Mandatory Spending

Function 370 - Commerce and Housing Credit

Raise Fannie Mae’s and Freddie Mac’s Guarantee Fees and Decrease Their Eligible Loan Limits

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of Dollars 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2017-2021 2017-2026
Change in Outlays                        
  Increase guarantee fees 0 -0.8 -0.3 -0.1 -0.3 -0.5 -0.5 -0.7 -1.0 -1.4 -1.6 -5.6
  Decrease loan limits 0 -0.1 -0.1 * -0.1 -0.2 -0.2 -0.1 -0.2 -0.3 -0.3 -1.2
  Both alternatives abovea 0 -0.9 -0.4 -0.1 -0.4 -0.6 -0.6 -0.7 -1.0 -1.4 -1.8 -6.0

This option would take effect in October 2017.

* = between –$50 million and zero.

a. If both alternatives were enacted together, the total effect would be less than the sum of the effects of each alternative because of interactions between them.

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. Those GSEs carry out that mission through two activities in the secondary mortgage market (that is, the market for buying and selling 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 generally can 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 half of all single-family mortgages that originated in 2015.

In September 2008—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—the federal government took control of Fannie Mae and Freddie Mac in a conservatorship process. 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 2017 through 2026 will cost the federal government $12 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. CBO’s estimates are constructed on a present-value basis. (A present value is a single number that expresses a flow of current and future payments in terms of an equivalent lump sum paid today; the present value of future cash flows depends on the discount rate that is used to translate them into current dollars.) By contrast, the Administration’s projections focus on the cash flows between the enterprises and the Treasury. Those cash flows reflect a mix of existing and new business. Both CBO and the Administration expect the government to receive substantial net cash inflows from Fannie Mae and Freddie Mac over the 2017–2026 period.

This option includes two approaches to reduce the federal subsidies that Fannie Mae and Freddie Mac receive. 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 is equivalent to 1 percentage point), to more than 65 basis points, on average, beginning in October 2017. 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, with respect 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 $6 billion from 2017 through 2026, would cause new guarantees by Fannie Mae and Freddie Mac to fall by around 10 percent, and would change the mix of borrowers, CBO estimates. (The effect on spending is the sum of the present values of the decreases in subsidies for mortgages made in each of nine years after the option would take effect.)

In the second approach, the maximum size of a mortgage that Fannie Mae and Freddie Mac could include in their MBSs would be reduced, beginning with a drop to $417,000 in October 2017, followed by drops to $260,000 in 2021 and $175,000 in 2024. (Guarantee fees would remain as they are under current law.) That reduction in loan limits would save $1 billion from 2017 through 2026 because new guarantees would fall by about 20 percent, CBO estimates.

Taking both approaches together would lower federal subsidies for Fannie Mae and Freddie Mac by $6 billion from 2017 through 2026 and would result in a drop in new guarantees of about 25 percent, 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 little effect on subsidies. For consistency, similar changes could be made to the limits on loans guaranteed by the Federal Housing Administration (FHA). The estimates presented here do not include the effects of lower limits on FHA loans, which would affect discretionary spending subject to appropriations.

Because some of the subsidies that Fannie Mae and Freddie Mac receive 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 might be slightly higher, on average.

The major advantage of those approaches to reduce 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. Lessening subsidies also would help address the current underpricing of mortgage credit risk, which encourages borrowers to take out bigger mortgages and buy more expensive homes. Consequently, the option could reduce overinvestment in housing and shift the allocation of some capital toward more productive activities.

A particular advantage of lowering loan limits, instead of 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 other sources of financing. The $175,000 limit would allow for the purchase of a home for about $220,000 (with a 20 percent down payment), which was roughly the median price of an existing single-family residence in March 2016; thus, lowering loan limits as specified here would not affect most moderate- and low-income borrowers.

One disadvantage of reducing subsidies for the GSEs and thereby increasing the cost of mortgage borrowing is that doing so could weaken housing markets because new construction and new home sales have not completely recovered from their sharp drop several years ago. Moreover, mortgage delinquency rates remain elevated, and many borrowers are still “underwater” (that is, 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 some consumers and thereby dampening the growth of private spending. Phasing in the specified changes more slowly could mitigate those concerns, although that approach would reduce the budgetary savings as well. Finally, by affecting the GSEs, this option would make FHA loans more attractive to some borrowers (without 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.