David Penn Associate Professor of Economics GSES AND THE MORTGAGE MARKET

 Prior to the 1930s:  Mortgages mostly through local banks. Banks dependent on short- term bank deposits.  Mortgages were non-amortizing, 5-10 year term  50% down payment was typical  Balloon payment due at the end of the term was typical  Loans were callable by the banks  Only 40% of households owned homes THE GOOD OLD DAYS Your friendly banker

 Federal Housing Administration (1934)  Does not make loans  Insures term mortgages that meet certain conditions.  Insures 15 year, then 30 year amortizing mortgages (no balloon payments)  Insured mortgages at 80% LTV, then 90% and higher  3.5% down payment typical  Loans up to $417,000  Insures only ‘conforming’ mortgages.  Ginnie Mae established to purchase FHA loans GREAT DEPRESSION

 Federal National Mortgage Association (Fannie Mae)  Purpose: provide a secondary market for FHA loans  Allows banks to make loans, collect fees, and sell the loans to Fannie Mae  Purchased FHA loans until 1970 when allowed to purchase conventional loans  Issues bonds to raise funds to purchase loans  Repackages loans into securities for sale to investors worldwide with a Fannie Mae guarantee (MBS)  Keeps some loans in its own portfolio HISTORY Thrift institution president

Mortgage Originators FHA loansFannie MaeInvestors Conventional loans (1970) MARKET LINKAGES Borrowers Bond market Mortgage insurance Mortgage backed securities (MBS)

 1913 – mortgage interest deductible on individual income tax  1934 – FHA established  1938 – Fannie Mae established  1968 – Fannie Mae became an investor-owned government sponsored enterprise (GSE).  1970 – Freddie Mac created to compete with Fannie Mae  2008 – FHFA replaced OFHEO as overseer of Fannie Mae and Freddie Mac; Government purchases $180 billion in preferred stock. Fannie Mae and Freddie Mac placed in conservatorship by FHFA later in FEDERAL INVOLVEMENT IN THE MORTGAGE MARKET

GSE IMPACT IN THE MBS MARKET

 Conflicting goals for Fannie Mae and Freddie Mac – legally required to lend to low-income households and in depressed areas, but also must satisfy bond holders and stockholders.  Government backing – GSEs are private enterprises but with lines of credit at the U.S. Treasury. Implicit government backing became explicit with conservatorship in Taxpayers plowed $180 billion into Fannie Mae and Freddie Mac (GSEs have paid more than this back to the Treasury). ISSUES

 Perverse incentives – implicit government backing and lax oversight led to risk-taking behavior without the consequences. Stockholders benefit when the risk-taking paid off, but taxpayers lose when it did not. Heads I win, tails you lose.  Crowding out – some believe that GSE advantages push the private sector out of mortgage market; private sector left with the riskier Alt-A, jumbo, and subprime markets.  Inadequate capital – capital should be large enough to absorb losses in ordinary downturns. ISSUES

 General themes of proposed reforms (CRS report)  Limit taxpayer exposure in future downturns  Increase the private sector role in the mortgage market  Ensure that mortgage loans are available for creditworthy borrowers REFORMS

 HR 2767 Path Act 2013  SB 1217 Johnson-Crapo Bill 2013 REVISIONS

 Phase out Fannie Mae and Freddie Mac  No new entity would exist to guarantee conventional MBS  A new not-for-profit voluntary ‘utility’ would be created to facilitate issuance of new conventional MBS  FHA –  Limit to first-time buyers and low- to moderate-income buyers  Down-payment increased to 5% from 3.5%  Insure 50% of the loan value, down from 100%  Charge adequate insurance premiums  Increase capital requirements PATH ACT

 Phase out Fannie Mae and Freddie Mac  Establishes a new Federal Mortgage Insurance Corporation (FMIC) to explicitly guarantee qualifying MBS  MBS must be submitted by an approved ‘aggregator’; the FMIC would collect guarantee fees.  Private capital must absorb first losses, up to 10%, before government pays.  FMIC would securitize qualifying MBS, backed by the collected fees.  FHA –  Charge adequate insurance premiums  Increase capital requirements JOHNSON-CRAPO ACT

MODEL OF JOHNSON-CRAPO BILL

 Current structure of Fannie-Freddie not sustainable  Private sector should absorb initial losses in future downturns  Both reform bills eliminate the market-maker aspect of Fannie-Freddie  Senate bill includes an entity that insures MBS  When the housing market turns sour again, government agency will not exist in the secondary market  Treasury and the Fed could potentially purchase MBS in this scenario CONCLUSIONS