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Before the Committee on Banking, Housing, and Urban Affairs, U.S. 

United States Government Accountability Office: 

For Release on Delivery: 
Expected at 9:30 a.m. EDT: 
Thursday, October 8, 2009: 

Fannie Mae And Freddie Mac: 

Analysis of Options for Revising the Housing Enterprises’ Long-term 

Statement of William B. Shear, Director: 
Financial Markets and Community Investment: 


Chairman Dodd, Ranking Member Shelby, and Members of the Committee:
I am pleased to be here today to discuss the results of our recently 
issued report on options for restructuring two government-sponsored 
enterprises (GSE): Fannie Mae and Freddie Mac (enterprises).[Footnote 
1] On September 6, 2008, the Federal Housing Finance Agency (FHFA) 
placed Fannie Mae and Freddie Mac in conservatorship out of concern 
that their deteriorating financial condition and potential default on 
$5.4 trillion in financial obligations threatened the stability of 
financial markets. Since then, the Department of the Treasury 
(Treasury) has provided nearly $100 billion to the enterprises, and the 
Congressional Budget Office (CBO) estimated that the total cost of 
Treasury financial assistance will be nearly $400 billion.[Footnote 2] 
Moreover, the Board of Governors of the Federal Reserve System (Federal 
Reserve) has committed to purchasing up to $1.45 trillion in the debt 
and securities of the enterprises (and other entities) to support 
housing finance, housing markets, and financial markets. While the 
conservatorships can remain in place as efforts are undertaken to 
stabilize the enterprises and restore confidence in financial markets, 
FHFA said that the conservatorships were not intended to be permanent. 
Over the longer term, Congress and the executive branch will face 
difficult decisions on how to restructure the enterprises and promote 
housing opportunities while limiting risks to taxpayers and the 
stability of financial markets. 

Congress originally established Fannie Mae and Freddie Mac as 
government entities in 1968 and 1989, respectively, chartering them as 
for-profit, shareholder-owned corporations.[Footnote 3] They share a 
primary mission that has been to stabilize and assist the U.S. 
secondary mortgage market and facilitate the flow of mortgage credit, 
including in periods of economic stress. To accomplish this goal, the 
enterprises issued debt and stock and used the proceeds to purchase 
conventional mortgages (conforming mortgages) that met their 
underwriting standards from lenders such as banks or thrifts.[Footnote 
4] In turn, banks and thrifts used the proceeds to originate additional 
mortgages. The enterprises held some of the mortgages they purchased in 
portfolio, but packaged most into mortgage-backed securities (MBS) sold 
to investors in the secondary mortgage market.[Footnote 5] For a fee, 
the enterprises guaranteed the timely payment of interest and principal 
on MBS that they issued. Charter requirements for providing assistance 
to the secondary mortgage markets also specify that those markets are 
to include mortgages on residences for low- and moderate-income 
families (targeted groups). In 1992, Congress instituted authority for 
requiring the enterprises to meet numeric goals set by the Department 
of Housing and Urban Development (HUD) annually for the purchase of 
single- and multifamily mortgages that serve targeted groups. 

While the enterprises operated profitably for many years, their 
structures long have been in question. For example, critics questioned 
the extent to which private for-profit corporations could be expected 
to serve a federally mandated housing mission. Furthermore, critics 
stated that federal sponsorship conveyed certain financial and other 
advantages that encouraged them to engage in riskier activities than 
otherwise would be the case. In particular, despite the lack of an 
explicit government guarantee on enterprise debt and MBS, the 
assumption in financial markets of an “implied” federal guarantee 
enabled the enterprises to borrow at lower rates than other for-profit 
corporations. Critics argued that this implicit guarantee and access to 
less costly credit created a moral hazard, or encouraged the 
enterprises to assume greater risks and hold less capital than would 
have been the case in the absence of a guarantee. 

We initiated our recently issued report—on which my statement is based—
as part of a broader effort to assist Congress in its efforts to 
address the current financial crisis and weaknesses in the U.S. 
financial regulatory system. The report provides Congress with 
information on the roles, benefits, and risks associated with the 
enterprises’ activities and is intended to help inform the forthcoming 
deliberation on their future structures. In my testimony, I will: 

* summarize the enterprises’ performance in achieving key housing 
mission objectives; 

* identify various options for revising the enterprises’ long-term 

* analyze these options in terms of their potential capacity to achieve 
key housing mission and safety and soundness objectives; and; 

* discuss how the federal government’s management of the 
conservatorships and response to the housing crisis could affect any 

To meet our objectives, we reviewed reports, studies, and data on the 
enterprises and their regulation, including our reports, as well as 
proposals to revise their structures. We met with researchers who wrote 
relevant reports on or were knowledgeable about enterprise-related 
issues and with representatives from FHFA, Treasury, the Federal 
Reserve, HUD, the Government National Mortgage Association (Ginnie 
Mae), CBO, the enterprises, banking and mortgage organizations, the 
National Association of Home Builders, and community groups. In 
addition, FHFA provided written comments on a draft of the report. FHFA 
stated that the report is timely and does a good job summarizing the 
dominant proposals for restructuring the enterprises and some of their 
strengths and weaknesses. FHFA also offered key questions and 
principles for guiding initial decisions that will have to be made 
about the future of the mortgage market. 

Enterprises Had a Mixed Record in Achieving Housing Mission Objectives, 
and Risk Management Deficiencies Compromised Their Safety and 

It is generally accepted that the enterprises were successful in 
achieving key housing mission objectives to support the secondary 
mortgage market and facilitate the flow of mortgage credit: (1) We 
reported that the enterprises established a viable mortgage market for 
secondary loans that enabled capital to flow to areas with the greatest 
demand for mortgage credit. (2) The enterprises’ activities have been 
credited with lowering interest rates on qualifying mortgages below 
what they otherwise would have been, although estimates regarding the 
extent of this benefit vary.[Footnote 6] (3) Furthermore, the 
enterprises established underwriting practices and forms for 
conventional mortgages that became standard in the industry, increased 
the efficiency of underwriting, and helped develop the MBS market. 

However, it is not clear to what extent the enterprises have been able 
to support a stable and liquid secondary mortgage market during periods 
of economic stress, which is another key objective. As noted in our 
1996 report, we did not find clear evidence that Fannie Mae’s mortgage 
purchase activities during the 1980s supported mortgage markets in 
certain states that had experienced substantial economic setbacks. 
[Footnote 7] During the current financial crisis, the enterprises have 
provided critical support to mortgage finance as private-sector MBS 
issuance largely collapsed. Yet the enterprises have been able to 
provide this support to mortgage finance only with the substantial 
financial assistance from Treasury and the Federal Reserve discussed 

While the enterprises also were to facilitate mortgage credit 
opportunities for targeted groups, it is not clear that the numeric 
mortgage purchase program materially benefited such groups. HUD 
administered the program from 1992 until the authority was transferred 
to FHFA in 2008. Recent research indicates that, although the 
enterprises have enhanced their product offerings to meet the housing 
goals, the effects of the housing goals on affordability and 
opportunities for targeted groups have been limited. For example, one 
study found that as the enterprises’ activities increased in certain 
areas pursuant to the mortgage purchase program, they may have been 
offset by a decline in FHA’s existing activities in those areas. 
[Footnote 8] Earlier research sponsored by HUD in 2001 found that the 
enterprises generally did not play a leading role in affordable 
multifamily mortgage finance because their underwriting standards were 
considered conservative and fairly inflexible, compared with those of 
other multifamily mortgage providers.[Footnote 9] In contrast, I should 
note that representatives from mortgage finance, housing construction, 
and consumer groups we contacted said that the benefits from enterprise 
purchases of multifamily mortgages were significant. The 
representatives said that the enterprises’ involvement in or guarantees 
of the financing of affordable multifamily projects were crucial to 
their successful completion. In addition, they said that during the 
current financial crisis the enterprises were the only source of 
funding for multifamily projects because many other traditional 
providers, such as banks and insurance companies, largely have 
withdrawn from the market. 

While housing finance may have benefited from the enterprises’ 
activities over the years, GAO, federal regulators, researchers, and 
others long have argued that the enterprises’ structures (for-profit 
corporations with government sponsorship) undermined market discipline 
and provided incentives to engage in potentially profitable but risky 
business practices that did not necessarily support their public 
missions. As examples, 

* We and others raised consistent concerns about rapid growth in the 
enterprises’ retained mortgage portfolios, which reached a combined 
$1.6 trillion by 2005. Although increasing the size of the portfolios 
may have been more profitable than issuing MBS, it exposed the 
enterprises to significant interest rate risk. We reported that the 
rapid increase and the associated interest rate risk did not result in 
a corresponding benefit to the achievement of their housing missions. 

* In 2003 and 2004, the enterprises were found to have manipulated 
accounting rules so that their public financial statements showed 
steadily increasing profits over many years and thereby increased their 
attractiveness to potential investors. The misapplication of accounting 
rules generally involved standards for reporting on derivatives, which 
the enterprises used to help manage interest rate risks associated with 
their large retained portfolios. The enterprises had to restate their 
financial statements and adjust their earnings reports by billions of 

* Finally, beginning in 2004 and 2005, the enterprises purchased a 
large volume of questionable mortgage assets, such as private-label MBS 
and Alt-A mortgages, which typically did not have documentation of 
borrowers’ incomes and had high loan-to-value or debt-to-income ratios. 
According to FHFA, these questionable mortgage assets accounted for 
less than 20 percent of the enterprises’ total assets but represented a 
disproportionate share of credit-related losses in 2007 and 2008. FHFA 
stated that the losses on these assets helped precipitate the 
enterprises’ financial deterioration and resulted in the decision to 
place them in conservatorship in September 2008. 

Options for Restructuring the Enterprises Aim to Achieve Housing 
Mission Objectives while Mitigating Safety and Soundness Risks: 

The enterprises’ mixed records in achieving their housing mission 
objectives and the losses and weaknesses that resulted in the 
conservatorships reinforce the need for Congress and the executive 
branch to fundamentally reevaluate the enterprises’ roles, structures, 
and business activities in mortgage finance. Researchers and others 
believe a range of options could better achieve housing mission 
objectives (in some cases through other federal entities such as FHA), 
help ensure safe and sound operations, and minimize risks to financial 
stability. These options generally fall along a continuum, with some 
overlap among key features, and advocate (1) establishing a government 
corporation or agency, (2) reconstituting the enterprises as for-profit 
GSEs in some form, or (3) privatizing or terminating them (see table 

Table 1: Summary of Options to Revise the Enterprises’ Structures: 

Potential structure: Government corporation or agency; 
Proposed function: Focus on purchasing qualifying mortgages and issuing 
MBS but eliminate mortgage portfolios, which are complex to manage and 
can result in losses due to fluctuations in interest rates. 
Responsibilities for promoting homeownership for targeted groups could 
be transferred to FHA, which insures mortgages for low-income and first-
time borrowers. 

Potential structure: Reestablish for-profit enterprises with government 
Proposed function: Restore the enterprises to their previous status but 
add controls to minimize risk. These controls might include eliminating 
or reducing mortgage portfolios or imposing public utility-type 
regulation, which involves business activity restrictions and 
profitability limits, and establishing executive compensation limits. 
Or, convert the enterprises from publicly traded, shareholder-owned 
corporations to cooperative associations owned by mortgage lenders. 

Potential structure: Privatization or termination; 
Proposed function: Abolish the enterprises and disperse mortgage 
lending and risk management throughout the private sector. Some 
proposals involve the establishment of a federal mortgage insurer to 
help protect mortgage lenders against catastrophic mortgage losses. 

Source: GAO. 

[End of table] 

The following paragraphs summarize key principles and aspects of each 

Government corporation or agency.[Footnote 10] Supporters of these 
proposals maintain that the implied federal guarantee and the 
enterprises’ need to respond to shareholder demands to maximize 
profitability encouraged excessive risk taking and ultimately resulted 
in their failures. They believe that a government entity, which would 
not be concerned about maximizing shareholder value, would best ensure 
the availability of mortgage credit for primary lenders while 
minimizing risks associated with a for-profit structure with government 
sponsorship. Establishing a government corporation or agency also would 
help ensure transparency through appropriate disclosures of risks and 
costs in the federal budget. Elements of the proposals include 
eliminating retained mortgage portfolios over time; establishing sound 
underwriting standards and risk-sharing arrangements with the private 
sector; establishing financial and accountability requirements for 
lenders; instituting consumer protection standards for borrowers; and 
eliminating responsibility for the numeric mortgage purchase program 
(instead, FHA’s mortgage insurance programs would be expanded to 
address this objective). 

Reconstituted GSEs. Market participants and commenters, trade groups 
representing the banking and home construction industries, and 
community and housing advocates we contacted believe that 
reconstituting the enterprises would help ensure that they would remain 
responsive to market developments, continue to produce innovations in 
mortgage finance, and be less bureaucratic than a government agency or 
corporation. But they also advocate a variety of additional regulations 
and ownership structures to help offset the financial risks inherent in 
the for-profit GSE structure, such as substantially downsizing or 
eliminating the enterprises’ mortgage portfolios; breaking up the 
enterprises into multiple GSEs to mitigate safety and soundness and 
financial stability risks; establishing public utility-type regulation 
for the enterprises (for example, limiting their rates of return); and 
converting the enterprises into lender-owned associations (creating 
incentives for mortgage lenders to engage in more prudent underwriting 

Privatization or termination. Some analysts and financial commenters 
contend that privatizing or terminating the enterprises (including 
dispersing key functions among private-sector entities) represents the 
best public policy option.[Footnote 11] Advocates believe that 
privatized entities would align mortgage decisions more closely with 
market factors and that the resultant dispersal of credit and interest 
rate risk would reduce safety and soundness risks. Federal Reserve 
Chairman Ben S. Bernanke has suggested that privatized entities may be 
more innovative and efficient than government entities, and operate 
with less interference from political interests.[Footnote 12] Elements 
of the proposals include introducing a transition period to mitigate 
any potential market disruptions and facilitate the development of a 
new mortgage finance system; and establishing a federal entity to 
provide catastrophic mortgage insurance for lenders and help ensure 
that mortgage markets would continue functioning during stressful 
economic periods.[Footnote 13] 

A Framework for Analyzing Trade-offs Associated with the Options and 
Potential Oversight and Regulatory Structures to Help Ensure Their 
Effective Implementation: 

We sought to assess each restructuring option in terms of its capacity 
to meet key housing objectives (providing liquidity and support to 
mortgage markets and facilitating housing opportunities for targeted 
groups) while also mitigating safety and soundness and financial 
stability risks. Our analysis indicates that each option involves 
important trade-offs, which are summarized in table 2. The table also 
identifies regulatory and oversight structures that might help ensure 
that any option implemented would achieve housing mission and safety 
and soundness objectives. 

Table 2: Trade-offs Associated with Enterprise Reform Options as They 
Relate to Long-Established Enterprise Objectives and Potential 
Oversight Structures: 

Proposed reform option: Government corporation or agency; 
Provide liquidity and support to mortgage markets, including in bad 
economic times: A government entity, with access to Treasury-issued 
debt to fund its operations, may be in a better position to provide 
liquidity to the mortgage market during normal economic periods and 
when capital markets are impaired. However, because in some cases 
investor demand for its MBS may be limited in times of financial 
stress, a government entity that does not have a retained portfolio may 
face challenges supporting mortgage markets during such periods. 
Treasury or the Federal Reserve may have to purchase mortgage assets 
under such circumstances (as has been the case during the current 
disruption in mortgage credit markets).
Support housing opportunities for targeted groups: A government entity 
most likely would be expected to pursue housing opportunity programs 
for targeted groups because of its public status. However, if the 
government entity does not have a retained mortgage portfolio, it may 
face certain challenges in managing a housing goal program, since some 
types of affordable loans, like multifamily loans may be difficult to 
securitize, and therefore, often have been held in portfolio. As 
alternatives, fees could be assessed on the government entity’s 
activities to support housing opportunities for targeted groups or 
FHA’s mortgage insurance programs could be expanded.
Ensure safe and sound operations: This structure may represent less 
risk than has been the case with the GSE structure because MBS issuance 
is less complicated and risky than managing a retained mortgage 
portfolio. However, this activity still would be more complicated than 
Ginnie Mae’s (a government corporation that does not buy or sell loans 
or issue MBS) and could result in substantial taxpayer losses if 
mismanaged. A government corporation could face greater challenges than 
private-sector entities in obtaining the human and technological 
resources needed to manage complex processes or it might lack the 
operational flexibility to do so.
Possible elements of regulatory and oversight structure: Key elements 
for consideration include (1) certain operational flexibilities to 
obtain appropriate staff and information technology to carry out 
responsibilities, (2) risk-sharing agreements with private lenders or 
mortgage insurers, (3) appropriate disclosures in the federal budget of 
risks and liabilities to ensure financial transparency, and (4) robust 
congressional oversight of operations. 

Proposed reform option: Reconstituted GSEs; 
Provide liquidity and support to mortgage markets, including in bad 
economic times: As reconstituted GSEs, the enterprises may provide 
liquidity and other benefits to mortgage finance during normal economic 
times, as they did for many years. However, their ability to provide 
such support during stressful economic periods is questionable given 
current experience. Furthermore, with significantly reduced or 
eliminated retained mortgage portfolios, the capacity of reconstituted 
GSEs to provide support to mortgage markets during periods of economic 
distress also may be limited.
Support housing opportunities for targeted groups: Reconstituted GSEs, 
with their responsibility to maximize profits for their shareholders, 
might find it difficult to support some public policy housing 
initiatives. Moreover, without a retained mortgage portfolio, the 
reconstituted GSEs may face challenges in implementing a numeric 
housing goal purchase program. This challenge could be addressed by 
permitting a reconstituted GSE to maintain a relatively small portfolio 
or by supporting housing opportunities for targeted groups through 
assessments on its activities.
Ensure safe and sound operations: The current financial crisis 
highlights problems with the traditional GSE structure, including 
incentives to increase leverage and maximize portfolios. Reconstituting 
the GSEs would reestablish and might strengthen the incentive problems, 
which could lead to even greater moral hazard and safety and soundness 
concerns and increase systemic risks. Proposals to regulate GSEs like 
public utilities in principle could constrain excessive risk-taking, 
but the applicability of this model to the enterprises has not been 
established. Moreover, FHFA has not been tested as an independent 
safety and soundness and housing mission regulator, as the agency has 
largely acted as a conservator since its establishment in July 2008.
Possible elements of regulatory and oversight structure: Key elements 
for consideration include (1) reducing or perhaps eliminating retained 
mortgage portfolios as deemed appropriate depending on prioritization 
of numeric housing and safety and soundness objectives, (2) 
establishing capital standards commensurate with relevant risks, (3) 
developing additional regulations such as executive compensation limits 
or perhaps including public utility-type regulation, (4) requiring 
appropriate financial disclosures in the federal budget to enhance 
transparency, and (5) ensuring strong congressional oversight of the 
enterprises’ and FHFA’s performance. 

Proposed reform option: Privatization or termination; 
Provide liquidity and support to mortgage markets, including in bad 
economic times: Privatizing or terminating the enterprises would 
eliminate many problems with the current GSE model, including the 
conflict between public policy and private shareholders. If key 
enterprise activities such as mortgage purchases and MBS issuances are 
provided by other financial institutions, liquid mortgage markets could 
be reestablished in normal economic times. There is significant reason 
to question the capacity of private banks to support mortgage markets 
in times of financial distress without government support, given the 
failure or near failure of key financial institutions and the absence 
of private-label securitization during the current financial crisis. A 
federal mortgage insurer could help such lenders provide liquidity and 
other benefits in times of financial stress.
Support housing opportunities for targeted groups: Privatization or 
termination would remove the traditional legislative basis, government 
sponsorship, for the enterprises to implement programs to serve the 
mortgage credit needs of targeted groups. However, the basis for such 
programs may remain if a government insurer for mortgage debt is 
established and the federal government guarantees its financial 
obligations. Furthermore, Congress might justify the programs on the 
grounds that large lenders that assume responsibility for key 
enterprise activities or purchase their assets are viewed as “too big 
to fail” and benefit from implied federal guarantees of their financial 
Ensure safe and sound operations: Termination and reliance on private-
sector firms would leave market discipline and regulators of financial 
institutions with responsibility for promoting safety and soundness. 
However, moral hazard concerns would remain if some mortgage lenders 
were deemed “too big to fail.” These concerns may be heightened because 
the current financial regulatory system already faces challenges in 
overseeing such organizations. Additionally, safety and soundness 
concerns may remain if a federal entity were established to insure 
mortgage debt and did not charge appropriate premiums to offset the 
risks it incurred. FHA and the FHLBank System may become more prominent 
if the enterprises were privatized or terminated.
Possible elements of regulatory and oversight structure: The need for a 
new financial regulatory system, due to concerns about the current 
fragmented system, may be heightened to the extent that terminating or 
privatizing the enterprises results in larger and more complex 
financial institutions. In considering a new system, Congress should 
consider the need to mitigate taxpayer risks and consider establishing 
clear regulatory goals and a systemwide risk focus. If a new federal 
mortgage insurer is established, there should be an appropriate 
oversight structure for such an entity. This structure might include 
appropriate regulations and capital standards, the disclosure of risks 
and liabilities in the federal budget, and congressional oversight. 

Source: GAO. 

[End of table] 

While the table provides a comprehensive overview of our analysis, let 
me highlight some implications and trade-offs as they relate to the 
critical issues of safety and soundness and systemic risk. In some 
regards, a government entity may mitigate the safety and soundness and 
systemic risk concerns of the traditional GSE structure. That is, it 
would eliminate the concern that publicly held profit-maximizing 
corporations would be able to operate with relatively low levels of 
capital and take excessive risks because of an implied federal 
guarantee that undermined market discipline. And, if a government 
entity were to focus on MBS issuances and not retain a mortgage 
portfolio, then it would be less complex and potentially less risky 
than the GSEs were. Nevertheless, a government entity may find 
successfully managing a large conventional mortgage purchase and MBS 
issuance business to be challenging. As described in our previous work 
on FHA, government entities may lack the financial resources to attract 
highly skilled employees and obtain information technology to manage 
complex business activities.[Footnote 14] The failure to adequately 
manage the associated risks also could result in significant losses for 
taxpayers. For example, the enterprises’ losses in recent years have 
been credit-related (because of mortgage defaults), including 
substantial losses in their MBS guarantee business. This risk may be 
heightened if a government entity was expected to continue purchasing 
mortgages and issuing MBS during stressful economic periods. 

Reconstituting the GSEs could present significant safety and soundness 
concerns as well as systemic risks to the financial system. In 
particular, the potential that the enterprises would enjoy explicit 
federal guarantees of their financial obligations, rather than the 
implied guarantees of the past, might serve as incentives for them to 
engage in risky business practices to meet profitability objectives. 
One option to mitigate these safety and soundness concerns would be to 
make the enterprises into lender-owned associations. By selling 
mortgages to the enterprises, lenders would have financial incentives 
to adopt sound underwriting practices (as any losses the reconstituted 
GSEs incurred on such mortgages would affect the lenders’ investments 
in them). While the public utility model of regulation also has been 
proposed to help mitigate the risks associated with reconstituting the 
GSEs, it is not clear that this model is appropriate. Unlike natural 
monopolies such as electric utilities, the enterprises faced 
significant competition from other providers of mortgage credit over 
the years. 

It is difficult to determine the extent to which privatizing or 
terminating the enterprises mitigates current safety and soundness and 
financial stability risks. Under one scenario, such risks would be 
mitigated because large and complex enterprises that might engage in 
risky business practices due to an implied federal guarantee would not 
exist. Instead, private lenders would be subject to market discipline 
and be more likely to make credit decisions on the basis of credit risk 
and other market factors. However, if a federal entity were established 
to insure mortgage debt and did not set appropriate premiums to reflect 
its risks, then lenders might have incentives to engage in riskier 
business practices than otherwise would be the case. Moreover, if large 
private-sector financial institutions assumed responsibility for key 
enterprise activities or purchased a significant portion of their 
assets, the perception could arise that the failure of such an 
institution would involve unacceptable systemic financial risks. 
Therefore, perceptions that the federal government would provide 
financial assistance to such financial institutions could undermine 
market discipline. As we previously reported, the fragmented and 
outdated U.S. financial regulatory structure already lacks the capacity 
to effectively oversee large financial conglomerates and reform is 
urgently needed.[Footnote 15] 

Oversight and regulatory structures could help ensure that each option 
mitigated safety and soundness and systemic risk concerns while helping 
to achieving housing mission objectives. These oversight and regulatory 
structures could include the following: 

* for the government entity, granting operational flexibility to obtain 
staff and informational technology to carry out responsibilities, 
requiring appropriate disclosures in the federal budget of risks and 
liabilities to ensure transparency, and instituting robust 
congressional oversight; 

* for the reconstituted GSE option, reducing or perhaps eliminating 
mortgage portfolios, establishing capital standards commensurate with 
risk, and establishing executive compensation limits; and 

* for the privatization or termination option, reforming the current 
regulatory structure, setting capital standards commensurate with risks 
(if a federal insurer is established), disclosing risks and liabilities 
in the federal budget in the interests of transparency, and instituting 
robust congressional oversight. 

Federal Efforts to Support Housing Markets during the Conservatorships 
Could Affect Transition to New Structures: 

Since the beginning of the FHFA conservatorships, the enterprises have 
been tasked to initiate a range of programs, such as assisting 
homeowners to refinance or modify their mortgages. These initiatives 
could benefit housing markets and, in doing so, potentially improve the 
enterprises’ financial condition. However, the initiatives also may 
involve additional risks and costs for the enterprises, which could 
increase the costs and challenges associated with transitioning to new 
structures. For example, borrowers who received mortgage loan 
modifications could redefault, incurring additional losses. 

Similarly, certain provisions in the Treasury agreements with the 
enterprises may affect their long-term financial viability and 
complicate any transition. For example, the enterprises must pay 
quarterly dividends that accrue at 10 percent annually to the Treasury, 
and in a liquidation proceeding the department has a claim against the 
assets of any enterprise that cannot pay such dividends. Since Treasury 
has already purchased $50 billion in preferred shares of Freddie Mac to 
date, the enterprise is responsible for paying a dividend to Treasury 
of $5 billion annually. Prior to the conservatorship, Freddie Mac’s 
reported annual net income twice came close to or exceeded $5 billion, 
and the dividends it distributed to shareholders in those years likely 
were substantially lower. 

Although it is not possible to predict what effects federal initiatives 
to respond to the housing crisis and the Treasury agreements with the 
enterprises could have on any transition, they could be substantial. 
For example, under the proposal to reconstitute the enterprises, 
potential investors might not be willing to invest in reconstituted 
GSEs that had a substantial volume of nonperforming mortgage assets or 
financial obligations to Treasury. To minimize this risk, the federal 
government could retain nonperforming assets in a “bad bank,” spin off 
the performing assets to a “good bank,” and devolve key functions, such 
as issuing MBS, to investors in a reconstituted GSE.[Footnote 16] Or, 
the federal government could use this process to terminate or privatize 
the enterprises. However, to the extent that the enterprises previously 
engaged in activities or incurred financial obligations inconsistent 
with maintaining long-term financial viability, the level of 
nonperforming assets and long-term costs to taxpayers may be higher 
than otherwise would be the case. 

Regardless of what changes are implemented, policymakers should pay 
careful attention to how a potential transition is managed to mitigate 
potential risks to the housing finance system. The enterprises evolved 
to become dominant participants in housing finance, and, in some 
respects, their roles have expanded during the conservatorships. 
Therefore, transitioning to a new structure could have significant 
consequences for housing finance and should be managed carefully and 
perhaps implemented in phases, with periodic evaluations to determine 
if corrective actions were necessary. 

Finally, regardless of any enterprise structural reforms that are 
adopted, we urge Congress to continue to actively monitor the progress 
of such implementation and to be prepared to make legislative 
adjustments to ensure that any changes are as effective as possible. In 
addition, we believe that it is important that Congress provide for 
appropriate GAO oversight of any structural and related reforms to help 
ensure accountability and transparency in any new system. GAO stands 
ready to assist the Congress in its oversight capacity and evaluate the 
progress that is being made in implementing any changes. 

Chairman Dodd, Ranking Member Shelby, and Members of the Committee, 
this concludes my prepared testimony. I would be pleased to address any 
questions that you or the members of the committee may have. 

[End of section] 


[1] GAO, Fannie Mae and Freddie Mac: Analysis of Options for Revising 
the Housing Enterprises’ Long-Term Structures, [hyperlink,] (Washington, D.C.: Sept. 10, 

[2] On September 7, 2008, Treasury agreed to provide up to $100 billion 
in financial support to each enterprise through the purchase of its 
preferred stock so that the enterprises could maintain a positive net 
worth. In February 2009, Treasury increased this commitment to $200 
billion per enterprise. Treasury also agreed to purchase the 
enterprises’ mortgage-backed securities and establish a lending 
facility to meet their borrowing requirements if needed. 

[3] Congress initially chartered Fannie Mae in 1938 but did not 
establish it as a shareholder-owed corporation until 1968. Congress 
initially established Freddie Mac in 1970 as an entity within the 
Federal Home Loan Bank System and reestablished it as a shareholder-
owned corporation in 1989. 

[4] For example, the enterprises typically purchased mortgages with 
loan-to-value ratios of 80 percent or less (mortgages with down 
payments of at least 20 percent) and required private mortgage 
insurance on mortgages with higher loan-to-value ratios. The 
enterprises also had a limit on the size of mortgages they purchased 
(the conforming loan limit), with mortgages above this limit called 
jumbo mortgages. The conforming conventional market differs from other 
markets (such as the subprime market) that generally have differing 
underwriting standards, or markets in which the federal government 
insures or guarantees mortgages (for example, through Federal Housing 
Administration or Department of Veterans Affairs programs). 

[5] Each enterprise’s portfolio also includes MBS that it issued. 

[6] In 1996, we participated in research with CBO, HUD, and Treasury 
that included analysis of the degree to which the advantageous 
borrowing rates the enterprises derived from government sponsorship 
were passed to borrowers. We estimated the benefit on interest rates on 
30-year, fixed-rate, single-family mortgages below the conforming loan 
limits ranged from 15 to 35 basis points (a basis point is equal to one 
1/100 of a percent). This amounted to a savings of about $10–$25 on the 
monthly payments on a $100,000 mortgage. See GAO, Housing Enterprises: 
Potential Impacts of Severing Government Sponsorship, GAO/GGD-96-120 
(Washington, D.C.: May 13, 1996). More recent research by Federal 
Reserve staff suggests that borrower savings ranged from 0 to 7 basis 
points. See Wayne Passmore, Shane M. Sherlund, and Gilliam Burgess, 
“The Effect of Housing Government-Sponsored Enterprises on Mortgage 
Rates,” Real Estate Economics, 33, Fall 2005: 427-463, and Wayne 
Passmore, Diana Hancock, Andreas Lehnert, and Shane Sherlund, “Federal 
Reserve Research on Government-Sponsored Enterprises,” Proceedings from 
the 42th Annual Conference on Bank Structure and Competition, May 2006. 

[7] [hyperlink,]. 

[8] Xudong An and Raphael Bostic, “GSE Activity, FHA Feedback, and 
Implications for the Efficacy of the Affordable Housing Goals,” Journal 
of Real Estate Finance and Economics 36 (2008) 37: 207-231. 

[9] Abt Associates, “Study of the Multifamily Underwriting and the 
GSEs’ Role in the Multifamily Market: Final Report,” prepared for HUD 
(August 2001). 

[10] See Dwight M. Jaffee, “Reforming Fannie and Freddie,” Regulation, 
Winter 2008-2009: 52-57, and Thomas H. Stanton, “Lessons from Public 
Administration: Recommendations for the Future of Fannie Mae and 
Freddie Mae,” presented at the 45th Annual Conference on Bank Structure 
and Competition, Federal Reserve Bank of Chicago, May 7, 2009. 

[11] We treat “termination” and “privatization” as equivalent terms. 

[12] Federal Reserve Chairman Ben S. Bernanke, “The Mortgage Meltdown, 
the Economy, and Public Policy,” presented at the University of 
California at Berkeley/University of California at Los Angeles 
Symposium (Berkeley, California, Oct. 31, 2008). 

[13] See Arnold Kling, “Freddie Mac and Fannie Mae: An Exit Strategy 
for the Taxpayer,” Cato Institute Briefing Papers, no. 106 (Washington, 
D.C.: Sept. 8, 2008). For additional information on privatization and 
transition issues, see Peter Wallison, Thomas H. Stanton, and Bert Ely, 
Privatizing Fannie Mae, Freddie Mac, and the Federal Home Loan Banks: 
Why and How, The AEI Press ( Washington, D.C.: 2004); and HUD, Policy 
Development and Research, Studies on Privatizing Fannie Mae and Freddie 
Mac (Washington, D.C.: 1996). See also Diana Hancock and Wayne 
Passmore, “Three Mortgage Innovations for Enhancing the American 
Mortgage Market and Promoting Financial Stability” The University of 
California at Berkeley/University of California at Los Angeles 
Symposium. (Berkeley, California, Oct. 31, 2008). 

[14] See GAO, Federal Housing Administration: Modernization Proposals 
Would Have Program and Budget Implications and Require Continued 
Improvement in Risk Management, [hyperlink,] (Washington, D.C.: June 29, 
2007) and Information Technology: HUD Needs to Strengthen Its Capacity 
to Manage and Modernize Its IT Environment, [hyperlink,] (Washington, D.C.: July 31, 

[15] GAO, Financial Regulation: A Framework for Crafting and Assessing 
Proposals to Modernize the Outdated U.S. Financial Regulatory System, 
[hyperlink,] (Washington, D.C.: 
Jan. 8, 2009). 

[16] Such proposals generally involve the federal government 
maintaining existing guarantees on the assets in the “bad bank” as well 
as assets in the “good bank” as may be required. 

[End of section] 

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