Federal Housing Enterprises: HUD's Implementation of Its Mission
Oversight Needs to Be Strengthened (Testimony, 07/30/98,
GAO/T-GGD-98-177).

Pursuant to a congressional request, GAO discussed 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 (Fannie Mae) and the Federal Home Loan
Mortgage Corporation (Freddie Mac).

GAO noted that: (1) HUD adopted a generally conservative approach in
1995 to setting the final enterprise housing goals for 1996 through 1999
that placed a high priority on maintaining the enterprises' financial
soundness; (2) Fannie Mae and Freddie Mac were in compliance with the
final housing goals in 1996 and 1997, according to data the enterprises
submitted to HUD; (3) GAO also concluded that there are several
weaknesses in HUD's mission oversight that need to be addressed; and (4)
specifically: (a) HUD has not implemented a program to assess the
accuracy of the enterprises' housing goal-compliance data; (b) HUD's
research agenda does not address several issues necessary to fully
understand the extent to which the housing goals promote housing
opportunities; and (c) HUD 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.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-GGD-98-177
     TITLE:  Federal Housing Enterprises: HUD's Implementation of Its 
             Mission Oversight Needs to Be Strengthened
      DATE:  07/30/98
   SUBJECT:  Mortgage programs
             Mortgage loans
             Federal aid for housing
             Government sponsored enterprises
             Program evaluation
             Housing programs
             Financial management

             
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Cover
================================================================ COVER


Before the Subcommittee on Capital Markets,
Securities and Government Sponsored Enterprises,
Committee on Banking and Financial Services,
House of Representatives

For Release on Delivery
Expected at
10:00 a.m., EDT
on Thursday
July 30, 1998

FEDERAL HOUSING ENTERPRISES -
HUD'S IMPLEMENTATION OF ITS
MISSION OVERSIGHT NEEDS TO BE
STRENGTHENED

Statement of Nancy Kingsbury
Assistant Comptroller General
General Government Division

GAO/T-GGD-98-177

GAO/GGD-98-177t


(233575)


Abbreviations
=============================================================== ABBREV

  HUD -
  GAO -
  OFHEO -

FEDERAL HOUSING ENTERPRISES: 
HUD'S IMPLEMENTATION OF ITS
MISSION OVERSIGHT NEEDS TO BE
STRENGTHENED
====================================================== Chapter Summary

In a recently issued report, GAO assessed the Department of Housing
and Urban Development's (HUD) implementation of its housing mission
oversight responsibilities for Fannie Mae and Freddie Mac-(the
enterprises)-the two largest government sponsored enterprises.  GAO
found that HUD had adopted a conservative approach to setting housing
goals that require the enterprises to purchase mortgages serving low-
and moderate-income borrowers and those who live in central cities
and rural areas (targeted groups).  GAO also identified several
weaknesses in HUD's enterprise housing mission oversight activities
that need to be addressed. 

Among its other provisions, the Federal Housing Enterprises Financial
Safety and Soundness Act of 1992 required HUD to develop numeric
housing goals for the enterprises to promote housing opportunities
for targeted groups.  In 1995, HUD adopted a conservative approach to
setting the final housing goals for 1996 through 1999 that placed a
high priority on maintaining the enterprises' financial soundness. 
HUD's final housing goals represented a modest increase in the
enterprises' existing commitment to targeted mortgage purchases and
are not expected to generate significant financial losses, even
during periods of severe economic stress.  During 1996 and 1997, both
enterprises complied with the housing goals. 

GAO also recommended that HUD take the following actions to
strengthen its housing mission oversight: 

1.  Develop and implement a program to assess the accuracy of the
enterprises' reported housing goal compliance data. 

2.  Conduct further research to determine the extent to which the
implementation of the housing goals is promoting housing
opportunities.  For example, determine whether the housing goals have
provided mortgage lenders with incentives to lower mortgage interest
rates for targeted groups. 

3.  Implement a process and obtain the necessary expertise to ensure
that the enterprises' sophisticated financial activities are
consistent with their housing mission. 

Finally, GAO recommended that HUD estimate the costs of its mission
oversight requirements and consider proposing to Congress that the
enterprises bear these costs to help ensure effective oversight. 


FEDERAL HOUSING ENTERPRISES: 
HUD'S IMPLEMENTATION OF ITS
MISSION OVERSIGHT NEEDS TO BE
STRENGTHENED
==================================================== Chapter Statement

Mr.  Chairman and Members of the Subcommittee: 

We are pleased to be here today to discuss 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 (the enterprises).  HUD has a basic oversight
responsibility to ensure that the enterprises' mortgage purchase
activities serve the credit needs of all Americans and that the
enterprises' financial activities are consistent with their housing
mission. 

In 1992, Congress concluded that HUD's regulatory framework had not
been effective in ensuring that the enterprises' activities benefit
low- and moderate-income Americans and those who live in underserved
areas, such as central cities and rural communities (targeted
groups).  Consequently, Congress passed the Federal Housing
Enterprises Financial Safety and Soundness Act of 1992\1

(the 1992 Act).  The 1992 Act required HUD to develop, implement, and
enforce a comprehensive housing mission regulatory framework
established by Congress.  Among other provisions, the 1992 Act
directed HUD to set housing goals, which require the enterprises to
meet specified criteria each year for the purchase of mortgages
serving targeted groups. 

At your request, we recently issued a report\2 on HUD's
implementation of its enterprise housing mission oversight
responsibilities under the 1992 Act.  We concluded that (1) HUD
adopted a generally conservative approach in 1995 to setting the
final enterprise housing goals for 1996 through 1999 that placed a
high priority on maintaining the enterprises' financial soundness,
and (2) Fannie Mae and Freddie Mac were in compliance with the final
housing goals in 1996 and 1997, according to data the enterprises
submitted to HUD.  We also concluded that there are several
weaknesses in HUD's mission oversight that need to be addressed. 
Specifically,

  -- HUD has not implemented a program to assess the accuracy of the
     enterprises' housing goal-compliance data;

  -- HUD's research agenda does not address several issues necessary
     to fully understand the extent to which the housing goals
     promote housing opportunities; and

  -- HUD 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. 


--------------------
\1 P.L.  102-550, Title XIII, 106 Stat 3672 (1992). 

\2 Federal Housing Enterprises:  HUD's Mission Oversight Needs to Be
Strengthened (GAO/GGD-98-173, July 28, 1998). 


   CONGRESS HAS ESTABLISHED A
   COMPREHENSIVE ENTERPRISE
   HOUSING MISSION REGULATORY
   FRAMEWORK
-------------------------------------------------- Chapter Statement:1

Under their federal charters, the enterprises are responsible for
serving the secondary mortgage market credit needs of targeted
groups.  The enterprises also receive benefits from their
relationship with the federal government to assist in meeting their
housing mission.  The most important of these benefits allows the
enterprises to borrow money at lower interest rates than comparable
private corporations.  Given their federal charters and financial
benefits, Congress concluded in the 1992 Act that the enterprises had
a responsibility to reach out and meet the credit needs of targeted
groups.  Thus, the act directed the HUD Secretary to develop numeric
housing goals for each enterprise in the following three categories: 

  -- housing for low- and moderate-income\3 families;

  -- housing located in central cities, rural areas, and other
     underserved areas; and

  -- special affordability goals that target mortgage purchases
     serving very-low-income and low-income families living in
     low-income areas. 

The 1992 Act also defined HUD's general regulatory and new mortgage
program\4 approval authorities.  HUD has the general regulatory
authority to ensure that the enterprises' activities are consistent
with their housing mission.  HUD also has the authority to review new
mortgage programs proposed by the enterprises to ensure that the
programs are consistent with the enterprises' charters and not
contrary to the public interest. 


--------------------
\3 The government defines households whose incomes do not exceed an
area's median family income as moderate income and households whose
incomes do not exceed 80 percent of an area's median family income as
low income.  The government defines households whose income does not
exceed 60 percent of an area's median family income as very-low
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. 


   HUD'S APPROACH TO SETTING THE
   FINAL ENTERPRISE HOUSING GOALS
   WAS CONSERVATIVE
-------------------------------------------------- Chapter Statement:2

The 1992 Act provided the HUD Secretary with the authority to set the
final housing goals.  When setting the final housing goals for 1996
through 1999, the HUD Secretary adopted a conservative approach that
emphasized protecting the enterprises' financial soundness.  The
enterprises are reportedly in compliance with the goals, but HUD has
not taken sufficient steps to verify the reported data. 


      HUD SET CONSERVATIVE HOUSING
      GOALS
------------------------------------------------ Chapter Statement:2.1

The 1992 Act established six general, but potentially competing,
factors to guide the HUD Secretary's decisionmaking process in
setting the final housing goals.  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.  These factors may be in
competition with one another because requiring the enterprises to
significantly increase their purchases of targeted mortgages could
result in additional credit losses.\5

During our work, we found that HUD had adopted a conservative
approach to setting the final housing goal rule that placed a high
priority on maintaining the enterprises' financial soundness.  The
following summarizes our findings: 

  -- HUD defined the term "lead the industry" to mean that the
     enterprises should provide technical and financial assistance to
     mortgage lenders to encourage additional mortgage lending to
     targeted borrowers, rather than adopting alternative definitions
     that could have required the enterprises to substantially
     increase their targeted mortgage purchases; and

  -- HUD and the Office of Federal Housing Enterprise Oversight
     (OFHEO)--an independent HUD office responsible for ensuring the
     financial soundness of the enterprises--conducted research that
     found that the required targeted mortgage purchases under the
     final housing goals were modest and would not materially affect
     the enterprises' financial condition. 

Table 1 provides HUD's housing goals for 1996 through 1999.  We note
that HUD set the goals below HUD's estimates of targeted mortgage
lending that was already occurring in the primary mortgage market. 



                                Table 1
                
                 Enterprise Housing Goals for 1996-1999
                 and HUD's Estimates of Primary Market
                                Shares.

                                      Percentage goal\a
                                      ------------------
                                                             Estimated
                                                          originations
                                                   1997-    in primary
Goal category                             1996      1999      market\b
------------------------------------  --------  --------  ------------
Low-and moderate-income                    40%       42%        48-52%
Underserved areas                           21        24         25-28
Special affordability                       12        14         20-23
----------------------------------------------------------------------
\a 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.  Assuming an
enterprise purchased mortgages containing 1 million dwelling units in
a particular year, and that 400,000 of these units qualified under
the low- and moderate-income goal, the enterprise's goal compliance
would be 40 percent (400,000/1,000,000). 

\b In 1995, HUD estimated the percentage of dwelling units financed
by targeted mortgages originated by banks, thrifts, and mortgage
bankers in the primary mortgage market for each housing goal. 

Source:  HUD. 


--------------------
\5 Credit losses result from borrower defaults and associated
foreclosure expenses. 


      ENTERPRISE TARGETED MORTGAGE
      PURCHASE ACTIVITY INCREASED
      BETWEEN 1993 AND 1997
------------------------------------------------ Chapter Statement:2.2

According to annual data that Fannie Mae and Freddie Mac provide 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 (see table 2).  Fannie Mae's performance under
the housing goals has generally exceeded that of Freddie Mac. 



                                Table 2
                
                Enterprise Mortgage Purchases Under the
                Affordable Mortgage Housing Goals, 1993-
                                  1997

                 Enterpri
                 se         1993   1994   1995   1996       1997
Goal Category    --------  -----  -----  -----  -----  ---------------
Low-and          Fannie    34.1%  45.1%  42.8%  45.1%       45.5%
 moderate-        Mae
 income
 households
                 Freddie    30.0   38.0   39.6   41.3       42.9
                  Mac
Underserved      Fannie     22.9   29.0   31.2   28.2       29.0
 areas            Mae
                 Freddie    21.3   24.2   25.2   25.0       26.3
                  Mac
Special          Fannie     10.0   16.7   15.8   17.4       19.1
 affordable       Mae
                 Freddie     7.2   11.4   13.2   14.2       15.3
                  Mac
----------------------------------------------------------------------
Source:  HUD. 

HUD's housing goals may have contributed to the enterprises' reported
increases in targeted mortgage purchases.  However, other factors,
such as a generally growing U.S.  economy, favorable mortgage
interest rates, and a strong housing market also likely played a
role. 


      HUD HAS NOT VERIFIED THE
      ENTERPRISES' GOAL COMPLIANCE
      DATA
------------------------------------------------ Chapter Statement:2.3

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 resulting potential for error, it may therefore not
be possible for HUD at this time to independently draw conclusions
about the accuracy of the data.  In our report,\6

we recommend that HUD--consistent with available resources--develop
and implement a program to assess the accuracy of the goal compliance
data. 


--------------------
\6 GAO/GGD-98-173, July 28, 1998. 


   HUD'S RESEARCH AGENDA DOES NOT
   ADDRESS SEVERAL ISSUES THAT ARE
   ESSENTIAL TO UNDERSTANDING THE
   GOALS' EFFECTS
-------------------------------------------------- Chapter Statement:3

HUD has a basic oversight responsibility to try to determine the
extent to which the housing goals are meeting the intent of the 1992
Act (i.e., promoting housing affordability and opportunities for
targeted groups).  Such research is essential for HUD to determine
the appropriate levels at which to set the housing goals in the
future.  HUD has ongoing research to assess the goals' effects, but
the research agenda does not fully address several essential issues,
such as the goals' effects on mortgage terms for targeted groups and
the multifamily mortgage finance market. 


      HUD RESEARCH DOES NOT ASSESS
      GOALS' EFFECTS ON MORTGAGE
      LOAN TERMS
------------------------------------------------ Chapter Statement:3.1

HUD's reported data on the enterprises' compliance with the housing
goals are input measures that show the annual volumes of the
enterprises' targeted loan purchases.  The reported data do not
provide information on the extent to which the enterprises' increased
purchases are resulting in increased home ownership and housing
opportunities 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, in September 1997, HUD awarded 11
research grants totaling about $400,000 to study the mortgage
purchase activities of the enterprises. 

However, HUD's research agenda does not address the extent to which
the housing goals provide lenders with incentives to make mortgage
credit more affordable to targeted groups.  For example, in theory,
the additional liquidity associated with increased enterprise
purchases to meet the housing goals should lower lenders' costs on
qualifying loans, which then can be passed on in the form of lower
mortgage interest rates.  We recommend in our July 28 report that HUD
include in its research agenda the effect of the housing goals on
mortgage interest rates and other loan terms for targeted groups. 


      HUD HAS NOT ADEQUATELY
      ANALYZED MULTIFAMILY
      PURCHASE ACTIVITIES
------------------------------------------------ Chapter Statement:3.2

For an enterprise that is not in compliance with the housing goals,
HUD's final goal rule may provide regulatory incentives, especially
with regard to multifamily housing, to employ risk-management
strategies to help the enterprise meet or exceed the numeric goals. 
However, the possible enhancing effects of these risk-management
strategies on 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 estimated future losses that may occur due to
borrower defaults.  One reason that the enterprises employ these
risk-management strategies is that multifamily mortgage purchases are
considered riskier than single-family mortgage purchases.  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 that suggests 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 limit 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.  We recommend
in our report that HUD conduct further research on enterprise
risk-management strategies and their effects on multifamily mortgage
finance and housing opportunities. 


   HUD LACKS FOCUS AND EXPERTISE
   AS A FINANCIAL REGULATOR
-------------------------------------------------- Chapter Statement:4

Although HUD's staff have significant expertise in housing and
related issues, we have identified weaknesses in HUD's capacity and
focus as a regulator of financial institutions.  We note that
Congress reached similar conclusions when it passed the 1992 Act. 
The fact that HUD's enterprise oversight budget is financed through
congressional appropriations of taxpayer dollars rather than
assessments on the enterprises may be one reason for HUD's lack of
focus on financial regulatory issues. 


      HUD DID NOT ACT IN A TIMELY
      MANNER TO MONITOR ENTERPRISE
      NONMORTGAGE INVESTMENTS
------------------------------------------------ Chapter Statement:4.1

In our March 1998 report,\7 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.\8

HUD did not act on its general regulatory authority until 1997 when a
public controversy erupted over the fact that Freddie Mac had
invested in long-term Phillip Morris corporate bonds.  In 1997, HUD
initiated a process to oversee the enterprises' nonmortgage
investments, which has the potential to ensure more effective
oversight.  However, HUD has not yet fully implemented this process,
and we believe it should continue to do so as expeditiously as
possible. 


--------------------
\7 Government-Sponsored Enterprises:  Federal Oversight Needed for
Nonmortgage Investments (GAO/GGD-98-48, Mar.  11, 1998). 

\8 We defined the term "arbitrage" to mean that the enterprises use
their funding advantage from government sponsorship to raise funds
for making certain nonmortgage investments. 


      HUD LACKS EXPERTISE IN
      FINANCIAL PRODUCTS
------------------------------------------------ Chapter Statement:4.2

Since the passage of the 1992 Act, HUD has approved the four
enterprise new mortgage programs that have been proposed.  As
required by the act, HUD approved each of these programs within a
45-day deadline.  However, in our March 1998 report, we noted that in
1997 HUD staff who reviewed Fannie Mae's Mortgage Protection Plan
(MPP) proposal 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. 
We recommended that HUD ensure that it has sufficient
expertise--either inhouse or contract--to monitor the enterprises'
financial activities. 


      HUD MAY LACK ADEQUATE
      RESOURCES FOR EFFECTIVE
      OVERSIGHT
------------------------------------------------ Chapter Statement:4.3

Unlike other federal regulators that have housing enterprise
oversight responsibilities,\9 such as OFHEO, HUD's mission oversight
expenditures are funded through congressional appropriations of
taxpayer dollars rather than assessments on the regulated entities. 
As a result, HUD's mission oversight responsibilities necessarily
compete with and are constrained by other HUD priorities in a budget
environment of declining resources. 

In previous reports,\10 we have commented that regulatory costs
should be borne by the respective federal housing enterprises to
ensure safety and soundness as well as effective housing mission
oversight.  For example, HUD's capacity to obtain the expertise to
monitor the enterprises' financial activities may be limited,
particularly since HUD's traditional housing research focus may
continue to command a significant share of the Department's available
resources.  We recommended in our most recent report\11

that HUD collect data on the costs necessary to effectively oversee
the enterprises and propose to Congress that the enterprises be
assessed these costs. 


--------------------
\9 OFHEO's safety and soundness activities--about $15 million in
fiscal year 1997--are financed by assessments on the enterprises. 
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. 

\10 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). 

\11 GAO/GGD-98-173, July 28, 1998. 


   CONCLUSIONS
-------------------------------------------------- Chapter Statement:5

The 1992 Act established a comprehensive regulatory framework for HUD
to ensure that the enterprises complied with their housing mission. 
In 1995, HUD set conservative housing goals that were intended to
ensure the enterprises' financial soundness, and the enterprises have
reportedly complied with these goals.  However, there is little
information currently available on the extent to which the housing
goals promote housing opportunities.  We made several recommendations
in our recent report to strengthen HUD's mission oversight, enhance
its resources, and determine the effects of the housing goals. 

Over the years, we have recommended the creation of a single
regulator to be in charge of mission and safety and soundness
oversight for the enterprises and the Federal Home Loan Bank System. 
Last year, we completed a report\12 on OFHEO's financial soundness
oversight efforts, and we have just issued a report\13 addressing
OFHEO's progress in meeting our recommendations.  Our work on HUD's
mission oversight highlights the challenges the Department faces in
becoming an effective regulator of financial institutions.  OFHEO and
HUD are two agencies that generally operate independently of one
another.  We believe that this separation results in a fragmented
approach to regulation that does not adequately consider the
relationships between housing mission and financial soundness
objectives, including the potential trade-offs.  We also continue to
support the creation of a single regulator for federal housing
enterprises to ensure coherent and effective regulation. 


--------------------
\12 Federal Housing Enterprises:  OFHEO Faces Challenges in
Implementing a Comprehensive Oversight Program (GAO/GGD-98-6, Oct. 
22, 1997). 

\13 OFHEO's Progress in Implementing a Comprehensive Oversight
Program for Fannie Mae and Freddie Mac (GAO/GGD-98-182R, July 29,
1998). 


------------------------------------------------ Chapter Statement:5.1

Mr.  Chairman, this concludes my statement.  My colleagues and I
would be pleased to respond to any comments that you may have. 


*** End of document. ***