November 13, 2013
OPTIONS FOR REDUCING THE DEFICIT: 2014 TO 2023

Mandatory SpendingOption 5

370 - Commerce and Housing Credit

Reduce Subsidies to Fannie Mae and Freddie Mac

(Billions of dollars) 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2014-2018 2014-2023
Change in Outlays                        
  Increase guarantee fees 0 -6.5 -3.7 -2.4 -1.3 -0.4 -0.5 * -2.3 -1.5 -14.0 -18.7
  Decrease loan limits 0 0.1 0.1 0.1 * -0.1 -0.3 * -1.6 -1.4 0.3 -3.1
  Both of the above policiesa 0 -6.4 -3.6 -2.4 -1.4 -0.5 -0.7 * -2.3 -1.5 -13.8 -18.8

Notes: This option would take effect in October 2014.

* = between -$50 million and $50 million.

a. If both policies were enacted together, the total effects would be less than the sum of the effects for each policy because of interactions between the approaches.

Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs) that were federally chartered to help ensure a stable supply of financing for residential mortgages, including those for low- and moderate-income borrowers. Over the past 40 years, those GSEs have carried out that mission through two activities in the secondary mortgage market (that is, the market for mortgages after they have been issued): by issuing and guaranteeing mortgage-backed securities (MBSs) and by buying mortgages and MBSs to hold as investments. Under current law, the entities are generally able to guarantee and purchase mortgages up to $625,500 in areas with high housing costs and $417,000 in other areas, and regulators can alter those limits if house prices change. Those two GSEs provided credit guarantees for about two-thirds of all home mortgages originated in 2012.

In September 2008, the federal government took control of Fannie Mae and Freddie Mac in a conservatorship process, after falling house prices and rising mortgage delinquencies threatened the GSEs’ solvency and impaired their ability to ensure a steady supply of financing to the mortgage market. Because of that shift in control, the Congressional Budget Office concluded that the institutions had effectively become government entities whose operations should be reflected in the federal budget. By CBO’s projections under current law, the mortgage guarantees that the GSEs issue from 2015 through 2023 will cost the federal government $22 billion. That estimate reflects the subsidies inherent in the guarantees at the time they are made—that is, the up-front payments that a private entity would need to receive (in an orderly market and allowing for the fees that borrowers pay) to assume the federal government’s responsibility for those guarantees.

This option includes two approaches for reducing the federal subsidies provided to Fannie Mae and Freddie Mac. In the first approach, the average guarantee fee that Fannie Mae and Freddie Mac assess on loans they include in their MBSs would increase by 10 basis points (100 basis points are equivalent to 1 percentage point), to 60 basis points, beginning in October 2014. In addition, to keep guarantee fees constant after 2021—when an increase of 10 basis points that was put in place in 2011 is scheduled to expire—the average guarantee fee would be increased, relative to the amount under current law, by 20 basis points after 2021. The increased collections of fees, which the GSEs would be required to pass through to the Treasury, would reduce net federal spending by $19 billion from 2015 through 2023, CBO estimates.

In the second approach, the maximum size of a mortgage that Fannie Mae and Freddie Mac could include in their MBSs would be reduced to $150,000 nationally, beginning with a drop to $500,000 in October 2014, followed by a series of reductions averaging less than $50,000 a year. (Guarantee fees would remain as they are under current law.) This reduction in loan limits would save $3 billion from 2015 through 2023, CBO estimates. Because the GSEs would lose their most profitable customers first as loan limits fell, lowering limits would initially raise federal costs slightly.

Taking both approaches together would lower federal subsidies for Fannie Mae and Freddie Mac by $19 billion from 2015 through 2023, according to CBO’s estimates. Because raising guarantee fees by 10 basis points would eliminate most of the federal subsidies for the GSEs, taking the additional step of lowering loan limits would have very little effect on subsidies. For consistency, similar changes could be made to the limits on loans guaranteed by the Federal Housing Administration (FHA). The effects of lower limits on FHA loans, which would affect discretionary spending subject to appropriations, are not included in the estimates presented here.

Because some of the subsidies provided to Fannie Mae and Freddie Mac flow to mortgage borrowers in the form of lower rates, both approaches in this option would raise borrowing costs. The higher guarantee fees would probably pass directly through to borrowers in the form of higher mortgage rates. The lower loan limits would push some borrowers into the so-called jumbo mortgage market, where loans exceed the eligible size for guarantees by Fannie Mae and Freddie Mac and where rates are likely to be 20 to 50 basis points higher, on average.

The major advantage of those approaches for reducing federal subsidies for Fannie Mae and Freddie Mac is that they could restore a larger role for the private sector in the secondary mortgage market, which would reduce taxpayers’ exposure to the risk of defaults. CBO estimates that raising fees as specified here would cause new guarantees by Fannie Mae and Freddie Mac to fall by around 45 percent, on average, between 2015 and 2023 and that lowering loan limits to the level described here would cause new guarantees to fall by about 35 percent. Combining the approaches would result in a drop in new guarantees of about 60 percent. Lessening subsidies would also help address the current underpricing of mortgage credit risk, which encourages borrowers to take out bigger mortgages and purchase more expensive homes. Consequently, the option could shift the allocation of some capital away from housing and toward more productive activities.

A particular advantage of lowering loan limits, rather than raising fees, is that many moderate- and low-income borrowers would continue to benefit from the subsidies provided to the GSEs. More-affluent borrowers generally would lose that benefit, but they typically can more easily find alternative sources of financing. The $150,000 limit would allow for the purchase of a home for about $190,000 (with a 20 percent down payment), which was roughly the median price of an existing single-family residence in April 2013; thus, most moderate- and low-income borrowers would not be affected by lowering loan limits as specified here.

One disadvantage of reducing subsidies for the GSEs and thereby increasing the cost of mortgage borrowing is that doing so could weaken the housing market, which is currently recovering only slowly from its sharp drop several years ago. That concern is particularly salient because mortgage delinquency rates remain high, and many borrowers are still “underwater,” which is to say that they owe more than their homes are worth. Posing another drawback, the slightly higher mortgage rates resulting from lower subsidies would limit some opportunities for refinancing—perhaps constraining spending by consumers, which is currently growing only slowly, and thereby hampering the economic recovery. If those were the only concerns about this option, they could be addressed by phasing in the specified changes more slowly, although that approach would reduce the budgetary savings as well.

Finally, this option affecting the GSEs would make FHA loans more attractive to some borrowers (in the absence of corresponding changes to the rules governing FHA loans), which could increase risks for taxpayers because FHA guarantees loans with lower down payments than do the GSEs.