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

Background

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. The GSEs carry out that mission in the secondary mortgage market (the market for buying and selling mortgages after they have been issued): They buy mortgages from lenders and pool those mortgages to create mortgage-backed securities (MBSs), which they sell to investors and guarantee against losses from defaults. Under current law, in 2018 Fannie Mae and Freddie Mac generally can purchase mortgages of up to $679,650 in areas with high housing costs and up to $453,100 in other areas; regulators can alter those limits if house prices change. The two GSEs provided credit guarantees for about half of all mortgages for single-family homes that originated in 2017.

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. As a result, the Congressional Budget Office concluded that the institutions had effectively become government entities whose operations should be reflected in the federal budget. By contrast, the Administration considers the GSEs to be nongovernmental entities.

Under current law, CBO projects, the mortgage guarantees that the GSEs issue from 2019 through 2028 would cost the federal government $19 billion. That estimate reflects the subsidy rate that CBO attributes to the guarantees—the difference between the cost of the guarantees and any fees received by the GSEs as a percentage of the original unpaid principal balance. CBO's estimates are constructed on a present-value basis. (Present value is a single number that expresses a flow of current and future income or payments in terms of an equivalent lump sum received or paid today.)

The Administration's projections focus on the annual cash transactions between the enterprises and the Treasury. Those transactions include potential outlays for purchases of stock from the GSEs that would be needed to maintain the GSEs' solvency. Those transactions also include dividends on the Treasury's stock holdings, which are paid to the Treasury. Essentially, those dividend payments reflect the GSEs' quarterly income. Those cash flows stem from both existing and new business. Under current law, both CBO and the Administration expect that the Treasury would receive substantial net cash inflows from Fannie Mae and Freddie Mac over the 10-year period; CBO views those transactions as intragovernmental, whereas the Administration considers them to be payments from private firms to the government.

Option

This option includes two alternatives to reduce the budgetary costs of Fannie Mae and Freddie Mac. In the first alternative, the average guarantee fee that Fannie Mae and Freddie Mac assess on loans they include in their MBSs would increase by 5 basis points (100 basis points equal 1 percentage point), to more than 60 basis points, on average, beginning in October 2019. 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 by 15 basis points, relative to the fee that would be in effect under current law, after 2021.

In the second alternative, the size of the mortgages that Fannie Mae and Freddie Mac included in their MBSs would be reduced, beginning by setting the maximum mortgage in all areas at $453,100 in 2020 (eliminating the higher limit in high-cost areas) and then reducing that maximum by 5 percent a year until it reaches about $300,000 by 2028. (Guarantee fees would remain as they are under current law.)

Effects on the Budget

The first alternative, increasing guarantee fees, would reduce net federal spending by $10 billion from 2019 through 2028 and would cause the volume of new guarantees by Fannie Mae and Freddie Mac to fall by around 16 percent, CBO estimates. (The projected reduction in spending each year is the decrease in subsidy costs for mortgages guaranteed in that year.)

The second alternative, reducing loan limits, would save $3 billion from 2019 through 2028 because the volume of new guarantees would fall by about 29 percent, CBO estimates. That is because fewer loans would be eligible for the entities to purchase and pool as MBSs.

Taking both alternatives together would lower net federal spending by $12 billion from 2019 through 2028 and would result in a drop in new guarantees of about 38 percent, according to CBO's estimates. Because raising guarantee fees by 5 basis points initially and by 15 basis points after 2021 would eliminate most of the federal subsidy costs for the GSEs' guarantees, lowering the loan limits would have a smaller budgetary effect.

However, because the GSEs' profits would drop, CBO estimates that the alternatives would result in net reductions in cash receipts over 10 years under the Administration's cash accounting approach: The reduction in the amount the two GSEs paid the government would be greater than the amount that the government saved on potential stock purchases. Under the first alternative, increasing the fees would raise the net amount of cash flowing to the Treasury per loan, but the drop in the volume of guarantees would reduce that net cash flow by a larger amount. The effect would be a relatively small drop in net cash receipts from the GSEs to the Treasury. Under the second alternative, the decline in the volume of the guarantees would lead to substantial drops in cash receipts to the Treasury. Taking both alternatives together would also lead to significant decreases in net cash receipts.

To estimate changes in costs from increasing guarantee fees or decreasing loan limits, CBO estimates the effect on total loan guarantees and their subsidy rate. Raising guarantee fees would lower the cost of each guarantee and would reduce the number of guarantees because some borrowers would turn to privately backed mortgages. CBO's estimates of subsidy rates take into account how reducing loan limits and increasing fees would change the mix of borrowers and thus the credit risks borne by the GSEs.

Because the GSEs' guarantee fees are already close to those that CBO estimates private firms would charge, increases in those fees that were larger than those encompassed by this option would result in more borrowers taking out privately backed mortgages and would only marginally increase budgetary savings. Savings from changing the loan limits would be roughly proportional to the change in loan volume. (Whether savings would be proportional for bigger changes in loan limits is uncertain because the composition of the borrowers would change more.) Reducing loan limits more rapidly—say, over 5 years instead of 10 years—would save more money but would risk disrupting the supply of housing credit.

Many factors affect CBO's estimates of federal subsidies for Fannie Mae and Freddie Mac. CBO's model for the GSEs captures how changes in the mortgage market and in macroeconomic conditions affect mortgage performance and originations. Its inputs include projections of home prices, interest rates, unemployment rates, total mortgage originations, the GSEs' market share, and mortgage characteristics. CBO's estimates of subsidy rates are based on a large number of repeated (stochastic) simulations of mortgage defaults, losses given default, and the rate at which borrowers prepay their mortgages based on the GSEs' reported data on mortgage performance from 2000 to 2015.

The estimates for those alternatives are uncertain because both the total number of new guarantees and the cost per guarantee are uncertain. Those estimates rely in part on CBO's projections of the economy over the next decade. If a downturn in either the economy or in housing markets occurred, more borrowers would probably default on their mortgage loans and recoveries would be lower than in normal times, and as a result, budgetary costs would be higher than estimated. Conversely, if the GSEs purchased and guaranteed fewer mortgages than expected or if defaults were lower than expected, costs would be lower than estimated.

Other Effects

Because some of the benefits of Fannie Mae's and Freddie Mac's guarantees flow to mortgage borrowers in the form of lower rates, both alternatives in this option would slightly 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.

One argument for the alternatives is that they could support 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 GSEs' 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.

An argument for lowering loan limits instead of raising fees is that many moderate- and low-income borrowers would continue to benefit from the subsidies provided by the GSEs. More-affluent borrowers generally would lose that benefit, but they typically can more easily find other sources of financing. The $300,000 limit in 2028 would allow for the purchase of a home costing about $375,000 (with a 20 percent down payment). By comparison, the median price of an existing single-family residence in August 2018 was about $267,000; thus, lowering loan limits as specified here would probably not affect most moderate- and low-income borrowers.

One argument against taking steps that would increase the cost of mortgage borrowing is that doing so could slightly reduce home prices, hurting existing homeowners. 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, both alternatives would make loans guaranteed by the Federal Housing Administration (FHA) more attractive to the riskiest borrowers (unless there are corresponding changes to the rules governing such loans), which could increase risks for taxpayers because FHA guarantees loans with smaller down payments than do the GSEs.