1. David Penn Associate Professor of Economics GSES AND THE MORTGAGE MARKET

2.  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

3.  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

4.  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

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

6.  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 2008. FEDERAL INVOLVEMENT IN THE MORTGAGE MARKET

7. GSE IMPACT IN THE MBS MARKET

10.  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 2008. Taxpayers plowed $180 billion into Fannie Mae and Freddie Mac (GSEs have paid more than this back to the Treasury). ISSUES

11.  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

12.  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

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

14.  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

15.  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

16. MODEL OF JOHNSON-CRAPO BILL

17.  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