Treasury Has Been Providing Financial Support to the Enterprises during Their Conservatorships

As authorized by HERA, the Secretary of the Treasury entered into  agreements with Fannie Mae and Freddie Mac on September 7, 2008, to  provide substantial financial support to the enterprises and thereby  minimize potential systemic financial risks associated with their  deteriorating financial condition. The Enterprises Had a Mixed Record on Achieving Housing Mission Objectives, and Risk-Management Deficiencies Compromised Their Safety and Soundness

To help inform the forthcoming congressional consideration of the  enterprises’ future purposes and structures, this section discusses key  aspects of their histories and performance in achieving key housing  mission and safety and soundness objectives. Second, the 1992 Act expanded the enterprises’ previous housing mission  responsibilities by requiring them to meet specific annual goals for the  purchase of mortgages serving targeted groups. For example, the rapid growth in  the enterprises’ retained mortgage portfolios in the late 1990s, and in 2003  through 2004, occurred during periods of strong economic growth when  mortgage markets did not necessarily require the enterprises to be robust  portfolio lenders. According to some commenters,  the 2004 increase in housing goals provided the enterprises with incentives  to purchase mortgage assets, such as Alt-A mortgages and private-label  MBS collateralized by subprime and Alt-A mortgages,that in large degree  served targeted groups. Options to Revise the Enterprises’ Structures Aim to Help Ensure Housing Mission Achievement, While Mitigating Safety and Soundness Risks

The enterprises’ mixed records in achieving their housing mission  objectives and the losses and weaknesses that resulted in the  conservatorships reinforce the need for Congress and the Executive  Branch to fundamentally reevaluate the enterprises’ roles, structures, and  business activities in mortgage finance. These options generally fall along a continuum with some overlap among  key features and advocate (1) establishing a government corporation or  agency, (2) reconstituting the enterprises as for-profit GSEs in some form,  or (3) privatizing or terminating them (see table 4). Under one proposal, a government corporation would assume  responsibility for purchasing conventional mortgages from primary  lenders and issuing MBS. The government corporation or agency also  would focus its activities on middle-income borrowers, and the mortgage  credit needs of targeted groups would be served by an expansion of FHA’s  mortgage insurance programs. However, as  for-profit corporations, significant concerns remain about how well the  reconstituted enterprises would be able to support financial markets  during stressful economic periods without substantial financial support  from Treasury or the Federal Reserve. While converting the enterprises into multiple GSEs could mitigate safety  and soundness and systemic risk concerns by minimizing concentration  risks, it also likely would involve trade-offs. As discussed earlier, the  enterprises, through their secondary mortgage market activities, have been  credited with facilitating the development of a liquid national mortgage  market and establishing standardized underwriting practices for mortgage  lending. Federal Efforts to Support Housing Markets during the Conservatorships and Certain Terms of Treasury Agreements Could Increase the Costs and Challenges Associated with the Transition to New Enterprise Structures

Since the beginning of the FHFA conservatorships, the enterprises have  been tasked to initiate a range of programs, such as assisting homeowners  struggling to make their mortgage payments to refinance or modify their  mortgage terms, to respond to the current crisis in housing markets. Finally, any  transition to a new structure would need to take into consideration the  enterprises’ dominant position within housing finance, even during the  conservatorships, and, therefore, should be carefully implemented— perhaps in phases—to help ensure its success. In particular, (1) the draft report is organized  in such a way that makes it easy for the reader to conclude that the safety  and soundness benefits of the government entity option outweigh the  added risks; (2) the table in the draft report’s Highlights page states that  the lack of a “profit motive” for a government entity may mitigate risk  should be rephrased to state that the option “addresses the conflict  between private profits and public sector risk bearing;” and (3) the  discussion in the draft report on the potential elimination of the  enterprises’ mortgage portfolios fails to recognize that such an action is a  component of some but not all proposals to reconstitute the enterprises as  GSEs or to establish a government entity, and therefore, mentioning the  benefit of doing so under one option (the government entity option) and  not the other (the reconstituted GSE option) is a significant inconsistency. Appendix I: Objectives, Scope, and Methodology

The objectives of our report were to (1) discuss how the enterprises’ roles,  structures, and activities have changed over time and their performance in  achieving key housing mission objectives; (2) identify various options for  revising the enterprises’ eventual structure; (3) analyze these options in  terms of their potential capacity to achieve key housing mission and safety  and soundness objectives; and (4) discuss how the federal government’s  management of the conservatorships and response to the housing crisis  could affect any transition. We met with  representatives from FHFA, the Department of the Treasury (Treasury),  the Federal Reserve, HUD, the Government National Mortgage Association  (Ginnie Mae), CBO, the enterprises, bank and mortgage organizations, and  trade and community groups.
Why GAO Did This Study

Congress established Fannie Mae and Freddie Mac (the enterprises) with two key housing missions: (1) provide stability in the secondary market for residential mortgages (also in periods of economic stress) and (2) serve the mortgage credit needs of targeted groups such as low-income borrowers. To accomplish these goals, the enterprises issued debt and stock, purchased mortgages from lenders with the proceeds, and retained them in portfolio or pooled them into mortgage-backed securities (MBS) sold to investors. On September 6, 2008, the Federal Housing Finance Agency (FHFA) placed the enterprises into conservatorship out of concern that their deteriorating financial condition ($5.4 trillion in outstanding obligations) would destabilize the financial system. With estimates that the conservatorship will cost taxpayers nearly $400 billion, GAO initiated this report under the Comptroller General's authority to help inform the forthcoming congressional debate on the enterprises' future structures. It discusses the enterprises' performance in meeting mission requirements, identifies and analyzes options to revise their structures, and discusses key transition issues. GAO reviewed studies and data, and interviewed housing finance experts and officials from the enterprises, FHFA, Departments of the Treasury (Treasury) and Housing and Urban Development (HUD), the Federal Reserve, lenders, and community groups.

What GAO Found

The enterprises have a mixed record in meeting their housing mission objectives, and both capital and risk management deficiencies have compromised their safety and soundness as follows: (1) The enterprises' secondary market activities are credited with helping create a liquid national mortgage market, lowering mortgage rates somewhat, and standardizing mortgage underwriting processes. However, their capacity to support housing finance during periods of economic stress has not been established, and they only have been able to do so during the current recession with substantial financial assistance from Treasury and the Federal Reserve. (2)There is limited evidence that a program established in 1992 that required the enterprises to meet annual goals for purchasing mortgages serving targeted groups materially benefited such groups. (3) The enterprises' structures (for-profit corporations with government sponsorship) undermined market discipline and provided them with incentives to engage in potentially profitable business practices that were risky and not necessarily supportive of their public missions. For example, the enterprises' retained mortgage portfolios are complex to manage and expose them to losses resulting from changes in interest rates. Further, the enterprises' substantial investments in assets collateralized by subprime and other questionable mortgages in recent years generated losses that likely precipitated the conservatorship. It will be necessary for Congress to reevaluate the roles, structures, and performance of the enterprises, and to consider options to facilitate mortgage finance while mitigating safety and soundness and systemic risk concerns. These options generally fall along a continuum with some overlap in key areas: (1)Reconstitute the enterprises as for-profit corporations with government sponsorship but place additional restrictions on them. While restoring the enterprises to their previous status, this option would add controls to minimize risk. As examples, it would eliminate or reduce mortgage portfolios, establish executive compensation limits, or convert the enterprises from shareholder-owned corporations to associations owned by lenders. (2) Establish the enterprises as government corporations or agencies. Under this option, the enterprises would focus on purchasing qualifying mortgages and issuing MBS but eliminate their mortgage portfolios. The Federal Housing Administration (FHA), which insures mortgages for low-income and first-time borrowers, could assume additional responsibilities for promoting homeownership for targeted groups. (3) Privatize or terminate them. This option would abolish the enterprises in their current form and disperse mortgage lending and risk management throughout the private sector. Some proposals involve the establishment of a federal mortgage insurer to help protect mortgage lenders against catastrophic mortgage losses. During the conservatorship, the federal government has tasked the enterprises to implement a variety of programs designed to help respond to the current housing crisis, such as helping borrowers forestall foreclosures. While these efforts may be necessary to help mitigate the effects of the housing crisis, they also might significantly affect the costs of the conservatorship and transition to a new structure. For example, investors might be unwilling to invest capital in reconstituted enterprises unless Treasury assumed responsibility for losses incurred during their conservatorship. Finally, any transition to a new structure would need to consider the enterprises' still-dominant position in housing finance and be implemented carefully (perhaps in phases) to ensure its success.