GSEs: Recent Trends and Policy Issues (Testimony, 07/16/97,
GAO/T-OCE/GGD-97-76).

Congress originally created government-sponsored enterprises (GSE) to
enhance the credit available to home buyers, farmers, students, and
colleges. Congress established GSEs as federally chartered, but
privately owned and operated corporations, limited their activities to
economic sectors deemed worthy of public support, and gave them certain
advantages to help accomplish their missions. Today, the outstanding
volume of federally assisted GSE credit is large and rapidly increasing.
The volume of GSE credit more than doubled, to almost $1.8 trillion,
between 1990 and 1996, and has steadily increased as a percentage of the
total credit outstanding in the economy. By contrast, the share of total
net credit accounted for by federal direct and guaranteed loans has
declined substantially. Because GSEs involve significant risks and
potential costs to taxpayers, GAO has done several major evaluations of
the effectiveness of various GSE regulators and has developed criteria
to judge the effectiveness of regulation as well as criteria that
policymakers could use to evaluate proposals to expand the types of
products or services that GSEs currently offer.

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

 REPORTNUM:  T-OCE/GGD-97-76
     TITLE:  GSEs: Recent Trends and Policy Issues
      DATE:  07/16/97
   SUBJECT:  Government sponsored enterprises
             Farm credit
             Federal corporations
             Lending institutions
             Mortgage programs
             Government guaranteed loans
             Privatization
             Regulatory agencies
             Credit
IDENTIFIER:  Farm Credit System
             
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Cover
================================================================ COVER


Before Subcommittee on Capital Markets, Securities and Government
Sponsored Enterprises, House Committee on Banking and Financial
Services, and Subcommittee on Government Management, Information and
Technology, House Committee on Government Reform and Oversight

For Release on Delivery
Expected at
2:00 p.m.  EDT
on Wednesday
July 16, 1997

GSES - RECENT TRENDS AND POLICY

Statement of James L.  Bothwell
Chief Economist

GAO/T-OCE/GGD-97-76

GAO/OCE-97-76T


(972628)


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

  HUD - x
  OFHEO - x
  FHFB - x
  GSE - x
  MBS - x
  FIRREA - x
  FAC - x
  FCS - x
  FHA - x
  VA - x

============================================================ Chapter 0

Mr.  Chairmen and Members of the Committees: 

We are pleased to be here today to discuss the large and growing role
of government-sponsored enterprises (GSEs) in the nation's credit
markets.  As you are aware, Congress originally created GSEs to
enhance the credit available to homebuyers, farmers, students and
colleges.  Congress established GSEs as federally chartered, but
privately owned and operated corporations, limited their activities
to certain economic sectors deemed worthy of public support, and gave
them certain advantages to help accomplish their public purposes.\1
Today, the outstanding volume of federally assisted GSE credit is
large and rapidly increasing.  As shown in Figure 1, Appendix I, the
volume of GSE credit more than doubled between 1990 and 1996, from
$874 billion to almost $1.8 trillion, and is now almost double the
outstanding amount of credit made available through all federal
direct loan and federal loan guarantee programs combined.  As shown
in Figure 2, Appendix I, GSE credit has also steadily increased as a
percentage of the total net credit outstanding in our economy,\2

from less than 2 percent in 1970 to over 12 percent in 1996.  By
contrast, the share of total net credit accounted for by federal
direct and guaranteed loans has declined substantially over this
period from almost 13 percent in 1970 to less than 7 percent in 1996. 

As shown in Figure 3, Appendix I, 95 percent of total outstanding GSE
credit in 1996 was housing related, with the remaining 5 percent
going for agricultural and educational purposes.  In recent years,
housing has also been the only sector where GSE credit has been
growing as a percentage of the total available credit outstanding. 
In particular, as shown in Figure 4, Appendix I, the two largest
housing GSEs, Fannie Mae and Freddie Mac, have increased their share
of total residential mortgage debt from 23 percent in 1990 to over 37
percent in 1996.\3 By contrast, as shown in Figure 5, Appendix I, the
share of farm credit supplied by the Farm Credit System, the largest
agricultural GSE, actually declined between 1985 and 1995.  And
Congress passed legislationin 1996 that allowed the two education
GSEs -- Sallie Mae and ConnieLee -- to end their government
sponsorship and become fully private corporations. 

While the legal powers, organizational structures, and operating
styles of GSEs differ, they have several common characteristics.  For
example, each GSE was chartered by Congress to help achieve a
particular public purpose, each is privately owned and operated, and
each operates under certain restrictions and obligations which would
not apply to a completely private corporation.  Each GSE was also
given certain explicit advantages -- such as exemptions from state
and local corporate income taxes, lines of credit with the Treasury
Department, or exemptions from SEC registration requirements and fees
-- to help achieve its public purpose.  The most important benefit
that GSEs receive from their government sponsored status, however, is
an implicit one stemming from investors' perceptions that the federal
government would not allow a GSE to default on its obligations. 
Although GSE obligations are not obligations of the United States
Government, the lower perceived risk of holding GSE obligations
allows GSEs to borrow at rates lower than comparably creditworthy
private corporations that do not enjoy federal sponsorship.  In our
recent statement on the potential impacts of privatizing Fannie Mae
and Freddie Mac, we estimated that this funding advantage saved the
two GSEs from about $2 billion to $8 billion in 1995.\4

Because of their federal sponsorship, GSEs also involve significant
risks and potential costs to taxpayers, including the risk that
taxpayers could be potentially liable for a GSE's obligations if it
were to get into financial difficulty.  In 1987, Congress did in fact
authorize $4 billion in financial assistance to the Farm Credit
System when it experienced financial stress.\5 Limited financial and
regulatory relief was also provided to Fannie Mae when it suffered
losses of $277 million between 1981 and 1984.\6

The special nature of GSEs, and the potential taxpayer exposure to
large, rapidly increasing GSE financial obligations, raises several
important policy issues, including the adequacy of GSE regulation,
the potential for expansion of GSE activities, and potential ways to
limit GSE exposures.  Over the past few years, we have performed
several major evaluations of the effectiveness of the various GSE
regulators.\7 Based on our reviews, we developed the following five
criteria for an effective GSE regulator: 

  -- objectivity and arm's length status from the GSE,

  -- prominence in government,

  -- consistency in regulation of similar markets,

  -- separation of primary and secondary market regulation, and

  -- economy and efficiency. 

Although Congress has enacted some recent legislative changes to
strengthen and improve regulatory oversight of GSEs, our work has
shown that none of the three housing GSE regulators -- the Office of
Federal Housing Enterprise Oversight (OFHEO), the Department of
Housing and Urban Development (HUD), nor the Federal Housing Finance
Board (FHFB)-- meets all five of our criteria.  In 1993 we
recommended that OFHEO and the FHFB be merged to better meet these
criteria and our ongoing work continues to support merging the
housing GSE regulators and making one agency responsible for both GSE
safety and soundness and mission compliance. 

Based on our work, we have also developed several criteria that
policymakers could use to evaluate proposals to expand the types of
products or services that existing GSEs currently offer.\8 Under
these criteria, any new GSE product or service should: 

  -- add value and be consistent with the GSE's public mission,

  -- be properly priced to reflect risk,

  -- be within the GSE's area of expertise, and

  -- avoid competing with products and services offered by fully
     private companies or member institutions. 

Because GSEs have been given the advantages of federal sponsorship to
achieve particular public purposes, we believe that any proposals to
significantly expand their existing activities should be required to
meet these, or similarly rigorous, criteria before they are approved. 

Finally, we have also done work addressing ways that Congress might
limit the taxpayers' potential exposure to GSE obligations.  One
obvious way to do this is to end their federal sponsorship.  As I
mentioned at the beginning of my statement, Congress passed
legislation last year that would make two of the GSEs -- Sallie Mae
and Connie Lee -- fully private entities.  In 1996, we, along with
the Treasury Department, HUD, and the Congressional Budget Office,
produced reports that analyzed the potential impacts of privatizing
the two largest GSEs -- Fannie Mae and Freddie Mac.\9 While taking
such action could eliminate taxpayers' risk exposure to these GSEs,
it would also have major impacts on housing finance markets,
including a likely increase in mortgage interest rates for certain
borrowers.  Our report also discussed some more limited policy
options that would reduce the level of taxpayers' risk exposure to
these two GSEs, such as imposing "user fees" or greater restrictions
on their housing finance activities.  As with privatization, however,
each of the options that we presented had benefits, risks, and
trade-offs that would need to be considered and weighed carefully. 

Mr.  Chairmen, this concludes my prepared statement, and we would be
happy to respond to any questions that you or other members of the
committees may have. 


--------------------
\1 Appendix II provides more details on the creation and operations
of each of the major GSEs.  Appendix III provides a list of related
GAO products. 

\2 Total net credit outstanding in the economy includes debt owed by
all domestic sectors except financial intermediaries, which are
omitted to avoid double counting. 

\3 Specifically, of the $3.0 trillion in outstanding mortgage debt at
the end of fiscal year 1990, 12.5 percent was in Fannie Mae's
portfolio or its guaranteed mortgage pools, while 10.7 percent was in
Freddie Mac's portfolio or mortgage pools.  By the end of fiscal year
1996, Fannie Mae's share of the $4.1 trillion in outstanding mortgage
debt had increased to 22.5 percent, while Freddie Mac's share had
risen somewhat less, but still by a substantial amount, to 14.6
percent.  During this period, the share of total outstanding mortgage
credit supplied by the Federal Home Loan Bank System actually
declined from 3.9 percent to 3.7 percent. 

\4 Housing Enterprises:  Potential Impacts of Severing Government
Sponsorship, GAO/T-GGD-96-134, June 12, 1996. 

\5 Farm Credit System:  Repayment of Federal Assistance and
Competitive Position, GAO/GGD-94-39, March 10, 1994. 

\6 Housing Enterprises:  Potential Impacts of Severing Government
Sponsorship, GAO/GGD-96-120, May 13, 1996. 

\7 Government-Sponsored Enterprises:  A Framework for Limiting the
Government's Exposure to Risks, GAO/GGD-91-90, May 22, 1991;
Government-Sponsored Enterprises:  The Government's Exposure to
Risks, GAO/GGD-90-97, Aug.  15, 1990; FHLBank System:  Reforms Needed
to Promote Its Safety, Soundness, and Effectiveness,
GAO/T-GGD-95-244, Sept.  27, 1995; Government-Sponsored Enterprises: 
Development of the Federal Housing Enterprise Financial Regulator,
GAO/GGD-95-123, May 30, 1995; Farm Credit System:  Farm Credit
Administration Effectively Addresses Identified Problems,
GAO/GGD-94-14, Jan.  7, 1994; Federal Home Loan Bank System:  Reforms
Needed to Promote Its Safety, Soundness, and Effectiveness,
GAO/GGD-94-38, Dec.  8, 1993; Improved Regulatory Structure and
Minimum Capital Standards are Needed for Government-Sponsored
Enterprises, GAO/T-GGD-91-41, June 11, 1991. 

\8 See, in particular, Federal Home Loan Bank System:  Reforms Needed
to Promote Its Safety, Soundness, and Effectiveness, GAO/GGD-94-38,
Dec.  8, 1993. 

\9 Housing Enterprises:  Potential Impacts of Severing Government
Sponsorship, GAO/GGD-96-120, May 13, 1996; Assessing the Public Costs
and Benefits of Fannie Mae and Freddie Mac, Congressional Budget
Office, May 1996; Government Sponsorship of the Federal National
Mortgage Association and the Federal Home Loan Mortgage Corporation,
United States Department of the Treasury, July 11, 1996; Studies on
Privatizing Fannie Mae and Freddie Mac, May 1996, and Privatization
of Fannie Mae and Freddie Mac:  Desirability and Feasibility, July
1996, United States Department of Housing and Urban Development. 


=========================================================== Appendix I



   (See figure in printed
   edition.)

   Source:  U.S.  Budget with GAO
   adjustment for Sallie Mae's
   holdings of guaranteed loans.

   (See figure in printed
   edition.)



   (See figure in printed
   edition.)

   Source:  U.S.  Budget & Federal
   Reserve Board

   (See figure in printed
   edition.)



   (See figure in printed
   edition.)

   Source:  U.S.  Budget, FY 1998

   (See figure in printed
   edition.)



   (See figure in printed
   edition.)

   Source:  U.S.  Budget & Federal
   Reserve Bulletin

   (See figure in printed
   edition.)



   (See figure in printed
   edition.)

   Source:  U.S.  Budget, FY 1998

   (See figure in printed
   edition.)


========================================================== Appendix II


      HOUSING GSES
------------------------------------------------------ Appendix II:0.1

The two major housing GSEs--Fannie Mae and Freddie Mac--were both
created to improve the operations and efficiency of the housing
credit markets.  Although they were created in different
circumstances and have operated differently, their charters and
methods of operations have become much more similar. 

Fannie Mae was first created in 1938 as a government-held association
to buy FHA, and later VA and conventional, loans from originators,
primarily mortgage banks, with funds raised by selling bonds.  The
initial goals of the program were to support the development of a
national mortgage market and to improve liquidity through the
creation of a resale market for mortgage loans.  In the 1950s,
Congress began the process of shifting Fannie Mae to private
ownership.  This was to be accomplished by requiring each mortgage
seller to purchase a certain amount of common stock based on the
amount of loans it sold to Fannie Mae, which would allow the gradual
retirement of preferred stock owned by the Treasury Department. 

The Housing and Urban Development Act of 1968 completed the
transformation of Fannie Mae into a government-sponsored enterprise. 
The act separated Fannie Mae into two separate components.  One
component, Ginnie Mae, remained in HUD to provide support to FHA, VA,
and special assistance programs.  The other part was the
government-sponsored, privately owned, for-profit Federal National
Mortgage Association, which was to be concerned exclusively with
attracting funding into residential mortgages.  To accomplish this
purpose, Fannie Mae used funds raised by selling bonds to purchase
mortgage loans from originators and held them in its own portfolio. 

Congress chartered Freddie Mac in 1970 in reaction to the loss of
deposits in the savings and loan industry that was curtailing that
industry's ability to fund and originate home mortgages.  Its
creation ensured that the savings and loan industry had access to
funds to continue to fund mortgages.  In comparison to Fannie Mae,
Freddie Mac did not hold mortgages in its portfolio, but created
mortgage-backed securities (MBS) and sold them to investors. 
However, Freddie Mac guaranteed timely interest and principal
payments on these securities. 

In the early 1980s, Fannie Mae and Freddie Mac experienced different
financial results as short-term interest rates increased.  Because
Fannie Mae was funding the mortgages in its portfolio with short-term
debt, sharp short term rate increases meant that the interest earned
on the old mortgages in its portfolio was less than interest expenses
on the newly issued debt.  As a result, Fannie Mae experienced total
losses of about $277 million between 1981 and 1984.  In response to
Fannie Mae's financial problems, the federal government provided
limited tax relief and regulatory forbearance in the form of relaxed
capital requirements.  Freddie Mac's different method of operations
meant that investors, and not Freddie Mac, bore the risks of changing
interest rates.  To avoid future losses from interest rate changes,
Fannie Mae partially adopted Freddie Mac's strategy of issuing MBS
and shifting the interest rate risk to investors. 

The activities of Fannie Mae and Freddie Mac have largely converged. 
The effect of the Housing and Community Development Act of 1992,
along with the GSE-related provisions in the Financial Institutions
Reform, Recovery, and Enforcement Act of 1989 (FIRREA), was to make
the charters of Fannie Mae and Freddie Mac substantially the same. 
Both GSEs attempt to smooth the availability of mortgage funds across
time and regions and promote liquidity in the secondary mortgage
market.  In addition to their traditional goal of improving the
functioning of capital markets, the charters of both enterprises now
include distributional goals.  Both Fannie Mae and Freddie Mac have
the additional purpose of providing access to mortgage finance for
low-income families and underserved areas.  A primary difference
between the two GSEs continues to be Fannie Mae's relatively greater
use of debt-financing to hold mortgages in its own portfolio,
although Freddie Mac has increased its portfolio investment share in
recent years. 

The Federal Home Loan Bank System is the third housing-related GSE. 
It was established in 1932 to extend mortgage credit by making loans,
called advances, to its member institutions, who in turn lend to
homebuyers for mortgages.  The System consists of 12 federally
chartered, privately owned FHLBanks that raises funds by issuing
consolidated debt securities in the capital market.  The advances are
secured by home mortgage loans or such other collateral as U.S. 
Treasury securities.  These advances help member institutions,
originally limited to thrifts, by enhancing liquidity and providing
access to national capital markets. 

With the evolution of national mortgage markets and the contraction
of the thrift industry, the original justifications for the Federal
Home Loan Bank System to support housing credit and the thrift
industry have diminished.  Rather than phase down its activities,
Congress allowed the Federal Home Loan Bank System to expand its
membership pool to include commercial banks, which now comprise 65
percent of the members. 


      AGRICULTURAL GSES
------------------------------------------------------ Appendix II:0.2

The largest of the two agriculture GSEs, the Farm Credit System
(FCS), raises money through bond sales and makes loans directly to
farmers.  FCS lends this money to the farming sector through a
network of member-owned cooperatives with the purpose of ensuring a
stable supply of credit to agriculture.  Established in 1916, FCS
became insolvent in the mid-1980s when inadequate interest-rate risk
management and falling land prices depressed the value of collateral
behind FCS credit and created large losses for the institution.  This
necessitated a federal bailout through the FCS Financial Assistance
Corporation (FAC), which injected funds into FCS by issuing $1.261
billion in bonds. 

Unlike direct loans and FCS loans, the other agricultural GSE--Farmer
Mac--operates by promoting a secondary market for agricultural loans. 
Farmer Mac was created in 1987 by the same legislation that provided
for the FCS bailout.  Its purpose was to create and oversee a
secondary market for, and to guarantee securities based on, farm real
estate loans.  However, unlike the GSEs in the housing sector, Farmer
Mac was not able to establish a growing niche in farm credit markets
by guaranteeing farm securities.  As a result of the decline in
Farmer Mac's capital base, the Farm Credit System Reform Act of 1996
expanded its powers.  The 1996 Act transformed Farmer Mac from just a
guarantor of securities formed from loan pools into a direct
purchaser of mortgages in order to form pools to securitize.  The
expanded powers make it more attractive for banks to participate in
Farmer Mac and permit Farmer Mac to act as a pooler.  While the new
powers are intended to boost Farmer Mac's revenues, it is too early
to tell how this will affect Farmer Mac's role in agricultural
credit.  However, as a direct purchaser of loans with no required
subordination, this increased role does have the potential to expose
Farmer Mac to greater credit risk than on guaranteed pools, which
require loan originators or other entities outside the pool to hold a
10-percent subordinated interest in pooled loans. 


      EDUCATION GSES
------------------------------------------------------ Appendix II:0.3

The federal government created two GSEs to increase the availability
of credit in the educational sector.  The largest one, Sallie Mae,
was created in 1972 as a for-profit, shareholder-owned corporation. 
Sallie Mae purchases insured student loans from eligible lenders and
makes secured loans to lenders.  It now holds about one-third of all
outstanding guaranteed student loans.  In 1996 Congress passed
legislation establishing a process for restructuring Sallie Mae and
ultimately terminating its federal government sponsorship. 

The second education GSE, Connie Lee, was created in 1986 to insure
and reinsure the financing of postsecondary education facilities. 
Connie Lee's financial condition has been strong, particularly since
1991, when it obtained the "triple-A" credit rating necessary to
engage in the financial guaranty business as a direct writer of
insurance.  Legislation passed in 1996 privatized Connie Lee by
repealing the corporation's enabling legislation and requiring the
federal government to sell, and Connie Lee to purchase, the
corporation's federally owned stock during fiscal year 1997. 



RELATED GAO PRODUCTS
========================================================= Appendix III

Housing Enterprises:  Investment, Authority, Polices, and Practices,
GAO/GGD-97-137R, June 27, 1997. 

Housing Enterprises:  Potential Impacts of Severing Government
Sponsorship, GAO/T-GGD-96-134, June 12, 1996. 

Housing Enterprises:  Potential Impacts of Severing Government
Sponsorship, GAO/GGD-96-120, May 13, 1996. 

GAO views on the "Federal Home Loan Bank System Modernization Act of
1995", Letter from James L.  Bothwell, Director, Financial
Institutions and Markets Issues, GAO, to the Honorable James A. 
Leach, Chairman, Committee on Banking and Financial Services, U.S. 
House of Representatives, Oct.  11, 1995. 

FHLBank System:  Reforms Needed to Promote Its Safety, Soundness, and
Effectiveness, GAO/T-GGD-95-244, Sept.  27, 1995. 

Housing Finance:  Improving the Federal Home Loan Bank System's
Affordable Housing Program, GAO/RCED-95-82, June 9, 1995. 

Government-Sponsored Enterprises:  Development of the Federal Housing
Enterprise Financial Regulator, GAO/GGD-95-123, May 30, 1995. 

Farm Credit System:  Repayment of Federal Assistance and Competitive
Position, GAO/GGD-94-39, March 10, 1994. 

Farm Credit System:  Farm Credit Administration Effectively Addresses
Identified Problems, GAO/GGD-94-14, Jan.  7, 1994. 

Federal Home Loan Bank System:  Reforms Needed to Promote Its Safety,
Soundness, and Effectiveness, GAO/GGD-94-38, Dec.  8, 1993. 

Improved Regulatory Structure and Minimum Capital Standards are
Needed for Government-Sponsored Enterprises, GAO/T-GGD-91-41, June
11, 1991. 

Government-Sponsored Enterprises:  A Framework for Limiting the
Government's Exposure to Risks, GAO/GGD-91-90, May 22, 1991. 

Government-Sponsored Enterprises:  The Government's Exposure to
Risks, GAO/GGD-90-97, Aug.  15, 1990. 


*** End of document. ***