Introduction to Financial Services: The Housing Finance System

Introduction to Financial Services: The Housing Finance System

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Updated January 8, 2019
Introduction to Financial Services: The Housing Finance System
This In Focus provides a summary of the U.S. single-family
(MBS), and the payment streams associated with the
housing finance system and several related policy issues
mortgages are sold to investors.
that have been of importance to Congress.
Mortgages can be securitized through three channels:
The Mortgage Market
A loan that uses real estate as collateral is typically referred
 Fannie Mae and Freddie Mac, two government-
to as a mortgage. The U.S. mortgage market is one of the
sponsored enterprises (GSEs), securitize mortgages that
largest markets in the world, with approximately
conform to their standards (conforming mortgages). To
$10 trillion in debt outstanding. The mortgage market can
be a conforming mortgage, the mortgage must meet
be thought of as having two major components—the
certain creditworthiness thresholds and be below the
primary market in which mortgages are originated and the
conforming loan limit, a cap on the principal balance of
secondary market in which existing mortgages are bought
the mortgage. The GSEs guarantee that the investors in
and sold.
their MBS will receive timely payment of principal and
interest even if the borrower becomes delinquent.
Primary Market. A potential borrower applies for a
 Ginnie Mae, a government agency in the Department of
mortgage from a lender (a mortgage originator) in the
Housing and Urban Development, guarantees MBS
primary market. The lender underwrites, or evaluates, the
issued by private entities but made up exclusively of
borrower and decides whether and under what terms to
mortgages guaranteed by the federal government (such
extend a loan. Different types of lenders make home loans,
as by FHA). Ginnie Mae’s guarantee is backed by the
including banks, credit unions, and finance companies
full faith and credit of the U.S. government.
(institutions that lend money but do not accept deposits).
 Private financial institutions also issue MBS, known as
The lender usually requires some additional assurance that
private-label securities (PLS). PLS can be composed of
it will be likely to recoup the amount it is owed even if the
any type of mortgage but often contain nonconforming
borrower does not repay the mortgage. Typically, lenders
mortgages that either exceed the conforming loan limit
receive such assurance through a down payment (which
(jumbo mortgages) or do not meet Fannie Mae’s or
reduces the amount that is borrowed relative to the home
Freddie Mac’s creditworthiness standards (non-prime or
value), mortgage insurance, or a combination of the two.
subprime mortgages). PLS do not have an implicit or
Mortgage insurance protects the lender when a borrower
explicit government guarantee.
does not repay a mortgage. It can be provided privately or
MBS generally are divided into two broad categories:
through a government agency, such as the Federal Housing
agency MBS, which includes GSE and Ginnie Mae MBS,
Administration (FHA). Mortgage insurers set requirements
and non-agency MBS, which is only PLS. Investors that
that vary by provider, and borrowers typically pay explicit
purchase mortgages and MBS are an important source of
fees for the insurance. FHA is the largest provider of
funding for mortgages originated in the primary market.
government mortgage insurance, but the government also
Investors in MBS are typically large institutional investors,
provides access to the mortgage market through programs
such as pension funds, domestic banks, foreign banks, and
offered by the Department of Veterans Affairs and the U.S.
hedge funds. Investors choose which type of MBS to
Department of Agriculture.
purchase based on the type and amount of risk they wish to
bear and the expected return from their investment.
If a mortgage is made, the borrower sends the required
scheduled payments to a mortgage servicer, which then
Figure 1 illustrates the changing role of various MBS
remits the payments to the mortgage holder (which could
issuers since 2000. In the early 2000s, Ginnie Mae played a
be the original lender or, if the mortgage is sold, an
minor role and non-agency issuers played a growing role.
investor). If the borrower does not repay the mortgage as
During and after the financial crisis of 2007-2010, Ginnie
promised, the servicer can attempt to keep the borrower in
Mae’s market share increased and PLS issuance became
the home through a work out option (such as reducing the
negligible.
mortgage interest rate) or can repossess the property
through a process known as foreclosure.
Secondary Market. The secondary market is the market
for buying and selling mortgages. If a mortgage originator
sells the mortgage in the secondary market, the purchaser of
the mortgage may choose to hold the mortgage itself or to
securitize it. When a mortgage is securitized, it is pooled
with other mortgages to create a mortgage-backed security
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Introduction to Financial Services: The Housing Finance System
Figure 1. MBS Issuance Volume
Policy Issues
The bursting of the housing bubble in 2007, the ensuing
multiyear downturn in the housing and mortgage markets,
and the recovery from that downturn have raised several
issues for Congress, some of which are discussed below.
Financial Status of the GSEs and FHA. Fannie Mae and
Freddie Mac experienced significant financial losses due to
the housing downturn. FHFA placed them in voluntary
conservatorship in September 2008, where they currently
remain. They have received approximately $191 billion in
assistance from the government and in exchange have made
dividend payments to the government in excess of that
amount. FHA also experienced financial stress from the
housing downturn and received $1.7 billion from Treasury
Source: Inside Mortgage Finance Publications, 2018—Mortgage
in FY2013 to ensure it would have enough funds to cover
Market Statistical Annual.
its expected future costs. Although FHA and the GSEs have
been more financially stable of late, Congress continues to
Another key supplier of mortgage funding is the Federal
conduct oversight of the GSEs and FHA.
Home Loan Bank (FHLB) System, also a GSE. The FHLB
System is composed of 11 regional banks owned by their
Housing Finance Reform. Some have questioned whether
members, such as banks and other financial institutions
the precrisis structure of the housing finance system is
involved in housing finance. The FHLBs extend credit to
appropriate for the future. Congressional interest also has
their members, primarily to support mortgage lending.
focused on determining the future role of the federal
Government Regulation of the Mortgage government in housing finance. Many proposals in recent
Market
Congresses have suggested eliminating or shrinking Fannie
Mae and Freddie Mac. Some plans would rely
A full description of the government’s role in regulating the
predominantly on the private sector to replace them, and
housing finance system is beyond the scope of this In
others would have an explicit government guarantee to
Focus, but several important functions performed by the
supplement private capital under certain circumstances.
government are described below.
Mortgage Market Rulemakings. Financial regulators have
The Federal Housing Finance Agency (FHFA) is the
implemented many mortgage-related rules that were
regulator and conservator of Fannie Mae and Freddie Mac
required by the Dodd-Frank Act. Although each is different,
and the regulator of the FHLB system.
several policy issues are common across them, including
concerns about compliance costs for financial institutions,
The federal banking regulators—the Federal Reserve, the
questions about how the rules affect credit availability for
Office of the Comptroller of the Currency (OCC), the
creditworthy borrowers, and questions about whether
Federal Deposit Insurance Corporation (FDIC), and the
revisiting the new rules could lead to changes that may
National Credit Union Administration (NCUA)—influence
harm consumers.
the mortgage market through their oversight of banks. For
example, regulators influence the underwriting standards
Access to Credit and Affordability. In recent years, many
that banks use and set capital requirements that apply to
lenders tightened underwriting standards, making it more
mortgages and MBS held by banks.
difficult for some borrowers to receive mortgages. In
addition, some claim that recent rulemakings and other
The Securities and Exchange Commission (SEC) oversees,
factors have led to a contraction in the credit available to
among other things, the selling of securities to the public.
potential homeowners or increased the cost of such credit.
The SEC has disclosure and registration standards that, in
Congress may consider proposals to ensure that
some cases, apply to MBS.
creditworthy borrowers have access to affordable financing.
The Bureau of Consumer Financial Protection (BCFP or
CRS Resources
CFPB), created by the Dodd-Frank Act (P.L. 111-203),
CRS Report R42995, An Overview of the Housing Finance
regulates certain bank and nonbank participants in the
System in the United States.
mortgage market and administers certain rules intended to
protect consumers, including requirements that lenders
CRS Report R45296, Housing Issues in the 115th
verify a borrower’s ability to repay the mortgage and
Congress. In particular, see the “Housing Finance Issues in
standards related to mortgage servicing. The CFPB also has
the 115th Congress” section.
authority under additional federal consumer laws to
regulate parts of the mortgage market.
Katie Jones,
The states play an important role in the regulation of the
N. Eric Weiss,
housing and mortgage markets. For example, the
IF10126
foreclosure process is governed by state law.
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Introduction to Financial Services: The Housing Finance System

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