack of reliable information or transparency, and excessive risk taking. For example
Originators' and private-label securitizers' incentives were not aligned with those of borrowers and investors, because originators and private-label securitizers generally did not retain credit risk.
Some borrowers lacked reliable and relevant information to adequately understand the risks of mortgage products because originators were not required to share certain information.
A loosening of underwriting standards prior to the financial crisis likely led to excessive risk taking by borrowers.
Limitations in federal oversight of housing market participants exacerbated these weaknesses, though Congress has taken some steps designed to address these limitations. The Federal Housing Finance Agency and Bureau of Consumer Financial Protection (known as the Consumer Financial Protection Bureau) were
created to address regulatory gaps, including oversight of the enterprises and consumer protection. These agencies have taken steps designed to oversee the enterprises, protect consumers, and provide better information to the public. However, representatives of market participants said that they faced uncertainties because some regulations had not been implemented, and Congress was considering further changes to the system.
In light of the substantial increase in federal support of the single-family housing finance system and weaknesses revealed during and after the financial crisis, some experts believe the U.S. housing finance system warrants reform. In addition, GAO has identified the federal role in housing finance as a high risk area. GAO is providing a framework to help assess proposed changes in the housing finance system. This framework is comprised of nine elements (see table), and certain characteristics—transparency, accountability, aligned incentives, and efficiency and effectiveness—need to be addressed throughout the elements. Applying the elements of this framework should help reveal the relative strengths and weaknesses of any proposal for change and identify what are likely to be significant trade-offs among competing goals and policies. Similarly, the framework could be used to craft new proposals. Finally, the framework should help policymakers understand the risks associated with transitioning to a new housing finance system.