Introduction to Financial Services: The Housing Finance System

Introduction to Financial Services: The Housing Finance System

Updated January 5, 2023
Introduction to Financial Services: The Housing Finance System
Background
The Federal Housing Finance Agency (FHFA) is the
Prior to the Great Depression, U.S. residential mortgage
primary regulator of the FHLB System.
markets operated at local levels and were highly sensitive to
local conditions. Lenders funded mortgages by relying on
 Federal Housing Administration (FHA). The National
local deposits, which were concentrated in heavily
Housing Act of 1934 (P.L. 73-479) created FHA, now a
populated areas, such as Chicago and New York, rather
Department of Housing and Urban Development (HUD)
than less populated areas in need of loans. Interstate
agency. FHA insures private lenders against the default
banking restrictions made it difficult to move funds from
risks on mortgages meeting certain criteria. FHA
geographical areas with large concentrations of deposits to
introduced fixed-rate mortgages with maturities of 20
areas with comparatively smaller amounts. The immobility
years or more, evolving into the 30-year fixed rate
of funds contributed to differences in mortgage rates and
mortgages commonly used today.
underwriting (loan qualifying) criteria across the nation.
 Department of Veterans Affairs (VA). Congress
During economic downturns, frequent deposit withdrawals
created the VA home loan program in 1944 (P.L. 78-
led to cash flow (liquidity) shortages that stymied lending.
346). Similarly to FHA, the VA loan guaranty program
At the time, savings and loan associations (S&Ls)—
insures private lenders against the default risks on
nonprofit, member-owned cooperative financial institutions
mortgages made to veterans who meet certain criteria.
that relied on members’ savings deposits to fund
Unlike FHA, VA does not insure 100% of a loan’s
mortgages—were the primary sources of home financing
default risk; a percentage of the default risk is
during liquidity shortages. S&Ls were unable to borrow
guaranteed based on the loan’s principal balance.
temporary funds from the Federal Reserve System because
they were not eligible members. For this reason, the lending
 Fannie Mae (Federal National Mortgage
terms of residential mortgages were structured to reduce
Association). Title III of the National Housing Act of
liquidity risks borne by S&Ls. For example, borrowers
1934 initially established Fannie Mae as a federal
were required to make large down payments (e.g., 50%-
agency to purchase federally insured mortgages from
60%) to mitigate default risks and to reduce mortgage sizes,
lenders. By holding residential mortgages on its balance
thereby reducing the amount of funds small lenders needed
sheet, Fannie Mae extended the risk-bearing capacity of
to collect to make loans. Mortgages typically had variable
the mortgage market when small lenders lacked capacity
interest rates and 10- to 12-year maturities, thus mitigating
and access to funds. In 1968, Congress split Fannie Mae
cash flow disruptions due to frequent changes in local
into two distinct organizations (P.L. 90-448). The
mortgage rates.
private-sector organization retained the Fannie Mae
name and operated like an interstate lender, purchasing
Government Interventions to Facilitate
mortgages and funding them by issuing debt securities.
Mortgage Market Liquidity
Over the years, Congress has addressed market liquidity
 Ginnie Mae (Government National Mortgage
issues, particularly for single-family mortgages (i.e., loans
Association). Congress created the federal agency
secured by residential dwellings having one to four separate
Ginnie Mae in 1968 after splitting Fannie Mae. Ginnie
units), by establishing federal agencies and government-
Mae sells to private investors the interest rate risks
sponsored enterprises (GSEs). Some of the key ones are
linked to mortgages that are federally insured against
listed below.
default risk by FHA or VA.
 Federal Home Loan Bank (FHLB) System. Created in  Freddie Mac (Federal Home Loan Mortgage
1932 (P.L. 72-304), the FHLB System is a GSE that
Corporation). Congress created Freddie Mac in 1970
currently consists of 11 regional FHLBs. Each FHLB
(P.L. 91-351) as a GSE and subsidiary of the FHLB
provides liquidity to member lending institutions in its
System. Freddie Mac was authorized to buy
district in the form of advances, which are temporary
conventional mortgages, which are mortgages without
cash loans that must be collateralized (secured) by
insurance provided by a federal government agency.
members’ eligible assets that promote housing finance
Freddie Mac largely purchased mortgages from S&Ls
and community development (e.g., mortgages,
and funded them by issuing debt securities.
mortgage-related assets, and certain small business
loans). The FHLBs initially served as lenders of last
Following passage of P.L. 101-73 in 1989, the business
resort for S&Ls. Congress expanded their membership
models and missions of Fannie Mae and Freddie Mac
in 1989 to serve in that role for banks and credit unions.
(F&F) were harmonized, allowing them to purchase
mortgages and sell mortgage-backed securities (MBS)
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Introduction to Financial Services: The Housing Finance System
linked to the underlying mortgages. (MBS investors are
 Recent Congresses have debated the optimal post-crisis
typically large institutional investors, such as pension
structure of F&F. Some plans have suggested
funds, domestic banks, foreign banks, and hedge funds.)
eliminating or shrinking F&F. Some plans would rely
F&F must also fulfill required affordable housing goals
predominantly on the private sector to replace them, and
regularly set by their primary regulator, FHFA.
others would have an explicit government guarantee to
supplement private capital under certain circumstances.
The federal government does not facilitate all of the
 In response to relaxed pre-crisis mortgage underwriting
activities that would generate liquidity for mortgage
standards, in 2010 Congress passed the Dodd-Frank
markets. Private financial institutions may issue MBSs,
Wall Street Reform and Consumer Protection Act (P.L.
known as private-label securities (PLSs). Although PLSs
111-203). Among other things, the act provides legal
can be linked to any type of mortgage, they are often linked
protections to lenders if their loans satisfy the
to pools of nonconforming mortgages, which either exceed
requirements for qualified mortgage (QM) status.
the conforming loan limit (jumbo mortgages) or do not
Because all loans guaranteed by the federal agencies or
meet F&F’s creditworthiness standards.
purchased by F&F receive QM status, these entities
Selected Policy Issues
have increased in importance. Many originators have
limited themselves to making only QM loans to avoid
The U.S. mortgage market attracts funding from global
exposure to potential liability and litigation risks. A
investors. Consequently, rather than reflect more of the
loan’s ability to receive QM status after F&F purchases
costs borne by regional lenders to acquire funds, modern
it, however, expires either when F&F exit
mortgage rates better reflect the payment and default risk
conservatorship or after an October 1, 2022, deadline
behaviors of borrowers. Along with assuming various
extension—whichever comes first. Afterward, F&F
financial risks, the federal government agencies (FHA, VA,
could limit their purchases to QMs or charge higher fees
Ginnie Mae) and the GSEs (the FHLB System, F&F) have
for non-QM loans to offset potential legal and
facilitated greater standardization of mortgage products and
compliance risks. Either response would likely affect
borrower underwriting criteria. Greater liquidity in the
mortgage credit availability and liquidity.
modern mortgage market has made it possible to offer
products with less liquid features (e.g., fixed rates, 30-year
 The federal government also facilitates the liquidity of
maturities, larger amounts) than those offered in the early
multifamily mortgages (i.e., loans secured by residential
1900s. These developments have arguably contributed to
dwellings, such as apartment buildings, with at least five
lowering borrowers’ costs to finance homeownership,
or more separate units) to promote the construction of
possibly contributing to rising homeownership rates.
affordable rental units. Providing liquidity to this market
does not mitigate the impacts linked to rising
Along with liquidity benefits, government intervention in
construction costs and rents, which have risen at faster
the mortgage market brings about costs. For example, the
rates compared with household incomes.
financial markets might perceive the GSEs as being too
important for the government to allow any of them to fail.
Additional CRS Resources
In this case, the GSEs may have an incentive to take on
CRS Report R46855, Housing Issues in the 117th Congress
greater financial risks, including competing for lending
opportunities that the private sector would willingly take.
CRS Report R46499, The Federal Home Loan Bank
As a result, taxpayers could ultimately bear the costs of
(FHLB) System and Selected Policy Issues
risk-taking by the GSEs. The benefits to borrowers have
also been debated. F&F, for example, purchase mortgages
CRS Report RS20530, FHA-Insured Home Loans: An
primarily offered to prime (creditworthy) borrowers and
Overview
loan refinances for existing homeowners (rather than
focusing solely on first-time buyers). Hence, the liquidity
CRS Report R42504, VA Housing: Guaranteed Loans,
benefit may accrue to borrowers who would already have
Direct Loans, and Specially Adapted Housing Grants
access to favorable mortgage rates. In addition, the benefits
received by reducing the costs to finance homeownership
CRS Report R45828, Overview of Recent Administrative
may be offset if the overall demand for housing increases,
Reforms of Fannie Mae and Freddie Mac
prompting increases in house prices.
CRS Report R44525, Fannie Mae and Freddie Mac in
On September 6, 2008, FHFA placed F&F in
Conservatorship: Frequently Asked Questions
conservatorship (i.e., took control of F&F from their
stockholders and management) following financial loss
CRS In Focus IF11413, The Qualified Mortgage (QM) Rule
from extreme turmoil in the housing and mortgage markets.
and the QM Patch
Treasury received preferred shares in F&F in exchange for
financial support in the form of funding commitments. As
CRS Report R46480, Multifamily Housing Finance and
of June 15, 2020, Treasury has extended a combined total
Selected Policy Issues
of $191.4 billion to F&F and received $301 billion in
dividend payments, which are not applied to repayment of
Darryl E. Getter, Specialist in Financial Economics
the $191.4 billion in funding. These developments have led
to policy issues for Congress, including the following:
IF11715
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Introduction to Financial Services: The Housing Finance System

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