Modernizing the U.S. Financial Regulatory System and the Federal Role in Housing Finance
Congress and financial regulators have made progress in meeting criteria for removing the issue area of reforming the U.S. financial regulatory system from our High-Risk List. However, definitive steps have yet to be taken to address the federal government's role in housing finance. As the worst financial crisis in more than 75 years unfolded, unprecedented federal support was provided to many firms, including Fannie Mae and Freddie Mac, two large, housing-related government-sponsored enterprises (the enterprises). Many households suffered as a result of falling asset prices, tightening credit, and increasing unemployment. These events clearly demonstrated that the U.S. financial regulatory system had failed to respond effectively to developments in the markets and to the increase in systemic risks that contributed to the crisis.1 Given the challenges that regulators would face in identifying and implementing changes to reduce the potential for such events to occur again, we designated reform of the financial regulatory system as a high-risk area in 2009.2
According to data from Inside Mortgage Finance, the federal government has directly or indirectly supported more than two-thirds of the value of new mortgage originations in the single-family housing market in the years since the crisis began. Mortgages with federal support include those backed by the enterprises, which the Federal Housing Finance Agency (FHFA) placed under government conservatorship in 2008, and whose future role in the housing finance system has yet to be determined. The federal government also supports mortgages through insurance or guarantee programs, the largest of which is administered by the Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA).3 During the financial crisis, FHA served its traditional role of helping to stabilize the housing market, but also experienced financial difficulties from which it only recently recovered. Until decisions are made about what role the federal government will play in housing finance, housing and mortgage markets continue to pose increased risks to taxpayers and the U.S. financial system. In light of developments at the enterprises and FHA, we added this issue to the scope of this high-risk area in 2013.4
 GAO, Financial Regulation: A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System, GAO-09-216 (Washington, D.C.: Jan. 8, 2009).
 GAO, High-Risk Series: An Update, GAO-09-271 (Washington, D.C.: January 2009).
 GAO, High-Risk Series: An Update, GAO-13-283 (Washington, D.C.: February 2013).
Congress and financial regulators have made progress in meeting criteria for removing the issue area of reforming the U.S. financial regulatory system from our High-Risk List, but additional steps are needed to improve the structure of the financial regulatory system and the implementation of some reforms. Demonstrating leadership commitment and capacity, Congress enacted sweeping reforms in 2010 through the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and regulators have worked to implement the act's numerous reforms. Continued leadership commitment from financial regulators and Congress will be needed to fully implement the reforms and additional work will be needed to exhibit capacity to complete oversight and monitoring plans, monitor progress, and demonstrate the effectiveness of the new oversight bodies and regulations.
Policymakers have made proposals to overhaul the federal role in the housing finance system, but additional leadership commitment will be needed to reach consensus and enact changes to the system. The ongoing federal conservatorship of the enterprises and FHA's need for supplemental funds in 2013 underscore the need to reconsider the federal role. Federal agencies have taken some steps to develop plans, build capacity, and provide monitoring mechanisms that could help build a more robust housing finance system. However, progress toward resolving the federal role within that system will be difficult to achieve without an overall blueprint for change.
In the decades leading up to the recent crisis, the U.S. financial regulatory system failed to adapt to significant changes. First, although the U.S. financial system increasingly had become dominated by large, interconnected financial conglomerates, no single regulator was tasked with monitoring and assessing the risks that these firms' activities posed across the entire financial system. Second, entities—such as nonbank mortgage lenders, hedge funds, and credit rating agencies—that had come to play critical roles in the financial markets were not subject to sufficiently comprehensive regulation and oversight. Third, the regulatory system was not effectively providing key information and protections for new and more complex financial products for consumers and investors. Taking steps to better position regulators to oversee firms and products that pose risks to the financial system and consumers, and to adapt to new products and participants as they arise, could reduce the likelihood that the financial markets will experience another financial crisis similar to the one in 2007–2009.
Losses from risky mortgage products also resulted in the enterprises being placed into federal conservatorship in 2008, creating an explicit fiscal exposure for the federal government. The enterprises received more than $187 billion in financial assistance from the Department of the Treasury (Treasury) through purchases of senior preferred stock, but have paid more than $250 billion in dividends to Treasury under the stock purchase agreements. Distressed housing and mortgage markets also expanded FHA's role in the mortgage market, while leading to deterioration in the agency's financial condition from which it has taken years to recover. In 2015, mortgages directly or indirectly supported by the federal government accounted for more than 70 percent of the dollar value of new single-family mortgage originations, according to data from Inside Mortgage Finance.
Although more needs to be done to address this high-risk issue, there have been several benefits achieved by implementing our recommendations.
- In a March 2016, we reported that Treasury had not instituted a system to review the extent to which it would use the available program balance for the Making Home Affordable (MHA) program. Consistent with our recommendations, Treasury updated estimates of future MHA program expenditures, deobligated $2 billion from the MHA program, and announced a $2 billion increase in funding for the Hardest Hit Fund.
- In June 2013, we made recommendations intended to increase FHA's returns on sales of foreclosed properties with FHA-insured mortgages. FHA's actions in response to our recommendations improved its returns and led to financial benefits totaling more than $3.4 billion in fiscal years 2013–2016.
- In June 2012, we recommended that Treasury and FHA update their estimates of program participation and use the updated estimates to reassess the terms the $8 billion letter of credit facility for FHA's Refinance for Borrowers in Negative Equity Positions program. As a result, Treasury amended the purchase agreement and deobligated approximately $7.1 billion dollars, which was returned to the general fund in fiscal year 2013.
- In November 2005, we recommended that FHA take a number of steps to mitigate the risks associated with mortgages with down payment assistance from nonprofit organizations funded by property sellers. Citing our work, Congress prohibited seller-funded down-payment assistance, effective October 1, 2008. In fiscal year 2013, the financial benefit to the federal government of not insuring such loans was approximately $2.5 billion.
Actions Needed to Complete and Ensure the Effective Functioning of Reforms to the U.S. Financial Regulatory System
Continued leadership commitment is needed to ensure that financial regulations foster stable, competitive and well-functioning markets. Our review of selected major rules—that is, those likely to result in an annual impact on the economy of $100 million or more, among other things—found that regulators generally quantified some of the costs but not always the benefits of each rule, noting data and other limitations. Although the federal financial regulators—as independent agencies—are not subject to executive orders requiring detailed cost-benefit analysis in accordance with Office of Management and Budget (OMB) guidance, we have recommended that the regulators more fully incorporate OMB's regulatory guidance into their written rulemaking policies. However, not all regulators have implemented this recommendation. The Administration and members of Congress have expressed intentions to reduce financial regulatory burdens. Such actions would be most effective if they largely preserve the benefits sought by the regulations while allowing institutions to comply with the requirements in less costly ways.
The full impact of the Dodd-Frank Act remains uncertain because some of its rules have not been finalized and insufficient time has passed to evaluate others. For example, the Dodd-Frank Act prohibits insured depository institutions and any company affiliated with an insured depository institution from engaging in proprietary trading and from acquiring or retaining ownership interests in, sponsoring, or having certain relationships with a hedge fund or private equity fund. Banks were initially expected to have implemented these restrictions by July 2014, but the Federal Reserve twice extended the conformance date, with affected entities now required to conform by July 2017. Similarly, the higher capital requirements that regulators adopted for banks in October 2013 have some provisions that will not be fully effective until January 2019.
Additional leadership from Congress is also needed to improve the inefficiencies that hamper the current financial regulatory system. Although the Dodd-Frank Act implemented a number of key reforms intended to address significant weaknesses and gaps in the regulatory system, the U.S. financial regulatory structure remains complex, with responsibilities fragmented among a number of regulators that have overlapping authorities. We have noted that this fragmentation, overlap, and duplication introduce significant challenges for efficient and effective oversight of financial institutions and activities.
The framework we developed in 2009 for evaluating regulatory reform proposals noted that an effective regulatory system would address certain structural shortcomings created by fragmentation and overlap. To help achieve this, we have suggested that Congress consider whether additional changes to the financial regulatory structure are needed to reduce or better manage fragmentation and overlap in the oversight of financial institutions and activities to improve the efficiency and effectiveness of oversight. For example, Congress could consider consolidating the number of federal agencies involved in overseeing the safety and soundness of depository institutions, combining the entities involved in overseeing the securities and derivatives markets, transferring the remaining prudential regulators' consumer protection authorities over large depository institutions to the Consumer Financial Protection Bureau (CFPB), and determining the optimal federal role in insurance regulation.
Congressional leadership also could improve the ability of the U.S. regulatory system to address systemic risks. Although the Financial Stability Oversight Council (FSOC) represents advancement in addressing systemic risk threats to the U.S. financial system, its legal authorities may not be broad enough to ensure that it can address all threats effectively. Under the Dodd-Frank Act, FSOC can respond to certain potential systemic risks primarily through its authority to designate certain entities or activities that pose a threat to financial stability for enhanced supervision by a specific federal regulator. We reported in February 2016 that FSOC's designation authorities, by statute, cannot be used to address certain types of risks, such as specific industry-wide activities involving nonbank financial institutions, and the full scope of FSOC's designation authority remains untested and unclear to date.
FSOC has other nondesignation authorities that allow it to recommend that individual regulators address specific risks, but these recommendations are nonbinding. As a result, we suggested that Congress consider whether legislative changes would be necessary to align FSOC's authorities with its mission to respond to systemic risks. Such actions could include changes to FSOC's mission, its authorities, or both, or to the missions and authorities of one or more of the FSOC member agencies to support a stronger link between its responsibility and capacity to respond to systemic risks.
Additional leadership, planning, capacity, and monitoring activities by U.S. financial regulators also could improve systemic risk oversight. While the newly created systemic risk and financial research bodies have been established, we have continued to identify additional steps they need to take to fully meet their envisioned missions. The Dodd-Frank Act maintained the independence of the system's multiple regulators but created FSOC to identify and respond to systemic risks. We noted in February 2016 that this approach to systemic risk oversight requires consistent and highly effective interagency collaboration and the use of good quantitative and qualitative information. However, we reported then that FSOC's Systemic Risk Committee is not fully and consistently informed by the Office of Financial Research (OFR) and the Federal Reserve's monitoring tools or other outputs, and we recommended this be done.
In addition, we found that both OFR and the Federal Reserve conduct broad-based systemic risk monitoring activities that aim to identify threats across the financial system and recommended that the two agencies jointly articulate individual and common goals for their systemic risk monitoring activities, including a plan to monitor progress toward articulated goals, and formalize regular strategic and technical discussions around their activities and outputs to support those goals. Such efforts could help ensure that FSOC more accurately measures the effect of significant Dodd-Frank Act regulations but also more efficiently coordinates with its members to leverage retrospective reviews.
In our priority recommendations letter to Treasury, we identified some actions that could be taken to improve regulators' ability to oversee systemic risks. First, we noted that FSOC and OFR need to clarify responsibility for implementing requirements to monitor threats to financial stability across FSOC and OFR, including FSOC members and member agencies, to better ensure that the monitoring and analysis of the financial system are comprehensive and not unnecessarily duplicative.1 In addition, to improve the data that council members need to conduct their responsibilities, FSOC should direct OFR to work with its members to identify and collect the data necessary to assess the effect of the Dodd-Frank Act regulations on, among other things, the stability, efficiency, and competitiveness of the U.S. financial markets.2
Financial regulators need to demonstrate further progress by taking additional actions. Although FSOC's ability to identify firms whose financial difficulties could pose threats to the overall financial system is an important oversight tool, we reported in November 2014 that the transparency of its process for designating systemically important nonbank entities could be improved.3 Designating these entities in a way that supports public and market confidence could help mitigate the potential for such entities to endanger the stability of the U.S. financial system. Thus, we recommended that FSOC take various steps to improve the tracking of its process and disclose the rationales for its designations in greater detail. Since then, FSOC has issued supplemental procedures for nonbank financial company designations that stated its commitment to continuing to provide the public with an understanding of the council's analysis and a subsequent designation document included additional information compared to prior ones. However, that document did not fully explain how FSOC concluded that a company's characteristics were sufficiently large or significant enough, or had other attributes, to meet a determination standard.
Demonstrated progress is needed to ensure the effectiveness of reforms addressing the resolution of troubled firms. Although regulators have made progress conducting their reviews of the resolution plans of large financial institutions, the time they took to complete these reviews and provide feedback did not provide some companies with sufficient time to fully incorporate changes into subsequent plans. As a result, we recommended that the Federal Reserve and Federal Deposit Insurance Corporation address these weaknesses. In addition, we recommended in 2016 numerous steps the Federal Reserve could take to improve the stress tests that assess how large financial institutions would be affected by changes in economic or other conditions.
Additional progress is needed to address other risks. Although the Federal Reserve has worked with the two clearing banks for the repurchase (repo) market to reduce their problematic credit exposures, the FSOC 2015 annual report notes that the risk of fire sales of collateral by creditors of a defaulted broker-dealer remains an important financial stability concern. For instance, many of the creditors may themselves be vulnerable to runs in a stress event. As a result, the council expressed the need for market participants to continue to improve the settlement processes for these transactions.
Actions Needed to Resolve the Federal Role in Housing Finance
Resolving the role of the federal government in housing finance will require continued leadership commitment by Congress and the administration. Prolonged conservatorships and a change in leadership at FHFA could shift priorities for the conservatorships, which in turn could send mixed messages and create uncertainties for market participants and hinder the development of the broader secondary mortgage market. For this reason, we said in November 2016 that Congress should consider legislation establishing objectives for the future federal role in housing finance, including the structure of the enterprises, and a transition plan to a reformed housing finance system that enables the enterprises to exit conservatorship.4
Maintaining FHA's long-term financial health and defining its future role also will be critical to any effort to overhaul the housing finance system. We previously recommended that Congress or FHA specify the economic conditions that FHA's Mutual Mortgage Insurance (MMI) Fund would be expected to withstand without requiring supplemental funds.5 As evidenced by the $1.68 billion FHA received in 2013, the 2 percent capital requirement for FHA's MMI Fund may not always be adequate to avoid the need for supplemental funds under severe stress scenarios.
Implementing our recommendation would be an important step not only in addressing FHA's long-term financial viability, but also in clarifying FHA's role. FHA also will need to sustain the progress it made in strengthening the health of the MMI Fund and implementing sound risk-management practices. Furthermore, it will be important for FHA and other agencies with housing finance-related responsibilities to fully implement our recommendations on evaluating the effectiveness of foreclosure mitigation actions, opportunities for consolidating similar housing programs, and the effect of recent mortgage market regulations.6
Due to the interconnected nature of the housing finance system and the central role homeownership plays in the U.S. economy, changes will need to be carefully designed and implemented. In October 2014, we issued a framework consisting of nine elements that Congress and others can use as they consider changes to the housing finance system. 7 The framework has the following elements:
- clearly defined and prioritized goals for the housing finance system;
- policies and mechanisms that are aligned with goals and other economic policies;
- adherence to an appropriate financial regulatory framework;
- government entities with the capacity to manage risks;
- protections for mortgage borrowers and actions to address barriers to mortgage market access;
- protection for mortgage securities investors;
- consideration of the cyclical nature of housing finance and the effect of housing finance on financial stability;
- recognition and control of fiscal exposure and mitigation of moral hazard; and
- emphasis on implications of the transition.
Each element in the framework is critically important in establishing the most effective and efficient housing finance system. Applying the elements of this framework would help policymakers identify the relative strengths and weaknesses of any proposals they consider. Similarly, the framework can be used to craft proposals or to identify changes to existing proposals to make them more effective and appropriate for addressing any limitations of the current system. However, any viable proposal for change must recognize that sometimes tradeoffs will exist among and within the nine elements. If Congress enacts changes to the housing finance system, relevant federal agencies will need to develop the capacity and action plans necessary to effectively implement the changes and monitor progress.
FHA needs to complete or build on steps it has taken in response to two priority recommendations that were not fully implemented as of October 2016. First, FHA has partially addressed recommendations from our June 2012 report on reducing losses from troubled mortgages, but needs to finish analyzing and reevaluating its loss mitigation approaches in order to optimize these efforts.8 Second, FHA and other agencies that are part of a single-family housing task force need to evaluate and report on the opportunities for consolidating similar housing programs, as we recommended in an August 2012 report.9
Congressional Actions Needed
Additional congressional leadership is needed to address this high-risk area. Specifically, Congress should consider whether additional changes to the financial regulatory structure are needed to reduce or better manage fragmentation and overlap in the oversight of financial institutions and activities to improve (1) the efficiency and effectiveness of oversight; (2) the consistency of consumer and investor protections; and (3) the consistency of financial oversight for similar institutions, products, risks, and services. In addition, Congress could consider whether legislative changes would be necessary to align FSOC's authorities with its mission to respond to systemic risks. Such actions could include changes to FSOC's mission, its authorities, or both, or to the missions and authorities of one or more of the FSOC member agencies to support a stronger link between its responsibility and capacity to respond to systemic risks. Also, Congress should consider legislation establishing objectives for the future federal role in housing finance, including the structure of the enterprises, and a transition plan to a reformed housing finance system that enables the enterprises to exit conservatorship.
 GAO, Financial Stability: New Council and Research Office Should Strengthen the Accountability and Transparency of Their Decisions, GAO-12-886 (Washington, D.C: Sept. 11, 2012).
 GAO, Dodd-Frank Act Regulations: Implementation Could Benefit from Additional Analyses and Coordination, GAO-12-151 (Washington, D.C: Nov. 10, 2011).
 GAO, Federal Housing Finance Agency: Objectives Needed for the Future of Fannie Mae and Freddie Mac After Conservatorships, GAO-17-92 (Washington, D.C.: Nov. 17, 2016).
 GAO, Mortgage Financing: FHA's Fund Has Grown, but Options for Drawing on the Fund Have Uncertain Outcomes, GAO-01-460 (Washington, D.C.: Feb. 28, 2001).
 See GAO, Mortgage Reforms: Actions Needed to Help Assess Effects of New Regulations, GAO-15-185 (Washington, D.C.: June 25, 2015); Housing Assistance: Opportunities Exist to Increase Collaboration and Consider Consolidation, GAO-12-554 (Washington, D.C.: Aug. 16, 2012); and Foreclosure Mitigation: Agencies Could Improve Effectiveness of Federal Efforts with Additional Data Collection and Analysis, GAO-12-296 (Washington, D.C.: June 28, 2012).
 GAO, Housing Finance System: A Framework for Assessing Potential Changes, GAO-15-131 (Washington, D.C.: Oct. 7, 2014).
GAO-17-92: Published: Nov 17, 2016. Publicly Released: Nov 17, 2016.
The Federal Housing Finance Agency (FHFA) issued a new strategic plan for the conservatorships of Fannie Mae and Freddie Mac (the enterprises) in 2014 with reformulated goals and supporting actions that reflect a shift in priorities and changing market conditions. While the three goals in the 2014 strategic plan are broadly similar to those in the previous plan issued in 2012, FHFA changed the wei...
GAO-16-341: Published: Apr 12, 2016. Publicly Released: Apr 12, 2016.
The Federal Deposit Insurance Corporation (FDIC) and Federal Reserve System (Federal Reserve) have developed separate but similar review processes for determining whether a resolution plan is “not credible” or would not facilitate a company's orderly resolution under the Bankruptcy Code (the Code). Both regulators have processes for staffing review teams, determining whether a plan includes al...
GAO-16-278: Published: Mar 10, 2016. Publicly Released: Apr 11, 2016.
The share of home mortgages serviced by nonbanks increased from approximately 6.8 percent in 2012 to approximately 24.2 percent in 2015 (as measured by unpaid principal balance). However, banks continued to service the remainder (about 75.8 percent). Some market participants GAO interviewed said nonbank servicers' growth increased the capacity for servicing delinquent loans, but they also noted ch...
GAO-16-175: Published: Feb 25, 2016. Publicly Released: Mar 28, 2016.
The U.S. financial regulatory structure is complex, with responsibilities fragmented among multiple agencies that have overlapping authorities. As a result, financial entities may fall under the regulatory authority of multiple regulators depending on the types of activities in which they engage (see figure on next page). While the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Fr...
GAO-16-169: Published: Dec 30, 2015. Publicly Released: Dec 30, 2015.
Federal financial agencies conducted required regulatory analyses for rules issued pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and also reported required coordination. These agencies also addressed key elements of Office of Management and Budget guidance for conducting cost-benefit analyses for rules considered major—rules likely to result in an ann...
GAO-15-185: Published: Jun 25, 2015. Publicly Released: Jul 27, 2015.
Federal agency officials, market participants, and observers estimated that the qualified mortgage (QM) and qualified residential mortgage (QRM) regulations would have limited initial effects because most loans originated in recent years largely conformed with QM criteria.The QM regulations, which address lenders' responsibilities to determine a borrower's ability to repay a loan, set forth standa...
GAO-15-365: Published: Jun 25, 2015. Publicly Released: Jun 25, 2015.
Past banking-related crises highlight a number of regulatory lessons learned. These include the importance ofEarly and forceful action. GAO's past work on failed banks found that regulators frequently identified weak management practices that involved the banks in higher-risk activities early on in each crisis, before banks began experiencing declines in capital. However, regulators were not alway...
GAO-15-51: Published: Nov 20, 2014. Publicly Released: Nov 20, 2014.
The Financial Stability Oversight Council (FSOC) uses committees comprising staff from member agencies to help it evaluate nonbank financial companies and determine if they will receive enhanced supervision. FSOC has developed and followed a process for making determination decisions that is, in part, systematic and transparent. FSOC published a final rule and guidance that establish a three-stage...
GAO-15-131: Published: Oct 7, 2014. Publicly Released: Oct 7, 2014.
Developments in the single-family housing finance market from 2000-2013 led to changes in the federal government's role in the housing finance system and ultimately to a significant increase in that role. For example,Before the 2007-2009 financial crisis, the market share of nonprime mortgages—loans often made to borrowers with high-risk characteristics and funded by mortgage backed securities (...
GAO-12-886: Published: Sep 11, 2012. Publicly Released: Sep 13, 2012.
These new organizations--the Financial Stability Oversight Council (FSOC) and Office of Financial Research (OFR)--face challenges in achieving their missions. Key FSOC missions--to identify risks and respond to emerging threats to financial stability--are inherently challenging, in part, because risks to financial stability do not develop in precisely the same way in successive crises. Collaborati...
GAO-12-151: Published: Nov 10, 2011. Publicly Released: Nov 10, 2011.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) requires or authorizes various federal financial regulators to issue hundreds of rules to implement reforms intended to strengthen the financial services industry. GAO is required to annually study financial services regulations. This report examines (1) the regulatory analyses, including cost-benefit analyses, financia...
GAO-09-216: Published: Jan 8, 2009. Publicly Released: Jan 8, 2009.
The United States and other countries are in the midst of the worst financial crisis in more than 75 years. While much of the attention of policymakers understandably has been focused on taking short-term steps to address the immediate nature of the crisis, these events have served to strikingly demonstrate that the current U.S. financial regulatory system is in need of significant reform. To help...
GAO-01-460: Published: Feb 28, 2001. Publicly Released: Mar 19, 2001.
The Mutual Mortgage Insurance Fund has maintained an economic value of at least two percent of the Fund's insurance-in-force, as required by law. GAO's and the Department of Housing and Urban Development's (HUD) analysis show that the Fund had an economic value of $15.8 billion (3.20 percent) and $16.6 billion (3.66 percent), respectively. Given the economic value of the Fund and the state of the...