Federal Housing Enterprises: HUD's Mission Oversight Needs to Be
Strengthened (Letter Report, 07/28/98, GAO/GGD-98-173).
This report discusses the Department of Housing and Urban Development's
(HUD) housing mission oversight of the two largest government-sponsored
housing enterprises: the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation. GAO found that (1) HUD adopted a
generally conservative approach in 1995 to setting the final housing
goals for 1996 through 1999 that placed a high priority on maintaining
the enterprises' financial soundness and (2) Fannie Mae and Freddie Mac
complied with the final housing goals in 1996 and 1997, according to
data they submitted to HUD. GAO also found several weaknesses in HUD's
mission oversight. Specifically, HUD has not implemented a program to
assess the accuracy of their data on compliance with their housing
goals, HUD's research agenda does not address several issues necessary
to fully understand the extent to which the housing goals promote
housing opportunities, and the agency has not yet fully implemented a
process under its general regulatory and new mortgage program approval
authorities to ensure that the enterprises' financial activities are
consistent with their housing mission. GAO summarized this report in
testimony before Congress; see: Federal Housing Enterprises: HUD's
Implementation of Its Mission Oversight Needs to Be Strengthened, by
Nancy Kingsbury, Assistant Comptroller General for General Government
Programs, before the Subcommittee on Capital Markets, Securities and
Government Sponsored Enterprises, House Committee on Banking and
Financial Services. GAO/T-GGD-98-177, July 30 (16 pages).
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-98-173
TITLE: Federal Housing Enterprises: HUD's Mission Oversight Needs
to Be Strengthened
DATE: 07/28/98
SUBJECT: Performance measures
Mortgage programs
Mortgage loans
Federal aid for housing
Government sponsored enterprises
Program evaluation
Housing programs
Financial management
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Cover
================================================================ COVER
Report to the Chairman, Subcommittee on Capital Markets, Securities
and Government Sponsored Enterprises, Committee on Banking and
Financial Services, House of Representatives
July 1998
FEDERAL HOUSING ENTERPRISES -
HUD'S MISSION OVERSIGHT NEEDS TO
BE STRENGTHENED
GAO/GGD-98-173
HUD's Mission Oversight Needs to Be Strengthened
(233541)
Abbreviations
=============================================================== ABBREV
ANPR - Advance Notice of Proposed Rulemaking
FASIT - Financial Asset Securitization Investment Trust
FHA - Federal Housing Administration
FHEO - Office of Fair Housing and Equal Opportunity
FTE - full-time equivalent
GSE - Government Sponsored Enterprise
HMDA - Home Mortgage Disclosure Act of 1990
HUD - Department of Housing and Urban Development
LTV - loan-to-value
MBS - mortgage-backed securities
MPP - Mortgage Protection Plan
OFHEO - Office of Federal Housing Enterprise Oversight
OMB - Office of Management and Budget
PD&R - Office of Policy Development and Research
REMIC - Real Estate Mortgage Investment Conduit
ROE - return on equity
Letter
=============================================================== LETTER
B-278383
July 28, 1998
The Honorable Richard H. Baker
Chairman, Subcommittee on Capital
Markets, Securities and
Government Sponsored Enterprises
Committee on Banking and Financial Services
House of Representatives
Dear Mr. Chairman:
This report responds to your request that we assess the Department of
Housing and Urban Development's (HUD) overall housing mission
oversight of the two largest government-sponsored enterprises
(enterprises), which are the Federal National Mortgage Association
(Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie
Mac). In 1992, Congress enacted the Federal Housing Enterprises
Financial Safety and Soundness Act\1 (the 1992 Act), which, among
other provisions, directed that HUD establish numeric housing goals
that require the enterprises to purchase mortgages serving targeted
groups,\2
such as low- and moderate-income borrowers\3 and those who live in
central cities and rural communities. HUD's development,
implementation, and enforcement of the numeric housing goals have
represented the primary component of its enterprise housing mission
oversight. Under the 1992 Act, HUD's enterprise housing mission
oversight also includes its general regulatory, new mortgage program
approval,\4 and fair lending responsibilities.\5
As agreed with your office, our objectives were to (1) discuss HUD's
legal basis, approach, and rationale for setting the numeric housing
goals at their current levels; (2) report on the enterprises'
compliance with the goals and HUD's assessment of the goals' impacts
on promoting homeownership and housing opportunities; (3) assess
HUD's procedures and efforts to verify goal compliance data; (4)
analyze the enterprises' multifamily mortgage purchase activities
under the housing goals and HUD's assessment of these activities'
effects on promoting housing opportunities; and (5) review HUD's
implementation of its general regulatory and new mortgage program
approval oversight authorities under the 1992 Act.
--------------------
\1 P. L. 102-550, Title XIII, 106 Stat 3672 (1992).
\2 In this report, the term "targeted" refers to (1) populations that
have traditionally been underserved by the mortgage market or (2)
mortgages serving such groups that are purchased by the enterprises.
\3 Households are defined as low income if their income does not
exceed 80 percent of the area median family income. Moderate income
includes household borrowers with incomes that do not exceed the area
median family income.
\4 The 1992 Act defines a "new mortgage program" as being
significantly different from programs that have been approved, or
that represent an expansion, in terms of the dollar volume or number
of mortgages or securities involved, of programs previously approved.
\5 The 1992 Act requires that HUD prohibit, by regulation, the
enterprises from discriminating in any manner in the purchase of any
mortgage because of the borrowers' race, color, religion, sex,
handicap, familial status, age, or national origin or the age or
location of the property financed.
BACKGROUND
------------------------------------------------------------ Letter :1
Congress established and chartered Fannie Mae and Freddie Mac as
government-sponsored, privately owned corporations to enhance the
availability of mortgage credit across the nation during both good
and bad economic times.\6 The enterprises are to accomplish this
mission by purchasing mortgages from lenders in the primary mortgage
market (i.e., banks, thrifts, and mortgage bankers), which can then
use the proceeds to make additional mortgage loans to homebuyers.
Purchasing mortgages from primary mortgage market originators and
others is commonly referred to as a "secondary mortgage market"
transaction. The enterprises issue debt to finance some of the
mortgage assets that they retain in their portfolios. However, a
majority of the mortgages the enterprises purchase are pooled to
create mortgage-backed securities (MBS) that may be sold to
investors. At year-end 1997, the enterprises had combined debt and
net MBS obligations outstanding of about $1.6 trillion.
The enterprises are large, sophisticated financial institutions that
have developed several mechanisms to finance residential mortgage
purchases. These mechanisms include callable bonds\7 and MBS that
tailor cash flows to different classes of investors. It is widely
recognized that the enterprises' activities and sophisticated
financial products have facilitated the development of a liquid,
secondary mortgage market, particularly for mortgages on
single-family residences.
The federal government's creation of and continued relationship with
Fannie Mae and Freddie Mac have played an integral role in the
enterprises' efforts to develop a secondary mortgage market. In
particular, this relationship has created the perception in the
financial markets that the government would not allow the enterprises
to default on their debt and MBS obligations, even though the
government is not required to back these obligations. As a result,
the enterprises can borrow money in the capital markets at lower
interest rates than comparably creditworthy private corporations. At
least a portion of these financial benefits are passed along to
homebuyers in the form of lower mortgage interest rates. The
enterprises also enjoy other benefits resulting from their federal
ties, such as exemptions from state and local income taxes and
securities registration fees imposed by the Securities and Exchange
Commission.
--------------------
\6 Congress chartered Fannie Mae in 1938 as a government-held
association to buy and hold mortgages insured by the Federal Housing
Administration. In 1968, Congress reorganized Fannie Mae as a
government-sponsored, privately owned for-profit corporation.
Congress chartered Freddie Mac in 1970, and it was initially a part
of the Federal Home Loan Bank System. In 1989, Congress established
Freddie Mac as a government-sponsored enterprise that is owned by
private investors.
\7 Callable bonds give the issuer the option of repurchasing the bond
before it matures.
CONGRESS HAS ENACTED A
REGULATORY FRAMEWORK
DIRECTING THE ENTERPRISES TO
PURCHASE MORTGAGES SERVING
TARGETED GROUPS
---------------------------------------------------------- Letter :1.1
Among other provisions, the enterprises' federal charters require
them to provide a secondary market for home mortgages of low- and
moderate-income borrowers as well as those who live in central
cities, rural areas, and other underserved areas. The enterprises'
charters also provide for the possibility that extending mortgage
credit to targeted groups may involve more risks and potential losses
than extending mortgage credit to other groups. Thus, the charters
state that the enterprises' profitability--or rate of return--on
mortgage purchases serving targeted groups must be reasonable, but
the rate of return on these purchases may also be lower than on other
activities.
In 1968, Congress provided the HUD Secretary with general regulatory
authority over Fannie Mae and authorized the Secretary to require
that a reasonable portion of the enterprise's mortgage purchases
serve low- and moderate-income families. In response to this
mandate, HUD established numeric housing goals for Fannie Mae that
essentially required that at least 30 percent of the enterprise's
purchases serve low- and moderate-income families and at least 30
percent serve families living in central cities. However, HUD did
not (1) enforce the housing goals consistently or (2) collect the
necessary data to monitor compliance with the goals. Before 1992,
Congress had not extended the housing goals to cover Freddie Mac.
By 1992, Congress concluded that the enterprises' mortgage purchase
activities did not adequately serve low- and moderate-income and
minority borrowers. As a result, these potential borrowers were not
sufficiently benefiting from the enterprises' secondary mortgage
market operations, which can serve to lower mortgage and rental
costs, thereby enhancing housing affordability. Congress also
concluded that, because of the financial benefits that Fannie Mae and
Freddie Mac enjoy from their federal charters and sponsorship, the
enterprises had a public responsibility to reach out to targeted
borrowers.
To address these congressional concerns, the 1992 Act established a
comprehensive framework for HUD to (1) promulgate numeric housing
goals for the enterprises and (2) obtain the necessary data from the
enterprises to monitor their compliance with the goals. The 1992 Act
also provided HUD with enforcement tools to help ensure enterprise
compliance with the goals. Specifically, the 1992 Act directed the
HUD Secretary to promulgate regulations setting annual housing goals
for each enterprise for the purchase of mortgages relating to each of
the following three categories:
-- housing for low- and moderate-income families;
-- housing located in central cities, rural areas, and other
underserved areas; and
-- special affordable\8 goals that targeted mortgage purchases
serving very-low-income\9 and low-income families living in
low-income areas.
Further, the 1992 Act (1) requires the enterprises to provide HUD
with reports on their mortgage purchase activities and (2) authorizes
HUD to take enforcement actions, such as issuing cease-and-desist
orders, to ensure the enterprises' compliance with the goals. The
1992 Act also established calendar years 1993 and 1994 as a
transition period to allow time for HUD to collect data to implement
these requirements and provided interim annual purchase goals for
each enterprise during that period.
--------------------
\8 In this report, the term "affordable" refers to income or location
standards established in the 1992 Act or similar statutes for
very-low-, low-, or moderate-income borrowers or those who live in
central cities or rural communities.
\9 Very-low-income households have incomes that do not exceed 60
percent of the area median family income.
THE 1992 ACT ALSO DEFINED
HUD'S GENERAL REGULATORY,
NEW MORTGAGE PROGRAM
APPROVAL, AND FAIR LENDING
AUTHORITIES
---------------------------------------------------------- Letter :1.2
The 1992 Act created the Office of Federal Housing Enterprise
Oversight (OFHEO) as an independent HUD office responsible for
helping to ensure the enterprises' financial safety and soundness.
The primary means by which OFHEO is to help ensure the enterprises'
safety and soundness are that OFHEO is to establish a stress test and
risk-based capital standards\10 and conduct annual, on-site
examinations. Moreover, the 1992 Act ratified and clarified HUD's
general regulatory authority over the enterprises.\11 Except for the
specific powers granted OFHEO, according to the 1992 Act, HUD has
"general regulatory power" over each enterprise and is charged with
making "such rules and regulations as shall be necessary and proper
to ensure" that the act's provisions and the enterprises' charters
are accomplished.
The 1992 Act also specified procedures that HUD must follow when
reviewing and approving new mortgage proposals by the enterprises.\12
The 1992 Act directs the HUD Secretary to approve any new program
that an enterprise proposes, unless the Secretary determines that the
program (1) violates the enterprise's charter or (2) would not be in
the public interest. The Secretary is also required to reject a new
program proposal if the Director of OFHEO determines that the
proposal would risk a significant financial deterioration of the
enterprise.\13 Under the 1992 Act, the Secretary must approve or
reject an enterprise's new program proposal within 45 days of its
submission, although the Secretary can extend the deadline for one
15-day period if the Secretary requests additional information. New
enterprise mortgage program proposals are automatically approved
under the 1992 Act if the Secretary does not comply with these
deadlines.
Finally, the 1992 Act under its fair lending provisions required that
HUD, by regulation, prohibit each enterprise from discriminating on
the basis of race and other borrower characteristics. Among HUD's
fair lending responsibilities, it is required to periodically review
and comment on the underwriting and appraisal guidelines of each
enterprise to ensure that such guidelines are consistent with the
Fair Housing Act.\14
--------------------
\10 Under the 1992 Act, the purpose of the stress test is to lower
taxpayer risks from the enterprises' activities by computer model
simulations where the enterprises are exposed to adverse credit and
interest rate scenarios. The 1992 Act also requires that the
enterprises hold sufficient risk-based capital levels to withstand
the stress test for 10 years, plus an additional 30 percent to cover
management and operations risks.
\11 Congress initially provided HUD with general regulatory authority
over Fannie Mae in 1968 and Freddie Mac in 1989.
\12 Congress initially provided HUD with the authority to review
Fannie Mae's new mortgage programs in 1970 and Freddie Mac's new
programs in 1989.
\13 Under the 1992 Act, this requirement is in place until 12 months
after the effective date of OFHEO's risk-based capital standards for
the enterprises are issued in final form. OFHEO expects to issue the
final standards in 1999.
\14 The Fair Housing Act, among other provisions, prohibits
discrimination in the extension of mortgage loan credit.
HUD'S ENTERPRISE OVERSIGHT
ORGANIZATIONAL STRUCTURE AND
RESOURCES
---------------------------------------------------------- Letter :1.3
HUD's enterprise oversight efforts are shared among four offices.
These offices are collectively responsible for developing and
enforcing the housing goal regulations and implementing HUD's general
regulatory, new mortgage program approval, and fair lending
authorities (see table 1). The Office of Government Sponsored
Enterprises (GSE) Oversight coordinates HUD's oversight of the
enterprises and conducts research on relevant topics. The Office of
Policy Development and Research (PD&R) provides research support,
both in-house and contract, for the development of the goals and
other relevant issues, while the Office of the General Counsel
provides legal support. In addition, the Office of Fair Housing and
Equal Opportunity (FHEO) is responsible for the 1992 Act's fair
lending requirements.
According to HUD officials, 16.9 full-time equivalent (FTE)
positions\15 in the four offices are devoted to enterprise oversight
for fiscal year 1998 (see table 1). Five of these positions are in
the Office of GSE Oversight; as of April 1998, one position in the
office was vacant. In addition, the Acting Director of the office
was part-time while HUD conducted a search for a new Director. Since
April 1997, the Acting Director said, she has also worked in the
Federal Housing Administration's\16 (FHA) Office of the Comptroller
as the Director of the Office of Evaluation.
Table 1
HUD Offices That Are Responsible for
Enterprise Mission Oversight and Those
Offices' FTE Positions
HUD office Number of FTE positions
---------------------------------------- ----------------------------
FHEO 1.4
General Counsel 2.9
GSE Oversight 5.1
PD&R 7.5
======================================================================
Total 16.9
----------------------------------------------------------------------
Source: HUD.
In fiscal year 1998, HUD's total enterprise oversight budget was
about $2.7 million, including about $687,000 in PD&R for research and
computer support contracts (see table 2). Unlike other federal
regulators that have housing enterprise oversight
responsibilities,\17 such as OFHEO, HUD's mission oversight
expenditures are funded with taxpayer dollars from HUD's
congressional appropriations, rather than through assessments on the
regulated entities. In previous reports,\18 we have commented that
regulatory costs should be borne by the respective federal housing
enterprises to ensure effective safety and soundness and housing
mission oversight.
Table 2
HUD's Budget for Enterprise Oversight in
Fiscal Year 1998
((Dollars in thousands))
Genera
GSE l
Offi Counse Tota
Obligation category ce PD&R l FHEO l
-------------------------------------- ---- ---- ------ ---- ----
Contracting $0 $687 $0 $25\ $712
\a b
Overhead\c 111 188 67 35 401
Personnel 412 699 248 130 1,48
9
Space 43 65 13 15 136
======================================================================
Total $566 $1,6 $ 328 $205 $2,7
39 38
----------------------------------------------------------------------
\a Includes $425,000 in research contracts and $261,500 in computer
support contracts.
\b Research contracts.
\c Personnel costs (including benefits) multiplied by 27 percent.
Source: HUD.
--------------------
\15 The term "full-time equivalent position" is used in the federal
government to specify personnel resources that are assigned to a
particular function. The term does not necessarily constitute a
single person because, for example, two individuals working part-time
could represent one FTE.
\16 FHA is an agency within HUD that is responsible for insuring the
mortgages of low- and moderate-income borrowers.
\17 OFHEO's safety and soundness activities--about $15 million in
fiscal year 1997--are financed by assessments on Fannie Mae and
Freddie Mac. Another federal housing enterprise--the Federal Home
Loan Bank System--pays similar assessments for its housing mission
and safety and soundness regulator, the Federal Housing Finance
Board.
\18 Government-Sponsored Enterprises: Advantages and Disadvantages
of Creating a Single Housing GSE Regulator (GAO/GGD-97-139, July 9,
1997) and Government-Sponsored Enterprises: A Framework for Limiting
the Government's Exposure to Risks (GAO/GGD-91-90, May 22, 1991).
SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :2
To meet our objectives, we reviewed HUD's final housing goal rule and
associated research, interviewed HUD officials and representatives
from the mortgage industry and housing community groups, and reviewed
available data on the enterprises' compliance with the goals between
1993 and 1997. We also met with officials from Fannie Mae, Freddie
Mac, and OFHEO to obtain their views on the housing goals and HUD's
enterprise mission oversight. Appendix I provides a detailed
discussion of our objectives, scope, and methodology.
We conducted our work in Washington, D.C., between October 1997 and
May 1998 in accordance with generally accepted government auditing
standards.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :3
The 1992 Act provides the HUD Secretary with the authority to set the
final housing goals, and established six general, but potentially
competing, factors to guide the Secretary's decisionmaking process.
In particular, the 1992 Act directed the HUD Secretary to balance (1)
the ability of the enterprises to "lead the [mortgage finance]
industry" in financing the mortgages of targeted groups and (2) the
need to maintain the enterprises' financial soundness. Available
evidence from HUD's final housing goal rule indicates that the HUD
Secretary generally adopted a conservative approach to setting the
final goals in December 1995\19 for the period 1996 through 1999.
This conservative approach placed a high priority on maintaining the
enterprises' financial soundness. For example, in 1994 and 1995, HUD
and OFHEO conducted research which found that additional mortgage
purchases required under the goals were modest and would not
materially affect the enterprises' financial condition.
According to annual data that Fannie Mae and Freddie Mac provided to
HUD, the enterprises have increased their share of targeted mortgage
purchases since 1993 and were in compliance with the final housing
goals in 1996 and 1997. For example, the percentage of Fannie Mae
mortgage purchases qualifying under HUD's low- and moderate-income
housing goal\20 increased from 34 percent in 1993 to 45.5 percent in
1997. Similarly, Freddie Mac's reported performance under the low-
and moderate-income goal increased from 30 percent in 1993 to about
43 percent in 1997. Fannie Mae's performance under the housing goals
has generally exceeded that of Freddie Mac.
HUD has a basic oversight responsibility to determine whether the
housing goals are resulting in enhanced housing opportunities for
targeted groups because this was the intent of the 1992 Act. HUD has
ongoing research projects to assess housing needs and households
served by goal-oriented mortgage purchases, but its current research
agenda does not address several highly relevant issues that are
necessary to fully understand the goals' impacts. For example, HUD
has not initiated research to assess the goals' effects on (1)
interest rates and loan terms on targeted mortgages and (2) mortgage
originators' incentives to make targeted mortgage loans.
HUD has implemented some limited procedures to verify the accuracy of
the enterprises' reported goal compliance data. However, HUD has not
implemented a program to assess the overall data collection and
reporting process. Given the decentralized nature of the housing
goal data and the potential for errors, it may not be possible for
HUD at this time to independently draw conclusions about the accuracy
of the data.
For an enterprise that is not in compliance with the housing goals,
HUD's final housing goal rule may provide regulatory incentives,
especially for multifamily housing, to employ risk-management
strategies that help the enterprise meet or exceed the numeric goals.
However, the effects of these risk management strategies on enhancing
housing opportunities for targeted groups are not clear. Under the
rule, the enterprises are permitted to count multifamily mortgage
purchases toward full compliance with the goals where the mortgage
originator--such as a bank or thrift--is required to cover most or
all of the estimated future losses that may occur due to borrower
defaults. According to HUD, these risk-management strategies
encourage the enterprises to participate in the multifamily mortgage
market, promote liquidity, and are necessary to protect the
enterprises' financial soundness.
However, there is also available information suggesting that the
enterprises' risk-management strategies involve offsetting trade-offs
that may serve to limit lenders' incentives to originate affordable
multifamily mortgages. For example, by requiring lenders to retain
most or all of the expected credit risks, the enterprise risk
management strategies could impede the lenders' willingness to extend
mortgage credit. By contrast, when the enterprises purchase
single-family mortgages, they generally relieve the lenders of the
associated credit risks, which has encouraged the development of a
liquid, secondary market for single-family mortgages. HUD has not
conducted research to determine the effects of enterprise risk
management strategies on multifamily mortgage finance and housing
opportunities.
HUD has not fully implemented a procedure to assess sophisticated
enterprise financial activities under its general regulatory and new
mortgage program approval authorities under the 1992 Act. For
example, HUD did not begin to act on its general regulatory authority
until 1997, when congressional questions were raised about Freddie
Mac's investments in Phillip Morris bonds and other nonmortgage
investments.\21 HUD initiated a process to assess the relationship
between the enterprises' nonmortgage investments and housing mission
in 1997, but this process has not been completed. HUD has approved
enterprise new mortgage programs within the timeframes established by
the 1992 Act. However, HUD has not yet established a process to
ensure that it has sufficient expertise to review and monitor
sophisticated financial products that may be associated with new
mortgage program proposals.
--------------------
\19 HUD did not issue the final housing goal regulations, which are
effective from 1996 to 1999, until December 1, 1995. The HUD
Secretary carried over the transition goal requirements for 1993 and
1994 into 1995.
\20 HUD's goals are based on the number of dwelling units financed by
enterprise-targeted mortgage purchases as a percentage of the total
dwelling units financed through mortgage purchases. Thus, a
single-family residential mortgage purchase that qualifies under the
low- and moderate-income goal would count as 1 dwelling unit, while a
qualifying multifamily purchase containing 50 rental units would have
50 dwelling units. Assuming an enterprise purchased mortgages
containing 1 million dwelling units in a particular year, and that
300,000 of these units qualified under the low- and moderate-income
goal, the enterprise's goal compliance would be 30 percent
(300,000/1,000,000). In this report, we show information on the
enterprises' purchases under the goals as a percentage of their total
mortgage purchases to facilitate the presentation.
\21 See Government-Sponsored Enterprises: Federal Oversight Needed
For Nonmortgage Investments (GAO/GGD-98-48, Mar. 11, 1998).
HUD'S APPROACH TO SETTING THE
FINAL ENTERPRISE HOUSING GOALS
WAS CONSERVATIVE
------------------------------------------------------------ Letter :4
The 1992 Act provided the HUD Secretary with the general authority to
set the levels of the final housing goals and authority to define
relevant terms. The 1992 Act also provided six general, but
potentially competing, factors that the HUD Secretary should
consider. In particular, the 1992 Act directed the HUD Secretary to
balance (1) the ability of the enterprises to "lead the (mortgage
finance) industry" in financing the mortgages of targeted groups and
(2) the need to maintain the enterprises' financial soundness. When
setting the final housing goals, the Secretary generally adopted a
conservative approach that, according to a senior HUD official, was
necessary to help maintain the enterprises' financial soundness.
THE 1992 ACT DIRECTED THAT
THE HUD SECRETARY CONSIDER
POTENTIALLY COMPETING
FACTORS WHEN SETTING FINAL
HOUSING GOALS
---------------------------------------------------------- Letter :4.1
The 1992 Act provided six general factors\22 to help guide the
Secretary's decisionmaking process in setting the final housing
goals. These factors were (1) national housing needs; (2) economic,
housing, and demographic conditions; (3) the performance and effort
of the enterprises in achieving the goals in previous years; (4) the
size of the conventional mortgage market serving targeted borrowers
relative to the size of the overall conventional mortgage market; (5)
the ability of the enterprises to lead the industry in making
mortgage credit available to targeted borrowers; and (6) the need to
maintain the sound financial condition of the enterprises.
Several of these factors can be considered to be in competition with
one another. In particular, the requirement that the HUD Secretary
consider the "ability of the enterprises to lead the industry" could
compete with the requirement that the Secretary also maintain the
enterprises' financial soundness. According to the 1992 Act's
legislative history,\23 it was expected that the enterprises would
"lead the (mortgage finance) industry" in making mortgage credit
available to targeted borrowers, and that the enterprises would have
to "stretch" to meet the goals. However, neither the 1992 Act nor
its legislative history specifically defined the term "lead the
industry." A potential definition of the term that HUD considered
between 1993 and 1995 was that the enterprises' targeted mortgage
purchase requirements under the goals would exceed the primary
market's existing originations of such mortgages. During the
rulemaking process, HUD received comments that suggested that the
enterprises be required to purchase a higher percentage of mortgages
than were already originated by the marketplace under each housing
goal.
However, requiring Fannie Mae and Freddie Mac to purchase more
targeted mortgages than were already originated in the primary market
could potentially have increased the enterprises' credit risks,\24
thereby affecting their financial soundness. The 1992 Act's
legislative history states that increases in targeted purchases could
be accomplished while maintaining the financial safety and soundness
of the enterprises. Similarly, the 1992 Act created OFHEO as an
independent regulator with wide regulatory powers--such as the
establishment of a stress test and risk-based capital standards--to
help ensure that the enterprises' mortgage purchase activities are
consistent with maintaining their long-term safety and soundness.
Thus, we conclude that the 1992 Act and its legislative history
required the HUD Secretary to carefully weigh the trade-offs between
expanding homeownership and housing opportunities for targeted groups
and maintaining the enterprises' safety and soundness in setting the
final housing goal regulations.
--------------------
\22 The 1992 Act required the six general factors for the low- and
moderate-income goal and the central cities, rural areas, and other
underserved areas goal. The 1992 Act specified only five general
factors for the special affordable goal.
\23 See S. Rep. No. 102-282, at 34-35 (May 15, 1992). The Senate
Report addresses the provisions of the Federal Housing Enterprises
Regulatory Reform Act of 1992, S. 2733, 102nd Cong. (1992). Title
XIII of P.L. 102-550 was based on the provisions of S. 2733, which
require the HUD Secretary to set specific goals for the enterprises'
mortgage purchases to address the needs of targeted borrowers.
\24 Credit risk is the possibility of financial loss resulting from
borrower defaults. Requiring the enterprises to substantially
increase their purchases of targeted mortgages may result in a
relaxation of the enterprises' mortgage purchase underwriting
standards. Given that targeted borrowers may have weaker credit and
employment histories than other borrowers, substantially relaxing the
enterprises underwriting standards could result in higher default
rates and associated credit losses.
HUD GENERALLY ADOPTED A
CONSERVATIVE APPROACH WHEN
SETTING THE FINAL HOUSING
GOALS
---------------------------------------------------------- Letter :4.2
In setting the final regulations for 1996 through 1999, the HUD
Secretary identified national housing needs and found that the
housing goal regulations are necessary to help meet these needs. The
Secretary concluded that many Americans were unable to afford
adequate housing due to insufficient incomes, high debt levels, and
rising home prices. The Secretary also concluded that the
enterprises lagged behind mortgage originators in meeting the credit
needs of targeted groups. In addition, the Secretary found that, by
establishing national housing goals, the enterprises could play a
larger role in promoting affordable housing opportunities, such as by
promoting liquidity in the multifamily market. (See app. II for a
discussion of the national housing needs, the underserved borrowers
identified by HUD, and the potential influence of HUD's numeric goals
in enhancing housing affordability for these groups.)
On the basis of our review of HUD's final regulations and associated
research as well as our discussions with HUD officials, we determined
that the HUD Secretary generally adopted a conservative approach to
setting the final housing goals. The goals were conservative in that
HUD (1) defined "lead the industry" to mean that the enterprises
should provide technical and financial assistance to lenders to help
ensure additional affordable mortgage originations rather than
adopting another definition, such as, for example, requiring the
enterprises to purchase a larger share of targeted mortgages than is
originated in the primary market; (2) conducted research concluding
that required mortgage purchases under the goals were modest and
would not materially affect the enterprises' financial condition; and
(3) did not consider the potential financial consequences for the
enterprises of housing goals higher than those that were established.
In addition, OFHEO concluded that the housing goals were modest and
would not affect the enterprises' financial soundness. A HUD
official said that the Department's conservative approach to
developing the housing goal regulations was necessary to maintain the
enterprises' financial soundness and to ensure that the goals could
be met in good economic times as well as bad.
HUD DEFINED "LEAD THE
INDUSTRY" AS REQUIRING
THE ENTERPRISES TO
PROVIDE ASSISTANCE TO
MORTGAGE ORIGINATORS
-------------------------------------------------------- Letter :4.2.1
According to the final housing goal regulations, the HUD Secretary
interpreted the "lead the industry" provision of the 1992 Act to mean
that the enterprises should employ their dominant role in the
secondary mortgage market to help ensure additional affordable
mortgage originations. The Secretary concluded that the enterprises
could provide financial standards and technical assistance to
mortgage originators that would increase their willingness to extend
mortgage credit to targeted groups. By contrast, the Secretary did
not define "lead the industry" to mean that the enterprises'
purchases under all three housing goals should exceed the estimated
market shares of targeted mortgage lending already occurring in the
primary mortgage market. In fact, the Secretary set the three final
housing goals below HUD's estimates of targeted mortgage originations
already occurring in the primary market (see table 3).
Table 3
Enterprise Housing Goals for 1996-1999
and HUD's Estimates of Primary Market
Shares
Percentage
goal
------------
Estimated share
1997- of primary
Goal category 1996 1999 market
-------------------------------------- ---- ------ ----------------
Low-and moderate-income 40% 42% 48-52%
Underserved areas 21 24 25-28
Special affordable 12 14 20-23
----------------------------------------------------------------------
Source: HUD.
The HUD Secretary also decided to establish a multifamily subgoal as
part of the special affordable goal. Unlike the three housing goals,
which are based on the number of dwelling units financed by qualified
mortgage purchases, the HUD Secretary based the multifamily subgoal
on the dollar volume of qualified enterprise mortgage purchases.
Specifically, the goal was set at 0.8 percent of each enterprise's
total mortgage purchases in 1994. According to HUD, this subgoal
translates into a requirement that Fannie Mae purchase $1.29 billion
in affordable multifamily mortgages annually between 1996 and 1999,
while Freddie Mac is required to purchase $988 million in affordable
multifamily mortgages annually. The multifamily subgoal represented
a significant initial commitment for Freddie Mac because it
experienced substantial multifamily losses in 1989 and 1990 and
withdrew from the market completely in 1990.\25 Freddie Mac did not
return to the multifamily market until 1993, and its 1994 multifamily
purchases that qualified under the subgoal were only $425 million.
According to HUD's final rule, the purpose of the subgoal was to help
ensure the development of a liquid, secondary market for affordable
multifamily properties, which may promote housing opportunities.
Further, in setting the final underserved areas goal, the HUD
Secretary changed the definition of "central city" that had been
established in the 1992 Act for the transition goals of 1993 and
1994. Under the 1992 Act, HUD was required to base the definition of
central city on criteria established by the Office of Management and
Budget (OMB) during the transition period of 1993 and 1994, but HUD
decided to use a definition that was based on census tract
data--published by the U.S. Bureau of the Census--when setting the
final goals. According to HUD, a census tract definition was more
appropriate than OMB's central city definition because the former
definition would focus the enterprises' mortgage purchase efforts on
neighborhoods that have relatively high concentrations of low-income
and minority residents, areas that HUD identified as being
underserved by the mortgage market. By contrast, under OMB's central
city definition, HUD concluded that entire cities were being treated
as if they had mortgage access problems when, in fact, residents of
upper-income areas in cities usually do not confront obstacles in
obtaining mortgage credit.
--------------------
\25 Freddie Mac reported $278 million in multifamily mortgage losses
in 1989 and 1990 combined, representing 50 percent of Freddie Mac's
losses during those years. See Federal Home Loan Mortgage
Corporation: Abuses in Multifamily Program Increase Exposure to
Financial Losses (GAO/RCED-92-6, Oct. 7, 1991).
HUD DETERMINED THAT THE
FINAL GOALS IT
ESTABLISHED WOULD NOT
MATERIALLY AFFECT
ENTERPRISE EARNINGS
-------------------------------------------------------- Letter :4.2.2
In 1995, HUD analyzed the goals it established and estimated that the
goals would not materially affect the enterprises' earnings. For
example, HUD developed a simulation model,\26 which basically found
that the enterprises could increase their targeted mortgage purchases
to the levels established in the 1995 rule without incurring
substantial additional credit risk because the additional purchase
requirements under the established goals were modest.
Further, HUD estimated the enterprises' return on equity (ROE)--a
common measure of profitability--under alternative economic
scenarios. These analyses found that, despite the implementation of
the housing goals, which would require additional purchases of
targeted mortgages, the enterprises would generate ROEs generally
exceeding 17 percent\27 and only fall slightly below that even if the
enterprises encountered periods of severe economic stress. For
example, HUD's analysis found that Fannie Mae's ROE for multifamily
purchases--which are considered riskier than single-family mortgage
purchases\28 --would generally be above 19 percent during a period of
severe economic stress.\29 Similarly, Freddie Mac's ROE for
multifamily lending would be about 17 percent during a period of
economic stress. We note that multifamily mortgages represent only
about 4 percent of Fannie Mae's total mortgage portfolio and 1
percent of Freddie Mac's total portfolio. During periods of normal
economic activity, HUD estimated that both enterprises would achieve
ROEs exceeding 20 percent on their single-family and multifamily
mortgage purchases, despite the implementation of the housing goals.
In conducting this research, HUD did not estimate the financial
consequences of alternative goals to those final goals that were
ultimately adopted on the enterprises' financial soundness. For
example, HUD did not estimate whether setting the goals at higher
levels would materially lower the enterprises' ROE under differing
economic scenarios, such as those used in estimating the effects of
the final goals. Further, HUD did not conduct research on the extent
to which the enterprises' use of lender- provided "credit
enhancements"\30 --which are used to minimize or eliminate the credit
risks associated with mortgage purchases--could offset the effects of
an economic downturn. We discuss the enterprises' use of credit
enhancements and their potential effects on housing opportunities in
more detail later in this report.
During the rulemaking process, HUD and OFHEO officials said that they
consulted with one another and that OFHEO reviewed drafts of the
proposed housing goal rule in 1994 and 1995. In an internal 1994
document, OFHEO concluded that HUD's proposed housing goal rule
represented a "modest" increase in the enterprises' then existing
commitment to targeted mortgage purchases and would not likely affect
their financial condition. In 1995, OFHEO concluded that the
enterprises' could meet the final housing goals without sacrificing
their safety and soundness.\31
--------------------
\26 A simulation model is a computer model that estimates the impact
of specified economic scenarios on a financial institution's
financial performance.
\27 HUD assumed that the enterprises needed to achieve ROEs of at
least 17 percent to attract financial investors.
\28 Multifamily loans are riskier than single-family loans because
(1) multifamily loans often are not homogenous regarding the type of
collateral, interest rate, and amortization; (2) underwriting
standards often differ among multifamily loan originators; and (3)
multifamily loans are relatively large and one defaulted loan can
result in significant losses.
\29 By contrast, the U.S. commercial banking industry's ROE between
1993 and 1996, which was a period of record profitably due to an
improving economy and low interest rates, averaged about 14.8
percent.
\30 Such credit enhancements require the loan originator to accept
some or all of the estimated credit risk on a mortgage sold to an
enterprise in the event of a borrower default. In its analysis, HUD
assumed that all of the losses associated with multifamily defaults
would be absorbed by the enterprises, rather than the lenders with
whom the enterprises maintain credit enhancement agreements.
\31 OFHEO, Annual Report to Congress 1995.
HUD'S RATIONALE FOR ITS
APPROACH TO SETTING THE
FINAL HOUSING GOALS WAS
GENERALLY GROUNDED IN
SAFETY AND SOUNDNESS
CONCERNS
-------------------------------------------------------- Letter :4.2.3
A senior HUD official who was involved in the development of the
final housing goal rule said that maintaining the enterprises'
financial soundness was one of several priorities HUD emphasized
during the rulemaking process. According to the HUD official, other
reasons that HUD adopted a conservative approach were to (1) ensure
that the enterprises could meet the goals in bad economic times as
well as good and (2) adjust for Freddie Mac's initial difficulties in
meeting the multifamily mortgage purchase requirement.
THE ENTERPRISES HAVE REPORTEDLY
INCREASED THEIR PURCHASES OF
TARGETED MORTGAGES, BUT HUD
CANNOT DETERMINE IMPACTS ON
HOUSING OPPORTUNITIES
------------------------------------------------------------ Letter :5
According to data Fannie Mae and Freddie Mac reported to HUD, the
enterprises have increased the shares of their overall business
devoted to targeted mortgage purchases since the transition housing
goals went into effect in 1993. The enterprises were in compliance
with all three of the final goals in 1996 and 1997, although Fannie
Mae's performance has exceeded that of Freddie Mac. According to
HUD, the enterprises' purchases of targeted mortgages have also
generally increased relative to the originations of such mortgages in
the primary market.
However, HUD has not yet determined the extent to which the
implementation of the housing goals is resulting in enhanced housing
affordability and opportunities for targeted groups, which was the
intent of the 1992 Act. As the federal regulator mandated by the
1992 Act to establish, enforce, and adjust the housing goals as
necessary, HUD has a basic oversight responsibility to conduct
research to determine the goals' impacts on housing opportunities.
Although HUD has ongoing research to meet its oversight
responsibilities, HUD's current research agenda does not address
several important issues, such as the goals' effects on (1) interest
rates and loan terms on targeted mortgage loans and (2) mortgage
originators' incentives to make targeted mortgage loans.
ENTERPRISES INCREASED
PURCHASES OF TARGETED
MORTGAGES BETWEEN 1993 AND
1997
---------------------------------------------------------- Letter :5.1
Table 4 shows that the enterprises' reported mortgage purchases under
all three of HUD's housing goals increased as percentages of their
overall mortgage purchases between 1993 and 1997. For example,
Fannie Mae's purchases of mortgages under the low- and
moderate-income goal increased from 34.1 percent in 1993 to 45.5
percent in 1997. Similarly, Freddie Mac's purchases under the low-
and moderate-income goal increased from 30 percent in 1993 to 42.9
percent in 1997.
Table 4
Enterprise Mortgage Purchases Under the
Affordable Mortgage Housing Goals, 1993-
1997
Goal category Enterprise 1993 1994 1995 1996 1997
---------------------------- ---------- ------ ------ ------ ------ ------
Low-and moderate-income Fannie Mae 34.1% 45.1% 42.8% 45.1% 45.5%
Freddie 30.0 38.0 39.6 41.3 42.9
Mac
Underserved areas goal Fannie Mae 22.9 29.0 31.2 28.2 29.0
Freddie 21.3 24.2 25.2 25.0 26.3
Mac
Special affordable Fannie Mae 10.0 16.7 15.8 17.4 19.1
Freddie 7.2 11.4 13.2 14.2 15.3
Mac
--------------------------------------------------------------------------------
Source: The 1993-95 enterprise data are reported by HUD as having
been recalculated to represent goal definitions in the 1995 final
rule. According to HUD, the 1996 and 1997 figures were reported by
the enterprises in compliance with the final rule.
The enterprises' data also show that Fannie Mae and Freddie Mac
exceeded all three final housing goals in both 1996 and 1997, in some
cases by significant margins (see table 5). For example, Fannie
Mae's purchases qualifying under the special affordable goal exceeded
the goal by 45.0 percent in 1996 and 36.4 percent in 1997. Freddie
Mac also exceeded HUD's affordable housing goals in 1996 and 1997,
although not by as much as Fannie Mae.
Table 5
HUD Housing Goals and Enterprise
Compliance With the Goals in 1996 and
1997
Purchase Purchase
s as a s as a
1996 percenta 1997 percenta
Enterpri 1996 purchase ge of 1997 purchase ge of
Goal category se goal s goal goal s goal
------------------ -------- ---- -------- ======== ---- -------- ========
Low-and moderate- Fannie 40.0 45.1% 112.8% 42.0 45.5% 108.3%
income Mae % %
Freddie 40.0 41.3 103.3 42.0 42.9 102.1
Mac
Underserved areas Fannie 21.0 28.2 134.3 24.0 29.0 120.8
Mae
Freddie 21.0 25.0 119.0 24.0 26.3 109.6
Mac
Special affordable Fannie 12.0 17.4 145.0 14.0 19.1 136.4
Mae
Freddie 12.0 14.2 118.3 14.0 15.3 109.3
Mac
--------------------------------------------------------------------------------
Source: HUD reported the goal levels and enterprise performance
levels. GAO calculated the percentage differences.
Fannie Mae's relatively larger volume of affordable multifamily
mortgage purchases is one reason that Fannie Mae's performance under
the goals has exceeded that of Freddie Mac.\32
For example, table 6 shows that although both enterprises complied
with the multifamily affordable subgoal in 1996 and 1997, Fannie
Mae's multifamily purchases were higher.\33 This difference is
important because, under HUD's rules, a mortgage purchase under one
goal--such as the special affordable multifamily subgoal\34 --can
also count towards compliance with the other goals for which it
qualifies, such as the low- and moderate-income and special
affordable goals.\35 According to HUD, multifamily properties house
relatively large numbers of low- and moderate-income families and, by
definition, house many more families than a single-family property.
Consequently, Freddie Mac's smaller presence in the multifamily
market meant that it had more to accomplish than Fannie Mae when the
enterprises became subject to the final goals.
Table 6
Enterprise Goal Levels and Loan
Purchases Under the Multifamily Subgoal
of the Special Affordable Goal for 1996
and 1997
((Dollars in billions))
1996- 1996 Purchases as a 1997 Purchases as a
1997 purchase percentage of purchase percentage of
Enterprise goal s goal s goal
------------------ -------- -------- -------------- -------- --------------
Fannie Mae $1.29 $2.36 182.9% $3.19 247.3%
Freddie Mac .988 1.08 109.3 1.2 121.5
--------------------------------------------------------------------------------
Source: Qualifying mortgage purchases reported by Fannie Mae and
Freddie Mac.
--------------------
\32 As discussed in the previous section, Freddie Mac withdrew from
the multifamily market entirely in 1990 due to large losses and did
not return to the market until 1993.
\33 The multifamily subgoal's income and location criteria are
stricter than the low- and moderate-income criteria. Therefore, the
enterprises may purchase other affordable multifamily mortgages that
do not qualify under the special affordable subgoal but may meet the
requirements of the other goals. Thus, the enterprises' total
affordable multifamily purchases--which consist of subgoal purchases
and other goal-qualifying purchases--is larger than the special
affordable subgoal purchases alone. In 1997, Fannie Mae reported
$6.9 billion in total multifamily purchases, while Freddie Mac
reported $2.7 billion.
\34 The special affordable subgoal is based on the dollar volume of
qualified mortgage purchases. However, the enterprises also track
the dwelling units financed by these mortgage purchases to determine
the dwelling units' compliance towards the other housing goals.
\35 For example, multifamily units represented 12 percent of the
total housing units purchased by the enterprises in 1995, but such
units accounted for 22 percent of the units meeting the low- and
moderate-income goal and for 41 percent of the units meeting the
special affordable goal.
ENTERPRISE INITIATIVES TO
ENHANCE HOUSING
OPPORTUNITIES FOR TARGETED
GROUPS
---------------------------------------------------------- Letter :5.2
The annual reports that the enterprises submit to HUD on their
mortgage purchases under the affordable housing goals also describe
the programs that the enterprises have in place to improve the
availability of affordable housing. For example, in its 1997 annual
report, Fannie Mae attributed its success in meeting the affordable
housing goals to the partnerships it has with state and local housing
finance agencies, nonprofit agencies, and the mortgage industry. The
Fannie Mae report also describes the enterprise's programs in the
areas of home-buyer education, the development of new mortgage
products to meet needs in the affordable housing market, and the
efforts to ensure that its underwriting guidelines broaden access to
mortgage financing for more individuals and families, including
families previously excluded from the homebuying process.
Freddie Mac's 1997 annual report also describes its initiatives to
expand access to mortgage credit and simplify the loan origination
process. For example, the report describes initiatives to lower
down-payment requirements to expand homeownership opportunities; make
loans for the purchase and rehabilitation of homes more affordable by
lowering the cost of these mortgages; and expand financing of
affordable multifamily properties.
ENTERPRISES ALSO GENERALLY
IMPROVED THEIR MORTGAGE
PURCHASE PERFORMANCE
RELATIVE TO THE PRIMARY
MARKET
---------------------------------------------------------- Letter :5.3
As previously discussed, a potential definition of "lead the
[mortgage finance] industry" that HUD considered between 1993 and
1995 would have required the enterprises to purchase relatively more
targeted mortgages than are originated in the primary mortgage
market. Although HUD did not adopt this potential definition, HUD
research staff have collected and analyzed data on enterprise
targeted mortgage purchases compared to primary market
originations.\36 The HUD analyses show that the enterprises' targeted
mortgage purchases have generally improved relative to primary market
originations. The HUD research also found that (1) Fannie Mae's
performance compared to the primary market has improved more than
Freddie Mac's performance has improved relative to the primary market
and (2) the enterprises still trail the primary market in most
targeted mortgage categories. We discuss these issues in more detail
in appendix III.
--------------------
\36 Paul B. Manchester, Sue George Neal, and Harold L. Bunce,
Characteristics of Mortgages Purchased by Fannie Mae and Freddie Mac,
1993-95 (HUD, Office of Policy Development and Research, Working
Paper No. HF-003, Mar. 1998).
HUD'S RESEARCH AGENDA DOES
NOT ADDRESS SEVERAL ISSUES
RELEVANT TO UNDERSTANDING
THE GOALS' EFFECTS ON
PROMOTING HOMEOWNERSHIP AND
HOUSING OPPORTUNITIES
---------------------------------------------------------- Letter :5.4
HUD has initiated research to determine the extent to which the
implementation of the housing goals has resulted in enhanced housing
affordability and opportunities for targeted groups. Such research
is essential for HUD to effectively carry out its housing mission
oversight role, determine whether the intent of the 1992 Act is being
met, and identify the appropriate levels to set the goals in the
future. However, HUD's current research agenda does not address
several relevant issues necessary to understand the housing goals'
effects.
HUD's reported data on the enterprises' compliance with the housing
goals are input measures that show the annual volumes of Fannie Mae's
and Freddie Mac's targeted loan purchases. The reported data do not
provide information on the extent to which the enterprises' increased
purchases are resulting in the 1992 Act's desired outcomes (i.e.,
increased homeownership and housing opportunities for targeted
groups). For example, the reported data do not provide information
on the extent to which--if at all--the enterprises' mortgage
purchases are resulting in lower mortgage interest rates or more
flexible loan terms for low- and moderate-income borrowers or those
that live in underserved areas.
In this regard, a Department of the Treasury study\37 completed in
1996 found that the enterprises' targeted mortgage purchases
generally had relatively high down payments. In particular, the
study pointed out that in 1994 about 78 percent of Fannie Mae's
housing goal loan purchases that meet the low- and moderate-income
goal had loan-to-value (LTV) ratios\38 of less than or equal to 80
percent. Similarly in 1994, approximately 79 percent of Freddie
Mac's mortgage purchases meeting the low- and moderate-income goal
had LTV ratios of less than or equal to 80 percent. The study
concluded that many of the enterprises' goal-oriented mortgage
purchases likely would already have been financed by the private
sector, since loans with LTVs of 80 percent or less represent
relatively low credit risks to financial institutions, such as banks
and thrifts. Thus, the study suggested that the goals have not
materially affected the existing mortgage finance market for targeted
groups.
Currently, HUD has a variety of research projects--in-house,
contract, and grant--to assess a range of issues that address the
impacts of the goals. For example, HUD has awarded a contract to Abt
Associates, Inc., to review the enterprises' underwriting and
appraisal standards and practices, specifically in reference to
effects on the availability of loans on affordable housing (see table
7 for a list of HUD contracts). In September 1997, HUD also awarded
11 research grants totaling about $400,000 to study mortgage purchase
activities of the enterprises. According to HUD officials, one
reason HUD initiated these projects was to explore issues that may be
relevant should the Department decide to revise the housing goals
after 1999.
Table 7
HUD's Contracts for Research Support on
Housing Goals
Task
Contractor description Award date End date Amount
---------------- -------------- -------------- -------------- --------------
The Urban Single-family September 30, July 31, 1998 $174,014
Institute underwriting 1997
study
Affordable September 30, March 30, 2000 151,446
lending 1997
program
performance
study
Underserved February 18, June 18, 1998 24,490
homebuyers 1997
study
Abt Associates, Multifamily September 30, August 31, 121,564
Inc. underwriting 1997 1998
study
Studies on November 3, September 30, 25,000
enterprises' 1997 1998
fair lending
practices
--------------------------------------------------------------------------------
Source: HUD.
However, HUD's research agenda does not yet address several issues
that are relevant to understanding the effects of the goals and
enterprise activities in promoting homeownership and housing
opportunities for targeted groups. For example, we previously
reported that quantification of the enterprises' efforts to serve
targeted borrowers generally measures resource commitments and not
outcomes, such as the impacts on mortgage interest rates and housing
affordability for targeted groups.\39
Therefore, we reported that understanding the impacts of
goal-oriented enterprise purchases would require a determination of
how mortgage originations by other lenders (namely, depository
institutions that undertake portfolio lending and mortgage bankers
that originate federally insured mortgages for mortgage pools
guaranteed by the Government National Mortgage Association (Ginnie
Mae)) are affected and respond to this change in funding.\40 HUD has
not yet initiated in-house or contracted research to analyze the
extent to which goal-oriented enterprise purchases may affect (1)
mortgage interest rates and other loan terms and (2) mortgage
lenders' incentives to initiate affordable mortgages. However, HUD
officials said that they plan to initiate an analysis on the effects
of the housing goals on depository institutions.
--------------------
\37 U.S. Department of the Treasury, Government Sponsorship of the
Federal National Mortgage Association and the Federal Home Loan
Mortgage Corporation (July 11, 1996).
\38 In general, loans with lower LTV ratios represent smaller
borrower risks to mortgage loan originators and the enterprises than
those with higher LTV ratios. The LTV ratio is determined by
dividing the balance of the mortgage loan outstanding by the
estimated value of the residential property. Thus, the LTV ratio on
an outstanding mortgage balance of $60,000 on a single-family
residence with an estimated value of $100,000 would be 60 percent.
The enterprises generally require mortgage insurance or other credit
enhancements on mortgage loans with LTV ratios exceeding 80 percent.
\39 Housing Enterprises: Potential Impacts of Severing Government
Sponsorship (GAO/GGD-96-120, May 13, 1996).
\40 Ginnie Mae is an organization within HUD that guarantees the
timely payment of principal and interest on securities backed by
mortgages insured by FHA or the Department of Veterans Affairs.
HUD HAS NOT INITIATED
INSPECTIONS TO ASSESS THE
ACCURACY OF ENTERPRISE-SUPPLIED
GOAL COMPLIANCE DATA
------------------------------------------------------------ Letter :6
HUD's verification of enterprise-supplied goal compliance data would
have important implications on the usefulness of the information
because, without verification, incorrect data could be used as the
basis for policy decisions. Also, the mortgage data that the
enterprises report are very complex and come from a large number of
sources, increasing the potential for errors. Although HUD has
checked the accuracy of the calculations that are based on the data
that the enterprises provide, as of April 1998, HUD had not initiated
a program to assess the overall integrity of the data collection and
reporting process.
HOUSING GOAL DATA
RELIABILITY IS IMPORTANT
---------------------------------------------------------- Letter :6.1
Verification of the data HUD receives from the enterprises regarding
their affordable mortgage purchases is important. The data that
Fannie Mae and Freddie Mac are required to submit tell HUD whether
the enterprises are meeting the affordable housing goals. As such,
these data may be used to make important policy decisions about how
well the enterprises are using the benefits gained from their
government charters to support the nation's affordable housing goals.
If these data are inaccurate or if officials do not know that they
can rely on them, policymakers do not have the tools they need to
make informed decisions about, for example, where affordable housing
goals should be set in the future.
A key principle in the use of data from any entity being examined by
the government is that appropriate steps should be taken to ensure
the validity of the data collected, particularly data supplied by the
entity that is under examination.\41 If steps were not taken to
ensure the validity of these data, then the data may provide an
unreliable basis from which to draw conclusions.
In the final housing goal rule, HUD outlines the basis for its
authority to
" . . . independently verify the accuracy and completeness of
the data, information and reports, including conducting on-site
verification, when verification is reasonably related to
determining whether the (enterprises) are complying with the
law. . . . without the authority to verify the completeness
and accuracy of the data, information, or reports submitted by
each enterprise, the Secretary would be hampered in making the
determinations that are required. Such a situation could result
in the Secretary erroneously concluding that the enterprises are
complying with [the 1992 Act] when they are not, or that they
are not complying with [the 1992 Act] when they are."
--------------------
\41 For example, see GAO's Government Auditing Standards: 1994
Revision.
HOUSING GOAL DATA IS COMPLEX
AND SUBJECT TO ERRORS
---------------------------------------------------------- Letter :6.2
The data that the enterprises collect and report to HUD regarding
their mortgage purchases comes from many sources, are often complex,
and can be subject to errors. The data are supplied to the original
lenders by borrowers; the lenders, in turn, give the data to the
enterprises when they sell the loans to them. The enterprises then
assemble the data and provide them to HUD.
Officials from Fannie Mae and Freddie Mac told us how they perform a
number of checks, both on their own processing of data and on the
validity of data that they receive from lenders when they buy the
mortgage loans. Both enterprises noted that it would be impossible
to independently verify the millions of data records that the
enterprises receive when they purchase mortgages from lenders.
However, the enterprise officials said that they independently verify
samples of these data to help ensure accuracy. The enterprise
officials also said that they conduct audits of their own internal
processing of loan data to ensure that the data submitted to HUD are
accurate.
Multifamily mortgages present a number of unique challenges when it
comes to accurately determining whether the mortgages meet the
affordable housing criteria. For example, some enterprise purchases
of multifamily mortgages are of pooled, seasoned mortgages, which
tend to be older. Although older, seasoned mortgages are considered
safer and more desirable on the secondary mortgage market, they also
may contain out-of-date affordability data, such as reported rent
levels. Ensuring the accuracy of rent-level data is essential for
HUD's purposes because comparison of rent levels that are several
years old with current median income data for an area would
artificially inflate the apparent affordability of a property.
According to HUD researchers,\42 in 1995, Fannie Mae was missing data
items needed to determine affordability for 32 percent of its
multifamily mortgage purchase transactions.
--------------------
\42 See William Segal and Edward J. Szymanoski, The Multifamily
Secondary Mortgage Market: The Role of Government-Sponsored
Enterprises (Working Paper No. HF-002, Mar. 1997). The views
expressed in this paper are those of the authors and do not
necessarily represent HUD's official views.
HUD HAS NOT INDEPENDENTLY
VERIFIED THE ACCURACY OF
ENTERPRISE-SUPPLIED DATA
---------------------------------------------------------- Letter :6.3
To date, HUD has performed some limited procedures to assess the data
supplied by the enterprises. HUD officials explained how they
conducted a number of limited checks on the 1996 data the enterprises
supplied in 1997. HUD has not yet implemented a program to
independently verify the reported housing goal data, but HUD
officials told us that they plan to increase their data verification
activities in the future.
HUD's verification of enterprise-supplied data has, to date,
consisted primarily of internal validity checks (i.e., checks on the
results of calculations that the enterprises used to determine which
loan purchases qualify under which goals). HUD performed these
checks by replicating the data tables submitted by the enterprises
using the complete data sets of enterprise-supplied data, then
looking for areas where its results did not match the enterprises'
results. HUD officials also said that they examined the enterprise
data for missing items and for noticeable "out-of-line" values, such
as properties with geographic codes placing them in states, counties,
or census tracts that do not exist. Where HUD found discrepancies,
officials said that they discussed them with the appropriate
enterprise, and the enterprise submitted revised data, where
necessary.
HUD officials told us that independent verification of
enterprise-supplied data has been a goal but that the verification
was superseded by other priorities in 1997. The officials told us
that HUD's verification processes are "evolving," and that HUD plans
to conduct more detailed data verification in 1998. HUD officials
said that they may review the internal controls and audit steps that
the enterprises have in place to ensure the accuracy of the reported
goal compliance data. For example, HUD could review the procedures
that the enterprises have established to sample the data that they
receive from lenders.
HUD also did not use a relevant data integrity examination conducted
by OFHEO. Officials from OFHEO informed us that the organization
conducts on-site verification of data systems and system controls at
the enterprises, but that this activity is not regularly coordinated
with HUD. For example, a 1996 OFHEO examination of financial data
controls at Freddie Mac noted that controls over Freddie Mac's
nonfinancial data were inadequate to ensure integrity. These
nonfinancial data, which include information about the geographic
location of properties and demographic information about borrowers
and tenants, are key to determining whether a particular loan fits
different purchase goals. However, OFHEO did not immediately inform
HUD of its findings, and HUD officials responsible for enterprise
oversight said that they were unaware of the examination.\43
--------------------
\43 We note that OFHEO included the information about the examination
and its findings with respect to Freddie Mac's nonfinancial data
controls in OFHEO's 1997 Report to Congress.
RESOURCE LIMITATIONS COULD
IMPEDE HUD'S CAPACITY TO
COMPLETE COMPREHENSIVE DATA
INTEGRITY REVIEWS
---------------------------------------------------------- Letter :6.4
We recognize that any data verification steps that HUD implements may
require an allocation of additional resources. However, HUD's
resources are limited since the Department has initiated a major
downsizing from 10,500 employees in 1997 to a projected 9,000 in
2002. Similar to the situation at HUD as a whole, HUD's Office of
GSE Oversight lost one FTE in fiscal year 1998, leaving the office
with five FTEs.\44 As of April 1998, the Office of GSE Oversight had
one vacant position and the Acting Director served in a part-time
role. As discussed previously, federal oversight of housing
enterprises--except for HUD's mission oversight of Fannie Mae and
Freddie Mac--is financed by the respective enterprises via periodic
assessments on their activities. Because HUD's enterprise oversight
activities must compete with other priorities in HUD's annually
appropriated budget, its capacity to implement a program to assess
housing goal data accuracy may be limited.
--------------------
\44 Staff members from HUD's Office of Policy Development and
Research as well as contractor personnel are also involved with the
data verification aspects of HUD's oversight of the enterprises.
HOUSING GOAL RULE PROVIDES
CREDIT FOR ENTERPRISE
MULTIFAMILY MORTGAGE
RISK-MANAGEMENT PRACTICES WHOSE
EFFECTS ON ENHANCING HOUSING
OPPORTUNITIES FOR TARGETED
GROUPS ARE UNCLEAR
------------------------------------------------------------ Letter :7
For an enterprise that is not in compliance with the housing goals,
HUD's final housing goal rule may provide regulatory incentives,
especially for multifamily housing, to employ credit enhancements,
which help the enterprise meet or exceed the numeric goals. However,
the effects that credit enhancements have on enhancing housing
opportunities for targeted groups are unclear. Under the rule, the
enterprises are permitted to count multifamily mortgage purchases
toward full compliance with the goals, even where the mortgage
originator--such as a bank or thrift--is required by credit
enhancements to cover most or all estimated future credit losses.
According to HUD, credit enhancements encourage the enterprises to
participate in the multifamily mortgage market, promote liquidity,
and are necessary to protect the enterprises' financial soundness.
However, there is also available information suggesting that the
widespread use of credit enhancements also involve offsetting
trade-offs that may serve to limit lenders' incentives to originate
affordable multifamily mortgages. For example, by requiring lenders
to retain all of the credit risks associated with multifamily
mortgage financing, credit enhancements could impede the lenders'
willingness to extend mortgage credit. By contrast, when Fannie Mae
and Freddie Mac purchase single-family mortgages, they generally
relieve the lenders of the associated credit risks. This has
encouraged the development of a liquid, secondary market for
single-family mortgages. Moreover, depositories--banks and
thrifts--must meet federal risk-based capital standards for mortgage
loans sold to an enterprise on which the depositories retain expected
credit risks, which may further serve to limit their incentives to
originate multifamily mortgages. HUD has not conducted research to
determine the effects of enterprise risk management strategies on
multifamily mortgage finance and housing opportunities.
THE ENTERPRISES USE CREDIT
ENHANCEMENTS TO MANAGE THE
RISKS ASSOCIATED WITH
MULTIFAMILY MORTGAGE
PURCHASES
---------------------------------------------------------- Letter :7.1
We previously pointed out that multifamily mortgage purchases
represent greater risks of default than single-family mortgage
purchases. To mitigate the credit risks associated with multifamily
loan purchases under the goals,\45 the enterprises use credit
enhancements, which may require mortgage originators to cover up to
100 percent of actual losses from mortgage defaults over time. The
credit enhancements used by the enterprises include recourse and
collateralization agreements, which may require the mortgage loan
seller--such as a bank--to take the "first loss" on credit defaults
up to a specified percentage, such as 10 percent of the outstanding
mortgage balance, or pledge collateral (e.g., in the form of
high-grade securities) before the completion of the transaction.
As previously discussed, Fannie Mae purchases a relatively larger
volume of affordable multifamily mortgages than Freddie Mac. Through
the use of recourse agreements and other credit enhancements, Fannie
Mae was fully responsible for the potential credit losses on 14
percent of the multifamily mortgages in its mortgage portfolio and
MBS in 1997. According to Fannie Mae officials, Fannie Mae also
shares credit risks with lenders in a large number of credit-enhanced
multifamily mortgage purchases. In exchange for sharing credit risks
with Fannie Mae, the lenders are permitted to use Fannie Mae's
underwriting standards and make mortgage approval decisions without
prior approval from the enterprise,\46 which increases the lenders'
business flexibility. Fannie Mae officials added that the
enterprise's purchases of multifamily mortgages that are subject to
credit enhancements serve to enhance the liquidity of the market.
According to a Freddie Mac official, Freddie Mac generally
underwrites most of the multifamily mortgages that it purchases and
assumes all of the credit risk on these purchases. However, Freddie
Mac also has used recourse and collateralization agreements on
multifamily mortgages that it has purchased.
Credit enhancements are routinely used by the enterprises because
they are an attractive method to manage credit risks. For example,
recourse agreements, by subjecting the mortgage originator to credit
risk, motivate the originator to follow sound underwriting practices.
Such lender motivation can be especially important to the enterprises
for multifamily mortgage purchases because default rates on such
mortgages are generally higher than for single-family mortgages. In
addition, according to a Federal Reserve study,\47 the mortgage
originator may have better information on the specific risk
characteristics of the financed property and its value than does the
housing enterprise purchasing the mortgage. Another reason that the
enterprises use credit enhancements for multifamily mortgage
purchases is that private mortgage insurance\48 is generally not
available for such purchases as it is for single-family mortgage
purchases. As a result of these benefits, the enterprises will be
more willing to purchase multifamily mortgages at more favorable
terms from lenders when the lenders provide credit enhancements.
According to HUD officials we contacted, there are several benefits
associated with credit enhancements in the multifamily mortgage
market, including the following:
1. Credit enhancements encourage the enterprises to purchase
multifamily mortgages, thereby providing stability and liquidity to
the market, which is a requirement of their charters.
2. Credit enhancements, as previously discussed, promote sound
underwriting standards by multifamily lenders.
3. Credit enhancements help ensure the financial soundness of the
enterprises.
--------------------
\45 The enterprises do retain exposure to losses due to fluctuations
in interest rates on multifamily mortgages retained in their
portfolios. The enterprises may also absorb losses if a lender
subject to a credit enhancement fails, and the enterprise has not
obtained sufficient collateral to cover such losses.
\46 Fannie Mae's Delegated Underwriting and Servicing program allows
lenders who share credit risk on multifamily mortgages to make credit
decisions without prior approval. Fannie Mae also purchases
multifamily mortgages where lenders use their own underwriting
standards. These mortgage purchases are subject to higher "first
loss" provisions than are loans purchased under the Delegated
Underwriting and Servicing program.
\47 Glenn Canner and Wayne Passmore, "Credit Risk and the Provision
of Mortgages to Lower-Income and Minority Homebuyers," Federal
Reserve Bulletin (Nov. 1995), pp. 989-1016.
\48 Private mortgage insurers are generally large corporations that
insure but do not originate or purchase conventional mortgages, which
are mortgages that do not have federal mortgage insurance or a
federal guarantee. The enterprises' charters require them to obtain
private mortgage insurance or alternative credit enhancements on
mortgage purchases with LTVs exceeding 80 percent. According to HUD,
private mortgage insurance is generally not offered on multifamily
mortgage purchases.
CREDIT ENHANCEMENTS MAY ALSO
LIMIT LENDERS' INCENTIVES TO
ORIGINATE AFFORDABLE
MULTIFAMILY MORTGAGES
---------------------------------------------------------- Letter :7.2
While there are potential risk-management benefits associated with
credit enhancements, there is also information showing that their
widespread use could serve to limit lenders' incentives to originate
multifamily mortgages and promote housing opportunities. In
particular, credit enhancements (1) may require lenders to retain
most expected credit risks, (2) limit the geographic diversification
of credit risk, and (3) require depositories to continue to meet
risk-based capital standards on multifamily mortgage sales to the
enterprises.
By requiring lenders to retain most of the expected credit losses
associated with multifamily mortgage purchases, credit enhancements
may serve to limit lenders' willingness to originate such mortgages.
By contrast, it is generally acknowledged that the enterprises'
assumption of certain credit risks on single-family mortgages has
contributed to the development of a liquid, secondary market for
single-family mortgages. The development of this secondary market
has resulted in lower mortgage interest rates for borrowers and
helped ensure the nationwide availability of mortgage credit.
The use of credit enhancements may also limit geographic
diversification of the credit risks associated with multifamily
lending. When a financial institution can diversify credit risks
geographically, it can offset losses in one region that may be
experiencing an economic downturn with income from another region
that is growing. The enterprises operate on a nationwide basis and
thus have the ability to diversify the credit risks on single-family
mortgages purchased from lenders in the primary market. However, a
lending institution without the capacity to diversify credit risks
geographically, may be unable or unwilling to finance multifamily
mortgages or provide liquidity in the areas where it does business.
During an economic recession, lenders' incentive to initiate
affordable multifamily mortgages may be particularly limited, since
such projects may represent significant credit risks.
Moreover, the HUD staff study\49 we previously discussed pointed out
that regulatory risk-based capital requirements for federally insured
depository institutions, such as banks or thrifts, can serve to limit
multifamily mortgage originations. Under these requirements, a
depository is generally required to hold risk-based capital against a
mortgage loan that is subjected to a recourse agreement and sold to
Fannie Mae or Freddie Mac. Consequently, the study stated that
depositories' willingness to originate multifamily mortgage loans may
be limited by these risk-based capital requirements and questioned
whether the use of recourse agreements enhances the affordable
housing market. In addition, regulatory rules require that
depositories hold cash reserves against loans subject to recourse
agreements.
In a June 1998 HUD staff study,\50 HUD researchers reported that
there is a lack of liquidity for smaller multifamily properties--that
is those properties with 5 to 49 dwelling units--that tend to be
affordable to targeted groups. When HUD established the multifamily
subgoal, it intended that the enterprises' increased presence in the
multifamily mortgage market would improve the liquidity for smaller
properties, thereby enhancing housing opportunities. The reported
lack of liquidity for smaller multifamily properties continued over
the past 4 or 5 years when HUD's housing goals were in place and
overall mortgage market liquidity was strong.
--------------------
\49 The Multifamily Secondary Mortgage Market.
\50 William Segal and Edward J. Szymanoski, "Fannie Mae, Freddie
Mac, and the Multifamily Mortgage Market," Cityscape: A Journal of
Policy Development and Research, HUD, Vol. 4, Number 1 (1998), pp.
59-74. This paper represents the views of the authors and does not
necessarily represent HUD's official views.
HUD HOUSING GOAL RULE MAY
PROVIDE REGULATORY
INCENTIVES FOR THE USE OF
CREDIT ENHANCEMENTS ON
MULTIFAMILY MORTGAGE
PURCHASES
---------------------------------------------------------- Letter :7.3
HUD's final rule permits the enterprises to count multifamily
mortgage purchases that are subject to credit enhancements fully
toward compliance with the housing goals. For example, if an
enterprise purchased a multifamily mortgage in which the enterprise
required the seller to accept all potential losses via a recourse
agreement, the enterprise could report that purchase to HUD as
complying with the multifamily subgoal and any other goals that may
similarly be covered, such as the low- and moderate-income goal. By
authorizing full credit for multifamily mortgage purchases subject to
credit enhancements, the final rule may provide the enterprises with
a regulatory incentive, in addition to market-based incentives, to
require mortgage originators to retain most or all credit risks.
However, HUD's final rule also requires the enterprises to accept
additional credit risks on multifamily mortgage purchases financed
under FHA "risk-sharing" demonstration programs to receive full
credit toward compliance with the housing goals. The enterprises are
among the participants in FHA's risk-sharing programs for affordable
multifamily properties, which Congress has authorized as
demonstration programs.\51 In these demonstration programs, FHA may
enter into an agreement with an enterprise to accept half of the
credit risk on multifamily mortgages under the program, and FHA
collects an insurance fee from its partner for this guarantee. The
final housing goal rule only permits enterprise mortgage purchases
under the risk-sharing programs to count toward full compliance with
the goals when the enterprise agrees to accept significant additional
credit risk, defined as 50 percent or more.\52 According to the final
rule, the assumption of additional credit risk "serve(s) to increase
available housing opportunities." In a recently issued report, we
found that FHA's risk-sharing programs generally offer alternatives
and encourage the financing of affordable multifamily properties.\53
--------------------
\51 Congress authorized risk-sharing demonstration programs in the
Housing and Community Development Act of 1992. Congress has
authorized a total of 62,000 affordable dwelling units under the
risk-sharing programs.
\52 Fannie Mae--which participates extensively in FHA's risk-sharing
programs--uses credit enhancements on multifamily mortgages that are
purchased under the FHA programs. After 3 years, Fannie Mae may
relieve the lender of the credit risks associated with a mortgage
purchase if the loan is performing according to preestablished
criteria, such as cash flow. Fannie Mae's assumption of credit risks
relieves the lender of risk-based capital and cash reserve
requirements.
\53 Housing Finance: FHA's Risk-Sharing Programs Offer Alternatives
for Financing Affordable Multifamily Housing (GAO/RCED-98-117, Apr.
23, 1998).
HUD HAS NOT CONDUCTED
RESEARCH TO DETERMINE THE
EFFECTS OF CREDIT
ENHANCEMENTS ON MULTIFAMILY
MORTGAGE FINANCE AND HOUSING
OPPORTUNITIES
---------------------------------------------------------- Letter :7.4
HUD has not conducted research to determine the effects of credit
enhancements on multifamily mortgage finance and housing
opportunities. For example, HUD has not analyzed whether credit
enhancements promote liquidity by encouraging the enterprises to
participate in multifamily mortgage finance or limit liquidity due to
(1) the inability of lenders to diversify credit risks and (2) the
effects of recourse agreements and risk-based capital standards on
depositories' incentives to sell multifamily mortgages to the
enterprises. In addition, HUD has not conducted research on the
extent to which the housing goal rule may provide the enterprises
with incentives to use credit enhancements. HUD officials told us
that they do not collect data on the extent to which the enterprises
use credit enhancements on multifamily mortgage purchases that are
reported as in compliance with the housing goals.
We recognize that there are important safety and soundness issues
associated with multifamily mortgage purchases and that the
enterprises use credit enhancements to manage those risks. However,
under their charters, the enterprises also have an affirmative
obligation to meet the credit needs of targeted borrowers, which may
be accomplished at a lower, though reasonable, rate of return than
other activities.
Further, it is important to note that HUD took into account the
financial soundness consequences of the special affordable
multifamily subgoal by setting it at a "reasonable" level.
Specifically, Fannie Mae's annual subgoal requirement of $1.29
billion represented about 0.7 percent of the enterprise's approximate
total of $174 billion in mortgage purchases in 1996. Similarly,
Freddie Mac's annual multifamily subgoal purchase requirement of $988
million represented about 0.8 percent of Freddie Mac's total mortgage
purchases of about $125 billion in 1996.\54 About 4 percent of Fannie
Mae's and 1 percent of Freddie Mac's total mortgage portfolios are
comprised of multifamily mortgages.
Finally, we note that HUD has not conducted sufficient research to
determine the level at which the housing goals could be set in the
future. According to HUD, the possibility exists that credit
enhancement use may provide meaningful support and liquidity without
subjecting the enterprises to credit risk. In addition, the
enterprises may be more willing to purchase multifamily mortgages at
more favorable terms with credit enhancements. If so, the potential
exists that the enterprises could purchase more multifamily mortgages
than are currently required without significantly affecting the
enterprises' financial soundness. However, as previously discussed,
the possibility also exists that the housing goal rule provides the
enterprises with incentives to use credit enhancements, which,
according to the HUD staff study,\55 may not meaningfully enhance
existing housing opportunities.
--------------------
\54 Freddie Mac did incur substantial losses on its multifamily
mortgage portfolio in the late 1980s and early 1990s, but its overall
net income rose to record levels each year between 1990 and 1993, and
its ROE exceeded 20 percent.
\55 The Multifamily Secondary Mortgage Market.
HUD HAS NOT YET FULLY
IMPLEMENTED A PROCESS TO
MONITOR ENTERPRISE FINANCIAL
ACTIVITIES
------------------------------------------------------------ Letter :8
In the legislative history of the 1992 Act, Congress cited our 1990
report\56 that concluded that HUD lacked experience as a regulator of
financial firms and traditionally had dedicated few staff members to
such functions. Although HUD's staff have significant expertise in
housing and related issues, we remain concerned about HUD's capacity
as a regulator of financial institutions. On the basis of our March
1998 report,\57 we conclude that HUD has not yet fully implemented a
process under its general regulatory and new mortgage program
approval authorities to ensure the activities' consistency with the
enterprises' housing mission. In addition, HUD has determined that
enterprise automated underwriting systems warrant further oversight
under the fair lending provisions of the 1992 Act.
--------------------
\56 Government-Sponsored Enterprises: The Government's Exposure to
Risks (GAO/GGD-90-97, Aug. 15, 1990).
\57 GAO/GGD-98-48.
HUD DID NOT BEGIN TO
EXERCISE ITS GENERAL
REGULATORY AUTHORITY FOR
ENTERPRISE NONMORTGAGE
INVESTMENTS UNTIL 1997
---------------------------------------------------------- Letter :8.1
In our March 1998 report, we found that HUD had not used its general
regulatory authority provided under the 1992 Act until 1997 to ensure
that the enterprises' nonmortgage investment practices were
consistent with their housing mission. We pointed out that such
oversight by HUD is important because the enterprises have incentives
to use the funding advantage associated with their federal
sponsorship to make nonmortgage investments that may result in
arbitrage profits.\58 Consistent with a recommendation in our March
1998 report, HUD has initiated actions that, if effectively carried
out, have the potential to help ensure more effective enterprise
oversight.
Under their charters, the enterprises have broad authority to make
investment decisions. The enterprises have established investment
policies that specify permissible credit ratings, maturities, and
concentration limits, and that describe the relationship of such
investments to earnings and to achievement of the enterprises'
housing finance mission. Nonmortgage investments constituted about
15 percent of the on-balance sheet assets at Fannie Mae and 10
percent at Freddie Mac, as of June 30, 1997. The enterprises'
nonmortgage investments included cash and cash equivalents,
asset-backed securities, corporate debt, and state and municipal
bonds. According to enterprise officials, about 70 percent of these
nonmortgage assets had maturities under 1 year, and all were
investment grade securities. The officials said that the enterprises
hold short-term nonmortgage investments to meet liquidity needs for
residential mortgage purchases.
However, the enterprises also hold longer-term nonmortgage assets
whose relationship to their housing mission is less clear, and these
assets could be used to generate arbitrage profits. For example, in
March 1997, Freddie Mac authorized up to $10 billion over a 5-year
period to be used for long-term nonmortgage investments. By
investing in long-term corporate bonds, the enterprises may earn
higher profits than on alternative mortgage investments.\59
Although each enterprise has broad investment authority, their
investment practices are subject to regulatory oversight under the
1992 Act. OFHEO has clear authority to regulate the enterprises'
investments in both mortgage and nonmortgage assets to help ensure
that such investments are consistent with maintaining the
enterprises' financial safety and soundness. To date, OFHEO has
determined that the enterprises' investments in nonmortgage assets do
not constitute a significant risk to the enterprises' financial
condition. Except for the specific powers granted OFHEO, according
to the 1992 Act, HUD has "general regulatory power" over each
enterprise and is charged with making "such rules and regulations as
shall be necessary and proper to ensure" that the enterprises'
activities, such as their nonmortgage investments, are consistent
with the charters and the 1992 Act.
The 1992 Act does not specify any criteria, other than the charters
themselves, as the basis for HUD to monitor and evaluate the
appropriateness of the enterprises' nonmortgage investments. HUD did
not attempt to collect information on the enterprises' nonmortgage
investments or define the scope of its regulatory authority until
1997, which was nearly 5 years after the passage of the 1992 Act.
HUD officials told us that they began to focus attention on the
enterprises' nonmortgage investments in April 1997 as a result of the
publicity surrounding the disclosure that Freddie Mac had invested in
long-term Phillip Morris corporate bonds.
In 1997, HUD requested for the first time that the enterprises
provide basic information about their nonmortgage investment policies
and holdings. Moreover, in December 1997, HUD issued an Advance
Notice of Proposed Rulemaking (ANPR), which solicited public comments
on how HUD should carry out its general regulatory authorities
regarding nonmortgage investments by the housing enterprises. HUD
officials said that during 1998, they plan to begin collecting
quarterly information from the enterprises on their nonmortgage
investments and discuss the issues relating to these investments with
OFHEO officials. The HUD officials said that if a decision to
develop a Notice of Proposed Rulemaking is made, they plan to draft
the notice by year-end 1998.
HUD's decision to publish the ANPR was consistent with the
recommendation in our March 1998 report on the enterprises'
nonmortgage investments. Specifically, we recommended that the HUD
Secretary develop written criteria, through the appropriate
rulemaking processes, to help ensure that the housing enterprises'
nonmortgage investments are consistent with the purposes expressed in
their charters.
--------------------
\58 We defined the term "arbitrage" to mean that the enterprises use
their funding advantage from government sponsorship to raise funds
for making nonmortgage investments.
\59 The enterprises generate income on the difference between their
debt servicing costs and the income they receive from their mortgage
and nonmortgage assets. At least some of the financial benefits that
the enterprises receive from their federal charters are passed along
to borrowers in the form of lower mortgage interest rates, which
reduces the enterprises' income from mortgage investments. Because
this mechanism is not present for enterprise nonmortgage investments,
certain nonmortgage investments may be more profitable to the
enterprises.
HUD'S CAPACITY TO MONITOR
SOPHISTICATED FINANCIAL
PRODUCTS THAT MAY BE
ASSOCIATED WITH NEW MORTGAGE
PROPOSALS IS LIMITED
---------------------------------------------------------- Letter :8.2
The 1992 Act prescribed the conditions under which HUD must review
and consider the approval of enterprise new mortgage programs.
Specifically, HUD must find that a proposed new mortgage program is
consistent with the enterprises' charters and not contrary to the
public interest. Further, the OFHEO Director must certify that the
proposed program would not jeopardize the enterprises' financial
condition. Since the passage of the 1992 Act, HUD has approved
four\60 new enterprise mortgage program proposals within the 45-day
deadline established by the 1992 Act (see table 8). However, our
March 1998 report found that HUD lacked the financial expertise
necessary to fully evaluate Fannie Mae's Mortgage Protection Plan
(MPP). Subsequently, HUD gave both enterprises the approval to
create Financial Asset Securitization Investment Trusts (FASIT),
which are sophisticated financial vehicles that can include
nonmortgage assets. We have no basis to question HUD's decision to
approve FASIT authority for the enterprises. However, we note that
HUD will need to develop an effective oversight process to ensure
that the enterprises use FASITs in accordance with their housing
mission.
Table 8
New Enterprise Mortgage Programs
Approved by HUD
Days
Program Final in
Program name description Submission date action date review
---------------- ------------------ ---------------- ---------------- ------
Fannie Mae
--------------------------------------------------------------------------------
Single Family Purchase energy March 4, 1994 April 14, 1994 41
Energy Loan loans made to
Purchase single family
Program homebuyers by
banks, housing
finance agencies,
and utility
companies.
Mortgage Obtain life, May 23, 1997 June 23, 1997 31
Protection Plan disability, and
(MPP) involuntary
unemployment
insurance on
first-time
homebuyers.
Financial Asset Issue asset- July 30, 1997 September 12, 44
Securitization backed securities 1997
Investment using the FASIT
Trust (FASIT) tax election.
Freddie Mac
--------------------------------------------------------------------------------
Financial Asset Issue, purchase, October 10, 1997 November 24, 45
Securitization service, sell, 1997
Investment and lend on
Trust (FASIT) asset-backed
securities using
the FASIT tax
election.
--------------------------------------------------------------------------------
Source: HUD
HUD officials who reviewed Fannie Mae's MPP proposal in 1997 did not
have expertise in the intricacies of the cash-value life insurance
industry. Such expertise was important because, under the MPP,
Fannie Mae proposed that it would purchase a cash-value life
insurance policy on a first-time homebuyer after the selected
borrower's residential mortgage was purchased by Fannie Mae. During
the course of our work on the March 1998 report, we did not see
evidence that HUD provided Fannie Mae's MPP proposal to anyone with
experience in evaluating cash-value life insurance. A Treasury
attorney with expertise in life insurance provided basic information
about life insurance products to HUD, and HUD determined that
providing information on the MPP to Treasury was not necessary
because HUD had obtained sufficient information and analysis to
complete its work. In our March 1998 report, we also noted that tax
consequences were a major factor in Fannie Mae's MPP proposal, but
that tax consequences had not been included in HUD's analysis.\61
Since HUD's approval of the MPP in June 1997, both enterprises have
received HUD approval for the creation of FASITs. FASITs are
sophisticated and new financial vehicles that are intended to provide
issuers of pass-through securities\62 with greater flexibility (i.e.,
in relation to other pass-through securities, such as those issued
through Real Estate Mortgage Investment Conduits (REMIC))\63 in the
financial assets that can be used to support the security issue. For
example, a FASIT can be partially supported by financial instruments
that help hedge cash-flow risks associated with mortgage
investments.\64 FASITs can also be supported with both mortgage and
nonmortgage financial instruments, such as credit card or automobile
receivables. However, the enterprises' proposals to HUD contained
assurances that the financial instruments used to support a FASIT
would consist primarily of cash and cash equivalents, government
securities, certain corporate debt obligations, qualifying hedging
contracts, and other assets consistent with their charters. HUD
found that the creation of FASITs by the enterprises would benefit
the public interest by promoting greater efficiency in the
mortgage-related securities market and enhancing mortgage market
liquidity. As of May 1998, the enterprises had not created any
FASITs.
We have no basis to question HUD's decision to approve the
enterprises' FASIT authority or that the enterprises will issue
FASITs in accordance with their agreements with HUD. However, we
note that as the enterprises' mission regulator, HUD has an ongoing
responsibility to monitor the enterprises' FASIT use to ensure
compliance, particularly with the requirement that the enterprises
use FASITs in accordance with their charters. In our view, such
oversight requires the ability to analyze sophisticated financial
products and a regulatory focus on the enterprises' financial
activities. In the past, HUD has not always demonstrated either the
financial expertise or regulatory focus, which was the case with
nonmortgage investments. Moreover, HUD's current list of contractors
for enterprise oversight activities have not contracted with HUD to
provide such ongoing financial expertise and focus.
--------------------
\60 We counted HUD's approvals of Fannie Mae's and Freddie Mac's
Financial Asset Securitization Investment Trust programs as two
separate approvals in determining that HUD had approved four
programs.
\61 Since HUD's approval, a new tax bill was signed into law that,
according to Treasury, substantially reduced the tax benefits that
were available to Fannie Mae under the MPP. Fannie Mae officials
told us that Fannie Mae has decided not to go forward with the MPP.
\62 A pass-through security passes payments from borrowers to
investors as loan payments are collected. The cash flow is from a
pool or pools of underlying loans. The issuer remits, or passes
through, to the investor monthly payments of principal and interest.
\63 REMICs are multiclass mortgage securities that assign cash flows
to different classes of investors. For example, some classes may
receive cash flows that are largely based on principal payments,
while other classes may receive cash flows that are largely based on
interest payments. REMICs may be issued by the enterprises or
private companies that specialize in real estate finance.
\64 For example, when interest rates decline, mortgage refinancings
tend to increase, which reduces future cash flows to mortgage
investors. This situation is commonly referred to as "prepayment
risk." The enterprises purchase financial instruments, such as
options on financial contracts, to help offset--or
"hedge"--prepayment risks.
HUD HAS DETERMINED THAT
ENTERPRISE AUTOMATED
UNDERWRITING SYSTEMS WARRANT
FURTHER OVERSIGHT
---------------------------------------------------------- Letter :8.3
The enterprises have developed and implemented automated underwriting
systems that have generated significant changes in the traditional
mortgage application and review process, which has relied on mortgage
originators to make credit decisions and to process the associated
paperwork. However, HUD has also considered whether the enterprises'
use of automated systems constitute new mortgage programs or raise
fair lending concerns on the basis of HUD's authorities provided
under the 1992 Act. HUD concluded in 1996 that the enterprises'
automated underwriting systems did not represent new mortgage
programs, but warranted further oversight under the fair lending
provisions of the 1992 Act.
ENTERPRISE AUTOMATED
UNDERWRITING SYSTEMS CAN
REDUCE MORTGAGE
TRANSACTION TIME AND
COSTS
-------------------------------------------------------- Letter :8.3.1
Requiring borrowers to meet certain underwriting standards is an
important step that lenders take to manage mortgage credit risk.
Lenders undertake the underwriting process to assess the possibility
that a prospective borrower may default on a mortgage. The
assessment includes analyzing sources of income,
debt-payment-to-income ratios, credit history, and proposed down
payment on a home purchase. The enterprises have both developed
automated underwriting systems that have a number of benefits. One
of these benefits is that, by using computers, automated systems can
reduce the processing time of traditional underwriting, which has
relied on labor-intensive manual reviews of mortgage applications.
Consequently, automated underwriting systems may also reduce the
costs associated with the mortgage application and review process.
HUD HAS ANALYZED ENTERPRISE
AUTOMATED SYSTEMS UNDER ITS
NEW MORTGAGE PROGRAM
AUTHORITY
---------------------------------------------------------- Letter :8.4
Despite the potential benefits of the enterprises' automated
underwriting systems, HUD has also reviewed the use of these systems
as part of its oversight responsibilities provided in the 1992 Act.
In 1996, HUD conducted an analysis of the enterprises' automated
underwriting systems and concluded that they were not new mortgage
programs under the 1992 Act. In this analysis, HUD determined that
the enterprise systems represented alternative business processes,
rather than new mortgage programs. Therefore, HUD concluded that the
enterprises did not have to submit official new mortgage program
proposals for their automated underwriting systems.
HUD's 1996 analysis also reviewed issues relating to enterprise
charter compliance that may be associated with automated underwriting
systems. For example, because of the speed at which automated
underwriting systems can process a mortgage application, the
potential exists that the enterprise may, at some point, bypass the
mortgage originator and interact more directly with the borrower and
make credit decisions as to whether an applicant should receive a
mortgage. However, the enterprises' charters prohibit them from
originating mortgages in the primary market. According to the 1996
analysis, HUD concluded that the systems do not remove mortgage
originators from the mortgage application and approval process
entirely. For example, HUD found that underwriters who work for
mortgage originators must still reconcile borrowers' application
documentation to the systems' analysis for all loans. Further,
underwriters must manually underwrite certain mortgage loan
applications that are referred to them by an automated system for
further review.
THERE ARE FAIR LENDING
IMPLICATIONS ASSOCIATED
WITH AUTOMATED
UNDERWRITING SYSTEMS
-------------------------------------------------------- Letter :8.4.1
According to HUD's 1996 analysis and our August 1996 report,\65
automated underwriting systems have implications for enterprise and
mortgage originator compliance with the fair lending laws under the
1992 Act. Under the 1992 Act, HUD is required to issue regulations
that prohibit each enterprise from discriminating in any manner in
the purchase of mortgages. In addition, HUD is responsible for
periodically commenting on the enterprises' underwriting guidelines
to ensure their compliance with the Fair Housing Act.
In our August 1996 report, we stated that the use of automated
underwriting systems could potentially result in disparate impacts on
minority borrowers. Under federal policy, a disparate impact occurs
when a seemingly neutral policy or practice is applied equally to all
credit applicants but with the result that the policy or practice has
a disparate impact on applicants from a targeted group, such as
minorities. For a prohibited disparate impact to occur, it must be
the case that the policy or practice is not justified by a business
necessity. If a business necessity does exist, the institution may
still be held liable if it could have adopted a less discriminatory
policy than the one that was adopted.
The possibility exists that the use of automated underwriting
systems--which rely on uniform underwriting criteria--could result in
a disparate impact on minority borrowers. For example, the use of
automated underwriting systems could, according to a HUD official,
result in relatively low mortgage acceptance rates for minority
borrowers. According to mortgage industry representatives we
contacted, originators are concerned that they will be held
accountable for potentially discriminatory decisions that are based
upon analyses provided by the enterprises' automated underwriting
systems.
Enterprise officials we contacted stated that their automated
underwriting systems do not result in discrimination against minority
borrowers. Rather, the officials argued that the use of automated
underwriting systems promotes mortgage lending to minority borrowers
and ensures fair and equal treatment.
--------------------
\65 Fair Lending: Federal Oversight and Enforcement Improved but
Some Challenges Remain (GAO/GGD-96-145, Aug. 13, 1996).
HUD PLANS TO REVIEW
ENTERPRISE AUTOMATED
UNDERWRITING SYSTEMS
-------------------------------------------------------- Letter :8.4.2
In HUD's 1996 analysis, HUD officials stated that they planned to
review the enterprises' automated underwriting systems under the fair
lending provisions of the 1992 Act. Since 1996, HUD has continued to
provide for the review of the enterprises' automated underwriting
systems. For example, in 1997, HUD hired a contractor to review the
potential implications of the enterprises' automated underwriting
systems on fair lending issues. In addition, a HUD official told us
that HUD has the authority under its enforcement authority to review
the enterprises' automated systems if a fair lending complaint is
filed.
In February 1998, FHA entered into a statement of understanding with
Freddie Mac, under which the enterprise is to provide automated
underwriting services to FHA to assist in the provision of FHA
mortgage insurance. To enable Freddie Mac to provide these services,
FHA is to give the enterprise loan data on FHA-insured mortgages.
According to HUD, FHA's agreement with Freddie Mac has the potential
to reduce the processing time and credit losses associated with
FHA-insured mortgages. According to the Acting Director of the
Office of GSE Oversight, her office was informed but not consulted as
FHA developed and implemented its approach to evaluating and
approving automated underwriting systems. The Acting Director told
us that while she participated in discussions regarding the
evaluation of the automated underwriting systems, to help avoid a
conflict with HUD's oversight role, she was not included in FHA's
decision to approve Freddie Mac's system.
CONCLUSIONS
------------------------------------------------------------ Letter :9
HUD completed a substantial amount of in-house and contract research
in establishing the final enterprises' housing goal rule in 1995.
HUD set the housing goals conservatively because, among other
reasons, HUD had concerns about the goals' potential impacts on the
enterprises' financial safety and soundness. Since 1996, the
enterprises have been in compliance with the final goals and have
improved their performance in targeted mortgage purchases when
compared to the primary market, although Fannie Mae's performance has
generally exceeded that of Freddie Mac. Despite the enterprises'
increased purchases of targeted mortgages, there is little
information currently available on the extent to which the housing
goals have resulted in increased housing affordability for targeted
borrowers.
Our review identified several weaknesses in HUD's enterprise
oversight activities that limit its effectiveness as a housing
mission regulator. The following summarizes these weaknesses:
1. HUD has not yet verified the accuracy of the mortgage purchase
data that it receives from Fannie Mae and Freddie Mac. The
recalculation steps that HUD performed on the enterprises' data
constitute an important element of the validation process, but
recalculation alone cannot support conclusions about the accuracy of
the data upon which the original calculations were based.
2. HUD's research agenda does not focus on all of the key issues
that are necessary to evaluate the impacts of the enterprises'
housing goals. In particular, HUD's research does not currently
evaluate the goals' effects on mortgage interest rates and other loan
terms for targeted borrowers and lenders' incentive to originate
targeted mortgages. In addition, HUD has not conducted research to
determine the effects of credit enhancements on affordable
multifamily mortgage finance and housing opportunities or whether the
housing goal rule provides the enterprises with regulatory incentives
to use credit enhancements. Consequently, HUD cannot adequately
determine the extent to which the goals promote housing opportunities
or at which levels to set the goals in the future.
3. HUD has not fully implemented a procedure to monitor
sophisticated enterprise financial activities under its general
regulatory and new mortgage program approval authorities.
Consequently, HUD may not have the ability to ensure that these
financial products--such as nonmortgage investments--are consistent
with the enterprises' housing mission.
Other federal regulators that have the responsibility for regulating
housing enterprises, such as OFHEO, are financed by the regulated
entities. However, HUD's capability to strengthen its enterprise
housing mission oversight may be limited because resources that could
be used for that purpose must compete with other priorities for HUD's
appropriated funds. For example, HUD's capacity to implement a
program to verify housing goal data, which would necessarily involve
a commitment of additional resources, may be limited.
Moreover, HUD's capacity to obtain the expertise to monitor the
enterprises' financial activities may also be limited, particularly
since HUD's traditional housing research focus may continue to
command a significant share of HUD's available resources. In our
previous reports on housing enterprise oversight, we recommended that
enterprise regulators have the authority to assess the enterprises
for the costs of federal oversight.\66 This practice would help
ensure that the costs of regulation are borne by the enterprises that
benefit from ties to the government. Further, imposing assessments
helps ensure that funding for oversight is not constrained by
competing responsibilities.
--------------------
\66 GAO/GGD-97-139 and GAO/GGD-91-90.
RECOMMENDATIONS
----------------------------------------------------------- Letter :10
To strengthen HUD's capacity as the enterprises' housing mission
regulator and enhance, to the extent consistent with financial
soundness concerns, housing affordability and opportunities for
targeted borrowers, we recommend that the HUD Secretary take the
following actions:
1. Develop and implement a program to assess the accuracy of housing
goal compliance data. The HUD Secretary should also coordinate any
such reviews with OFHEO.
2. Develop a better understanding of whether the housing goals are
enhancing housing affordability and opportunities for targeted groups
as intended by the 1992 Act by conducting research on the following
issues: (1) the goals' effects on mortgage interest rates and
associated loan terms for targeted groups, (2) the effects of credit
enhancements on enhancing housing opportunities, and (3) the extent
to which the housing goal rule may provide the enterprises with
regulatory incentives to use credit enhancements.
3. Continue implementing the existing process to monitor the
enterprises' use of nonmortgage investments. Ensure that expertise
is available to help ensure that the enterprises' financial
activities are consistent with their housing mission.
4. Collect information on the necessary costs for effectively
overseeing the enterprises, including the necessary costs to
implement the recommendations in this report, and develop a proposal
for congressional consideration that would require the enterprises to
reimburse HUD for these costs.
AGENCY COMMENTS AND OUR
EVALUATION
----------------------------------------------------------- Letter :11
We requested and received written comments on a draft of this report
from HUD and OFHEO. These written comments are provided in
appendixes IV and V. Overall, HUD was in general agreement with our
report findings, conclusions, and recommendations. OFHEO agreed with
our recommendation that the enterprises should bear the costs of
HUD's mission oversight. We also discussed our draft report findings
with Fannie Mae and Freddie Mac officials, and provided the officials
sections of the draft report that pertained directly to the
enterprises' operations (i.e., the sections on multifamily mortgage
finance and automated underwriting). A Fannie Mae official commented
on our conclusion that imposing assessments on the enterprises would
help ensure effective oversight. Enterprise officials also provided
technical comments on our findings that have been incorporated where
appropriate.
HUD's General Deputy Assistant Secretary for Housing generally agreed
with the draft report's conclusions and stated that HUD planned to
implement our recommendations. He stated that HUD planned to (1)
submit a legislative proposal to Congress for the Department's fiscal
year 2000 budget that would assess the enterprises for the costs of
HUD's oversight, (2) independently verify the housing goal compliance
data and coordinate these reviews with OFHEO, (3) consider the
housing goals' impacts on mortgage interest rates for targeted
groups, and (4) consider the appropriate counting requirements for
multifamily mortgage purchases that are subject to credit
enhancements.
HUD's letter commenting on our draft report also contained two
comments that we believe warrant further discussion. First, the
letter stated that HUD had considered the consequences for the
enterprises of alternative housing goals. Second, the letter stated
that HUD has in-house expertise and contracting vehicles in place to
assess new enterprise financial activities.
On the basis of our review of HUD's economic research supporting the
final rule and discussions with HUD officials, we did not see
evidence that HUD considered the financial consequences for the
enterprises of alternative goals. For example, HUD did not estimate
the enterprises' potential ROE under differing economic scenarios for
higher housing goals than those that were established in the final
rule. Regarding the second comment, we recognize that HUD staff have
significant expertise in housing and housing-related issues.
However, our review of HUD's oversight of the enterprises'
nonmortgage investments and HUD's review of Fannie Mae's MPP new
mortgage proposal suggested a lack of focus on financial activities
and a lack of expertise, such as in cash-value life insurance. In
addition, HUD has not yet contracted to obtain such expertise.
OFHEO's Acting Director agreed with our recommendation that HUD
should develop a proposal requesting that Congress consider requiring
that the enterprises bear the costs of HUD's housing mission
oversight. The Acting Director also said that the draft report
understated the extent to which HUD and OFHEO communicated with one
another in the development of the housing goals. In addition, the
Acting Director said that OFHEO did not inform HUD of the findings of
its 1996 data integrity examination at Freddie Mac before the
publication of its 1997 Report to Congress. However, the Acting
Director said that early in 1998, OFHEO agreed to a HUD request that
OFHEO provide technical assistance to HUD in ensuring the accuracy of
data submitted by the enterprises.
We have revised the report text to reflect the coordination between
HUD and OFHEO on the development of the housing goals. We also
support efforts by HUD and OFHEO to ensure, where possible, the
accuracy of data submitted by the enterprises.
A Fannie Mae official commented that it would be difficult for HUD to
separate its enterprise mission oversight responsibilities from its
other activities. The official expressed concern that HUD may use
enterprise assessments to fund other housing related research that is
not directly related to enterprise oversight.
We recognize that determining HUD's expenditures for housing mission
oversight may pose challenges, but continue to believe that the
enterprises should bear the relevant expenditures as do other federal
housing enterprises. We believe that HUD should clearly itemize and
justify its mission oversight resource requirements to ensure
accountability.
--------------------------------------------------------- Letter :11.1
We are sending copies of this report to the majority and minority
Members of the House and Senate Banking Committees and to other
interested parties. We will also make copies available to others
upon request.
Major contributors to this report are listed in appendix VI. Please
call me or Bill Shear, Assistant Director, at (202) 512-8678 if you
or your staff have any questions.
Sincerely yours,
Thomas J. McCool
Director, Financial Institutions
and Markets Issues
OBJECTIVES, SCOPE, AND METHODOLOGY
=========================================================== Appendix I
Our objectives for this report were to (1) discuss the Department of
Housing and Urban Development's (HUD) legal basis, approach, and
rationale for setting the numeric housing goals at their current
levels; (2) report on the government-sponsored housing enterprises'
(enterprises) compliance with these goals and HUD's assessment of the
goals' impacts on promoting homeownership and housing opportunities;
(3) assess HUD's procedures and efforts to verify goal compliance
data; (4) analyze the enterprises' multifamily mortgage purchase
activities under the housing goals and HUD's assessment of these
activities' effects on promoting housing opportunities; and (5)
review HUD's implementation of its general regulatory and new
mortgage program oversight authorities under the 1992 Act.
To provide HUD's legal basis, approach, and rationale for setting the
goals at their current levels, we reviewed the 1992 Act and its
legislative history, the final housing goal rule, and supporting
research and documentation. In addition, we interviewed senior
officials from HUD as well as officials from the Federal National
Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage
Corporation (Freddie Mac). We also interviewed officials from the
Office of Federal Housing Enterprise Oversight (OFHEO).
We reviewed the enterprises' reported data to HUD to provide
statistics on the enterprises' compliance with the housing goals
between 1993 and 1997. We also reviewed a March 1998 HUD report\67
that provided information on the enterprises' purchases of targeted
mortgage loans relative to the primary market's originations of such
mortgage loans. To assess HUD's analysis of the goals' impacts on
homeownership and housing opportunities, we reviewed our previous
reports and HUD's research on these issues and HUD's research
contracts and grants. We also met with representatives from the
mortgage finance industry and housing community groups.
We reviewed HUD's efforts to verify the enterprises' reported goal
compliance data by reviewing our standards on federal auditing
requirements\68 and HUD's final housing goal rule. We also discussed
the enterprise data collection process with HUD and enterprise
officials and reviewed relevant documents. Further, we reviewed an
OFHEO examination and its supporting workpapers regarding Freddie
Mac's data integrity process, and we discussed this examination with
OFHEO officials.
We obtained information about the housing goals' effects on the
enterprises' multifamily mortgage financing activities and housing
opportunities by reviewing reports issued by HUD staff researchers on
these issues. We also discussed HUD's research on these issues with
senior officials. Moreover, we compared the housing goal rule's
counting requirements for recourse agreements and similar credit
enhancements with the rule's treatment of risk-sharing agreements,
which are partnerships between the enterprises and the Federal
Housing Administration (FHA). We also discussed these issues with
enterprise and OFHEO officials as well as representatives from the
mortgage industry.
We assessed HUD's implementation of its general regulatory and new
mortgage program authorities by focusing on HUD's oversight of
enterprise financial activities and these activities' consistency
with the enterprises' housing mission. To conduct this assessment,
we reviewed our August 1990\69 and March 1998\70
reports. We also reviewed HUD's files on its approval of the
enterprises' new mortgage program proposals to issue Financial Asset
Securitization Investment Trusts (FASIT) and discussed FASITs with
HUD and enterprise officials. Regarding HUD's oversight of the fair
lending provisions of the 1992 Act, we reviewed internal HUD analyses
on the enterprises' automated underwriting systems and discussed the
systems with HUD and enterprise officials.
We conducted our work in Washington, D.C., between October 1997 and
May 1998 in accordance with generally accepted government auditing
standards.
We provided copies of a draft of this report to HUD and OFHEO for
review and comment. HUD's General Deputy Assistant Secretary for
Housing and OFHEO's Acting Director provided written comments on the
draft report's analysis and recommendations, which are summarized at
the conclusion of the report text and reprinted in appendixes IV and
V. HUD and OFHEO also provided technical comments, which have been
incorporated where appropriate. In addition, a Fannie Mae official
provided oral comments, and the enterprises provided technical
comments on draft sections of the report dealing with multifamily
mortgage finance and automated underwriting systems. These technical
comments have been incorporated where appropriate.
--------------------
\67 Characteristics of Mortgages Purchased.
\68 Government Auditing Standards: 1994 Revision.
\69 GAO/GGD-90-97.
\70 GAO/GGD-98-48.
THE ROLE OF HUD'S NUMERIC GOALS IN
ENHANCING HOUSING AFFORDABILITY
FOR TARGETED GROUPS
========================================================== Appendix II
Congress established and chartered the enterprises as government
sponsored, privately owned corporations with public purposes to
enhance the availability of mortgage credit across the nation during
both good and bad economic times. The enterprises' secondary market
activities and sophisticated financial products have facilitated the
development of a liquid, secondary mortgage market, particularly for
single-family residences. However, by 1992, industry participants
had the perception that the enterprises were lagging behind
conventional mortgage originators in extending mortgage credit
serving low- and moderate-income borrowers and borrowers in
underserved areas.
Congress concluded that the enterprises had a responsibility to reach
out to borrowers that have traditionally been underserved by the
mortgage markets because of the financial benefits that the
enterprises enjoy from their federal charters and sponsorship. To
address these congressional concerns, the 1992 Act established a
comprehensive framework for HUD to promulgate numeric housing goals
for the enterprises, obtain necessary data from the enterprises to
monitor their compliance with the goals, and enforce enterprise
compliance with the goals through the newly created enforcement
tools.
The enterprises' charters list the following public purposes:
(1) to provide stability in the secondary market for residential
mortgages;
(2) to respond appropriately to the private capital market;
(3) to provide ongoing assistance to the secondary market for
residential mortgages (including activities relating to mortgages on
housing for low- and moderate-income families involving a reasonable
economic return that may be less than the return earned on other
activities) by increasing the liquidity of mortgage investments and
improving the distribution of investment capital available for
residential mortgage financing; and
(4) to promote access to mortgage credit throughout the nation
(including central cities, rural areas, and underserved areas) by
increasing the liquidity of mortgage investments and improving the
distribution of investment capital available for residential mortgage
financing.
In carrying out their public purposes, the enterprises have made
important contributions to the residential mortgage market, including
(1) standardizing loan documents, underwriting standards, and
estimation of the value of single-family housing serving as
collateral for the mortgage loan and (2) taking on and management of
credit risks. These contributions helped establish and maintain a
link between the primary mortgage market and national financial
markets, thereby increasing the supply of residential mortgage
credit. In a previous report, we indicated that mortgage interest
rates on single-family, fixed-rate, conforming mortgages were reduced
on average by 15 to 35 basis points due to the contributions of
Fannie Mae and Freddie Mac.\71
Although the enterprises had generally made important contributions
to the residential mortgage market, by 1992, industry participants
had the perception that the enterprises' distribution of
conventional, conforming loan funding serving low- and
moderate-income borrowers and borrowers in underserved areas was
lagging behind the primary mortgage market's funding of such
mortgages. In 1994, a Federal Reserve Board study\72 using 1992 data
collected under the Home Mortgage Disclosure Act of 1990 (HMDA)\73
supported this perception. In passing the 1992 Act, Congress also
reached the finding that the enterprises "have an affirmative
obligation to facilitate the financing of affordable housing for low-
and moderate-income families in a manner consistent with their
overall public purposes, while maintaining a strong financial
condition and a reasonable economic return."
The 1992 Act specified interim low- and moderate-income, special
affordable housing, and central city\74 goals to be effective in 1993
and 1994. HUD retained low- and moderate-income and special
affordable housing goals. The 1992 Act provided HUD with discretion
in defining underserved areas in promulgating numeric goals beginning
in 1995. Thus, HUD was given the authority to help determine what
geographic areas would be targeted. Rather than relying on location
in a central city, the new underserved area goal is based on
concentrations of low-income and minority residents in the census
tract. According to HUD officials, this substitution was based, in
part, on research conducted at HUD. This research relied on HMDA
data on mortgage flows and U.S. Bureau of the Census data on housing
and demographic conditions across census tracts. The results
indicated that mortgage applications and originations in a census
tract, in relation to the housing stock in the census tract, tended
to be lower in census tracts that had concentrations of minority and
low-income households. HUD concluded that these results provided
more support for its underserved area definition than a definition
that is based solely on central city location.
The general purpose of the goals is to increase the total supply of
residential mortgage funds serving targeted households, which, in
turn, could lower mortgage interest rates, create more flexible
underwriting standards, and improve homeownership and housing
opportunities for low- and moderate-income households and residents
of underserved areas. Just as enterprise specialization and the
taking on and management of credit risk in the secondary market for
residential mortgages has generally helped facilitate such benefits
for single-family borrowers in general, the numeric goals can help
facilitate an increase in the supply of residential mortgage funds
serving targeted households.
The impact of the numeric goals on targeted households depends on (1)
the direct impact of the goals on enterprise purchases serving
targeted households and (2) the impact of the enterprise purchases on
mortgage originations by primary mortgage market lenders. Such
lenders include depository institutions that undertake single-family
portfolio lending, multifamily lenders, and mortgage bankers who
originate both conventional and federally insured residential
mortgages. As discussed in the body of this report, multifamily
mortgage purchases by the enterprises are a fairly low proportion of
their overall purchases.\75 However, multifamily purchases play a
greater role in helping the enterprises meet HUD's numeric goals.
For example, about 95 percent of the units in multifamily properties
qualify as low- and moderate-income housing.\76
We also note that the impact of increased enterprise goal purchases
on mortgage originations serving targeted households by primary
mortgage market lenders is much less understood than the impacts of
enterprise activities on the overall conforming, conventional
mortgage market. For example, in the overall market, the enterprises
generally provide corporate guarantees in which the credit risks
associated with mortgages they purchase are taken on and managed by
the enterprise, rather than by mortgage originators or
mortgage-backed securities (MBS) investors. The enterprises'
corporate guarantees have contributed to the link between the overall
primary mortgage market for single-family housing and national
financial markets because (1) the enterprises can diversify their
credit risks by purchasing mortgages across the nation while mortgage
originators generally cannot and (2) MBS investors do not have the
data and tools that the enterprises have to evaluate credit risks.
However, the risks associated with purchasing certain mortgages
counting toward the numeric goals and regulatory treatment of those
purchases may have created a regulatory incentive for the enterprises
to enter into agreements where mortgage originators provide credit
enhancements such as recourse arrangements, thus assuming credit
risk. The impacts of such arrangements on the supply of mortgage
credit by conventional mortgage originators serving targeted
households are not understood. For example, HUD has not analyzed
whether enterprise multifamily purchases with lender-provided credit
enhancements have been made representing mortgages (1) from across
the nation rather than from limited geographic areas, or (2) from
regions of the country undergoing relative economic declines as well
as those experiencing relative prosperity, thereby providing a
cushion in declining markets.
As previously stated, the enterprises' charters call upon them to
increase the liquidity of mortgage investments and improve the
distribution of investment capital available for residential mortgage
financing serving targeted households. We have concluded that HUD
has not conducted sufficient research to determine whether providing
increased liquidity to help serve targeted households across the
nation under different economic conditions can be achieved without
the enterprises taking on greater credit risks than they currently do
on certain purchases now qualifying toward achievement of the numeric
goals.
--------------------
\71 GAO/GGD-96-120. A basis point is 1/100 of a percentage point.
\72 Glenn B. Canner and Wayne Passmore, "Residential Lending to
Low-Income and Minority Families: Evidence From the 1992 HMDA Data,"
Federal Reserve Bulletin (Feb. 1994), pp. 79-108.
\73 HMDA data are collected by the government from residential
mortgage lenders to provide the public with information for
determining whether financial institutions are serving the housing
needs of their communities and to assist regulatory agencies in
identifying possible discriminatory lending patterns and enforcing
antidiscrimination statutes.
\74 The central city, or cities, of a Metropolitan Statistical Area
receive that designation by the Office of Management and Budget on
the basis of population and employment-to-residence and
commute-to-residence ratios. Central city designation is not based
on housing needs or economic conditions in a geographic area.
\75 About 4 percent of Fannie Mae's and 1 percent of Freddie Mac's
total mortgage portfolios are composed of multifamily mortgages.
\76 HUD, Economic Analysis for the Secretary of HUD's Regulation of
the Federal National Mortgage Association and the Federal Home Loan
Mortgage Corporation (Nov. 1, 1995), p. II-3.
ENTERPRISE-TARGETED MORTGAGE
PURCHASES COMPARED TO THE PRIMARY
MARKET'S ORIGINATIONS OF TARGETED
MORTGAGES
========================================================= Appendix III
In March 1998, HUD published a study\77 that, among other issues,
compared the enterprises' performance in serving the mortgage credit
needs to that of the primary market in 1992 and 1996.\78
According to the study, such comparisons are important because they
provide a means of evaluating the enterprises' efforts to serve the
credit needs of targeted groups. The study found that (1) the
enterprises' performance has generally improved compared to the
primary market's, (2) Fannie Mae's performance has exceeded that of
Freddie Mac, and (3) the enterprises still trail in most affordable
lending categories.
A number of factors may account for the enterprises' generally
improved performance, such as the implementation of HUD's goals and a
generally growing U.S. economy. There are also several factors that
may explain why the enterprises continue to trail the primary market
in most affordable lending categories. For example, the enterprises
may lack detailed knowledge about the risk characteristics of
targeted borrowers in local markets. Therefore, to manage credit
risks, the enterprises may establish stricter mortgage purchase
underwriting standards than the underwriting standards that lenders
establish to originate targeted mortgages in local markets.
--------------------
\77 Characteristics of Mortgages Purchased.
\78 The HUD study focused on the enterprises' mortgage purchase
performance between 1993 and 1995. HUD provided data to us for 1996.
THE ENTERPRISES HAVE
GENERALLY IMPROVED THEIR
MORTGAGE PURCHASE
PERFORMANCE RELATIVE TO THE
PRIMARY MARKET
----------------------------------------------------- Appendix III:0.1
Table III.1 provides HMDA data on enterprise purchases of targeted
mortgages and primary market originations of such mortgages in 1992
and 1996.\79 Specifically, the table shows the share of (1) each
enterprise's purchases of conventional conforming mortgages for
various targeted borrowers as a percentage of its total mortgage
purchases and (2) mortgage originators'--that is, banks, thrifts, and
mortgage banks--originations of targeted, conforming mortgage loans
as a percentage of their total mortgage originations. In addition,
the table shows each enterprise's share of targeted mortgage
purchases as a percentage of the primary market's share of
originations of such mortgages. This analysis provides a comparison
of the enterprises' performance relative to the primary market over
time.
Table III.1 shows that both the enterprises and originators in the
primary market generally increased their commitments to targeted
mortgages during the period, although both the primary market and
Freddie Mac's share in high-minority census tracts declined.
Overall, the enterprises' performances generally increased compared
to the primary market's. For example, in each of the seven
categories, Fannie Mae's performance improved compared to the primary
market's, and Fannie Mae exceeded the primary market in two areas
(Hispanic borrowers and high-minority tracts) by 1996. Freddie Mac's
performance improved relative to the primary market's in three areas,
declined in three areas (underserved areas, low-income census tract,
and high-minority census tract), and stayed the same in one area
(Hispanic).
Table III.1
Share of Conventional Conforming
Mortgage Loans by Fannie Mae, Freddie
Mac, and the Primary Mortgage Market
Serving Targeted Groups
Fannie Mae Freddie Mac
Share of Share of Primary share as a share as a
Targeted Fannie Mae Freddie Mac market percentage percentage
borrower mortgage mortgage origination of primary of primary
group purchases purchases share market share market share
---------- ------------ ------------ ------------ ------------ ------------
Very-low income
--------------------------------------------------------------------------------
1992 5.1% 5.2% 7.6% 67% 68%
1996 8.6 8.0 10.8 80 74
African-American
--------------------------------------------------------------------------------
1992 2.8 2.2 3.1 90 71
1996 4.4 3.6 4.7 94 77
Hispanic
--------------------------------------------------------------------------------
1992 3.9 3.6 4.4 89 82
1996 6.6 4.7 5.7 116 82
Underserved areas
--------------------------------------------------------------------------------
1992 18.7 18.9 21.9 85 86
1996 21.3 18.9 23.3 91 81
Low-income census tract
--------------------------------------------------------------------------------
1992 7.0 7.3 9.2 76 79
1996 8.5 7.4 10.0 85 74
High-minority census tract
--------------------------------------------------------------------------------
1992 12.9 12.0 13.1 98 92
1996 14.0 10.9 12.9 109 84
High African-
American census tract
--------------------------------------------------------------------------------
1992 3.2 2.6 3.7 86 70
1996 3.6 3.0 4.1 88 73
--------------------------------------------------------------------------------
Source: HUD.
HUD's housing goals may have contributed to the enterprises'
performance relative to the primary market. However, other factors
may have played a role as well. Between 1992 and 1996, the United
States experienced steady economic growth and mortgage interest rates
were generally favorable. According to the National Association of
Realtors, housing was more affordable in 1995 than in any year during
the 1975 to 1992 period. With a generally favorable economic
environment and increased housing affordability, more targeted
borrowers, such as low-income households and those living in
underserved areas, may have been able to qualify for mortgages, and
the enterprises may have found it profitable to increase their
purchases of such mortgages without prompting from HUD's housing
goals.
--------------------
\79 HMDA data differ from the housing goal data collected by HUD.
HMDA data are based on the number of mortgages originated and are
collected from a subset of institutions that originate mortgage
loans: commercial banks, thrifts, and mortgage banks in metropolitan
areas. HMDA data also report more categories of targeted mortgage
groups than do the housing goal data. The housing goal data consist
of the number of dwelling units financed by all enterprise mortgage
purchases.
THE ENTERPRISES CONTINUE TO
TRAIL THE PRIMARY MARKET
----------------------------------------------------- Appendix III:0.2
Despite their relative improvements, the enterprises continued to
trail the primary market in most categories identified in table
III.1. There are several potential reasons for these differences,
including the following:
-- According to a Federal Reserve study,\80 mortgage originators
have a better understanding of the risks associated with lending
in the areas where they do business than the enterprises. Thus,
the enterprises may establish mortgage purchase underwriting
criteria that are stricter than the underwriting criteria of
mortgage originators.
-- Banks and thrifts--major originators in the primary mortgage
market--are subject to the Community Reinvestment Act, which
requires them to serve the needs, including mortgage credit
needs, of targeted groups in areas where they do business.\81
-- HUD set the housing goals below the estimated shares of targeted
mortgage lending in the primary market.
(See figure in printed edition.)Appendix IV
--------------------
\80 Credit Risk and the Provision of Mortgages.
\81 See Characteristics of Mortgages Purchased.
COMMENTS FROM THE DEPARTMENT OF
HOUSING AND URBAN DEVELOPMENT
========================================================= Appendix III
at the end of this appendix.
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
The following are GAO's comments on the Department of Housing and
Urban Development's letter dated July 14, 1998.
GAO COMMENTS
1. In a letter to GAO, HUD provided an explanation of the
differences in counting requirements under the final rule. HUD
stated that the enterprises are required to accept additional credit
risks on mortgage purchases under the FHA risk-sharing programs
because such risks are mathematically quantifiable and agreed before
the purchase of loans. By contrast, HUD said that it is difficult to
determine the risks that the enterprises incur on multifamily
mortgage purchases subject to recourse agreements that are not made
under the FHA risk-sharing programs.
As HUD agrees in its comment letter, additional research on
multifamily credit enhancements is needed. Thus, we would expect HUD
to assess the risks that the enterprises incur on multifamily
mortgage purchases subject to credit enhancements.
2. We have added language to the report consistent with the accepted
definition of a prohibited disparate impact under federal policy (see
p. 38).
(See figure in printed edition.)Appendix V
COMMENTS FROM THE OFFICE OF
FEDERAL HOUSING ENTERPRISE
OVERSIGHT
========================================================= Appendix III
(See figure in printed edition.)
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix VI
GENERAL GOVERNMENT DIVISION
William Shear, Assistant Director
Wesley M. Phillips, Evaluator-in-Charge
Thomas H. Givens, Senior Evaluator
Phoebe Jones, Office Technician
RESOURCES, COMMUNITY, AND ECONOMIC
DEVELOPMENT DIVISION
David L. Lewis, Senior Evaluator
OFFICE OF THE GENERAL COUNSEL
Rachel DeMarcus, Assistant General Counsel
*** End of document. ***