More than six years after the federal government took control of Fannie and Freddie, policymakers are weighing a comprehensive overhaul of the mortgage finance system that could shrink or eventually close the two government-created monsters that guarantee mortgage-backed securities and contributed so much to the 2008 credit crisis.
Through its financial commitment to the two GSEs and its other mortgage programs, the federal government now directly or indirectly insures over 70% of all new residential mortgages. Loans guaranteed by Fannie and Freddie account for over two-thirds of those mortgages (about 50% of the total amount of mortgages), and loans insured by the Federal Housing Administration (FHA) make up most of the remaining federal share. Such government dominance was not always the case—in the 20 years before the financial crisis that began in 2007, roughly half of all mortgages were financed without backing from the federal government or either of the GSEs.
As the effects of the financial crisis have receded and as the housing market has recovered, policymakers have taken some initial steps toward returning to a secondary mortgage market with more private-sector involvement. Those steps include raising the fees that Fannie and Freddie charge for their guarantees to levels that private firms may be better able to compete with. CBO expects that the steps already taken, together with pending changes to financial regulations, will reduce the two GSEs’ share of the mortgage market over the next 10 years.
The CBO report examines various mechanisms that policymakers could use to attract more private capital to the secondary mortgage market. The report also addresses how those mechanisms could be combined in different ways to help the market make the transition to a new structure during the coming decade. CBO analyzed transition paths to four alternative structures that involve choices about whether the government would continue to guarantee payment on mortgages and MBSs and, if so, what form and prices those guarantees would have. Under those different structures, the government’s activities would range from providing full or partial guarantees for a large share of the mortgage market to playing a minimal role in a largely private market (except perhaps during a financial crisis). Any transition to a new type of secondary market would also require decisions about what to do with the existing operations, guarantee obligations, and investment holdings of Fannie and Freddie.
CBO’s analysis has three key findings:
- A transition to a new structure for housing finance that emphasized private capital could reduce costs and risks to taxpayers. One drawback to such a transition is that mortgages could become somewhat less available and more expensive to borrowers. Thus, over the longer term, it could also result in a modest shift of the economy’s resources away from housing toward other activities.
- Although the transition to a new structure could significantly decrease the number of borrowers who received mortgages backed by Fannie Mae or Freddie Mac, additional private capital would replace most of the lost funding. Borrowers would probably not face significant increases in interest rates because the two GSEs’ current pricing is not too far below market pricing. Consequently, a gradual transition would probably exert only modest downward pressure on house prices.
- Because policymakers have already raised the guarantee fees charged by Fannie Mae and Freddie Mac close to those that CBO estimates would be charged by private insurers, the budgetary costs of the two GSEs’ activities over the next 10 years are expected to be small. As a result, the budgetary savings would also be small under any of the transition paths to a more private system that CBO considered. Thus, the choice between the different market structures probably rests primarily on considerations other than budgetary costs.
CBO’s projections of budgetary costs and the size of the federal role in the mortgage market involve considerable uncertainty. In particular, because the market for mortgages is now dominated by large government-backed entities, the price that private investors would charge to bear the risks of mortgage guarantees and how that price might evolve over time are highly uncertain. CBO based its projections on its assessment of the middle of the distribution of estimates of that price.
To read the full analysis https://www.cbo.gov/publication/49765