June 2, 2011
Until recently the obligations of Fannie Mae and Freddie Mac—two federally chartered institutions (called government-sponsored enterprises, or GSEs) that provide credit guarantees for almost half of the outstanding mortgages in the United States—had no official backing from the federal government, nor were any costs associated with them reflected in the federal budget. However, starting in 2007, their losses mounted sharply as housing prices dropped and foreclosure rates climbed.
In September 2008, the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into federal conservatorship, and the Treasury entered into agreements with the GSEs to provide sufficient capital to keep their net worth from falling below zero. Under those agreements, the government made net payments to the GSEs of $130 billion through March 2011. In return, the government has received preferred stock and warrants that make the Treasury the effective owner of the Fannie Mae and Freddie Mac.
This morning CBO’s Assistant Director for Financial Analysis Deborah Lucas testified before the House Budget Committee on several topics related to the government’s mortgage programs, including:
- CBO’s estimates of the budgetary cost of the government’s takeover and continuing operation of Fannie Mae and Freddie Mac;
- How the budgetary treatment of those two enterprises differs from that of the Federal Housing Administration (FHA) and other federal mortgage programs and the potential problems those inconsistencies cause; and
- Alternative options for the future role of the federal government in the secondary mortgage market.
CBO’s Budgetary Treatment of Fannie Mae and Freddie Mac
In CBO’s judgment, the federal conservatorship of Fannie Mae and Freddie Mac make the two entities effectively part of the government and imply that their operations should be reflected in the federal budget. Hence, in its baseline budget projections, CBO accounts for the cost of the GSEs’ operations as though they are being conducted by a federal agency, showing the annual subsidy costs of their new mortgage guarantees. (A more complete discussion of CBO’s budgetary treatment can be found in a January 2010 background paper.)
After consulting with the House and Senate Budget Committees, CBO concluded that using a fair-value approach to estimate subsidy costs for Fannie Mae and Freddie Mac would give the Congress the most accurate and comprehensive information about the budgetary costs of supporting the GSEs. A fair-value approach provides estimates of the value of the GSEs’ assets and liabilities that either correspond to or approximate market prices in a well-functioning market.
The fair-value approach CBO is using for these projections differs from the procedures specified by the Federal Credit Reform Act of 1990 (or FCRA), which applies to most federal direct loan or loan guarantee programs. Unlike FCRA estimates (which use Treasury rates for discounting), fair-value estimates use discount rates that incorporate a risk premium. The inclusion of a risk premium recognizes that the financial risk that the government assumes when issuing guarantees represents a cost to taxpayers. Those two approaches paint very different pictures of the cost of continuing to operate Fannie Mae and Freddie Mac over the next decade under current law: Whereas on a fair-value basis new obligations generate a budgetary cost, under FCRA the continuing operations would result in budgetary savings.
Unlike CBO, the Administration’s Office of Management and Budget (OMB) treats Fannie Mae and Freddie Mac as nongovernmental entities for budgetary purposes. In the budget, OMB records only cash transfers between the Treasury and the two GSEs. That approach can postpone for many years the recognition of the costs of new guarantee obligations.
CBO’s Estimates of the Cost of the GSEs’ Activities
In August 2009, CBO estimated that the cost of all of the GSEs’ mortgage commitments made through the end of 2009 would total $291 billion on a fair-value basis. Since then, CBO has not updated its estimate of the cost of those past commitments. However, the GSEs’ financial reports suggest that losses on those obligations may have increased somewhat since that time because of the continued deterioration of conditions in the housing market.
Looking forward, in its March 2011 baseline projections CBO estimates that the new guarantees the GSEs will make over the next decade will cost the government $42 billion on a fair-value basis. Although the average subsidy rate for the GSEs’ new business has fallen since the peak of the financial crisis, the subsidy rate will remain positive as long as Fannie Mae and Freddie Mac provide guarantees on mortgages at prices below what private financial institutions offer.
Options for the Federal Role in the Secondary Mortgage Market
Policymakers are contemplating a wide range of proposals for the federal role in the secondary mortgage market in general, for the future of Fannie Mae and Freddie Mac in particular, and for the transition to a new model. The broad options include:
- Moving to a hybrid public/private approach that would involve explicit federal guarantees of some privately issued mortgage-backed securities;
- Establishing a fully federal agency that would purchase and guarantee qualifying mortgages; or
- Promoting a fully private secondary mortgage market with no federal guarantees.
Any new approach would need to confront major design issues—if the approach included federal guarantees, how to structure and price them; whether to support affordable housing and, if so, by what means; and how to structure and regulate the secondary market. In a recent study, CBO analyzed those alternatives and the tradeoffs among them.
Comparability of Cost Estimates Across Federal Housing Programs
In CBO’s judgment, continuing to use a fair-value approach to estimate subsidy costs for Fannie Mae and Freddie Mac would provide the most accurate and comprehensive measure of the cost to taxpayers of any eventual transition to a new model for the federal role in the secondary mortgage market. However, doing so would maintain the practice of accounting for similar federal credit programs and financial transactions in different ways. Currently, fair-value accounting is used to estimate the budgetary cost of activities of the Troubled Asset Relief Program, as well as for CBO’s baseline projections of the cost of operating Fannie Mae and Freddie Mac, but the FCRA approach is used to estimate the cost of federal mortgage guarantee programs operated by the Department of Veterans Affairs (VA) and FHA.
The practice of using different accounting methods for similar federal obligations can cause confusion, make it difficult to accurately compare costs between programs, and create an incentive to rely more on programs or activities that have relatively low budgetary costs even if their full costs to taxpayers are higher. Providing an illustration, CBO recently compared the estimated cost of FHA’s single-family mortgage insurance program on a FCRA versus a fair-value basis. The two approaches yield very different estimates. Under the FCRA methodology, the program would produce budgetary savings of $4.4 billion in fiscal year 2012. On a fair-value basis, in contrast, the program would have a cost of $3.5 billion in 2012.