Financing America's Housing

Financing America’s Housing:
The Vital Role of Freddie Mac

Executive Summary

Every day, Freddie Mac helps ensure that a stable supply of low-cost mortgages is available for families in every type of neighborhood all across America. Lower mortgage rates reduce housing costs for both owners and renters and contribute to higher homeownership rates. Stable mortgage flows help moderate cyclical swings in the housing market, which in turn stabilize broader business-cycle activity.

These public benefits flow directly from the charter and efficiencies of Freddie Mac--as Congress intended. In 1970, Congress created Freddie Mac and authorized Fannie Mae to create a secondary mortgage market for conventional mortgages.

The congressional charters contain restrictions to ensure that the two shareholder-owned corporations maintain a constant and exclusive focus on financing America’s housing. In addition, the charters provide tools to assist Freddie Mac and Fannie Mae in providing a stable supply of low-cost mortgage funds. With these tools and operating under the discipline of private-market incentives, the companies have proven their ability to reduce consumer costs, champion innovation and manage effectively. The companies not only pass through to borrowers the funding advantage that results from the charters and their efficient operations, but multiply this benefit to consumers several times over. The combination of congressional charter, public purpose and private capital uniquely positions Freddie Mac and Fannie Mae to serve as linchpins of the housing finance system.

Today, America’s housing finance system is the best in the world. Because of Freddie Mac and Fannie Mae, families across the nation can rely on a low-cost supply of mortgage credit whenever they need it:

Mortgage rates are lower. Mortgage rates in the conventional conforming market are one-half of a percentage point below jumbo market rates. This means, for example, that a borrower with a fixed-rate conforming loan pays 7.5 percent compared to 8.0 percent for a fixed-rate jumbo loan. This reduction saves homeowners $10 billion each year on interest costs. Lower mortgage rates, in turn, facilitate higher homeownership rates and reduce operating costs on rental property.
Home mortgage credit is readily available. Mortgage credit is readily available in communities across the country at about the same interest rate, regardless of whether a local housing market is at a cyclical peak or trough. This was not the case prior to the development of the secondary market for conventional mortgages. In short, Freddie Mac and Fannie Mae stabilize mortgage flows and help eliminate regional disparities.
A wider selection of mortgage products is offered. Borrowers enjoy a wide selection of loan products, including long-term, low-down-payment, fixed-rate mortgages without government insurance--the mortgage of choice in America. Such loans are less readily available in the U.S. jumbo market and largely absent in other nations.
Continuous innovation benefits families. From the creation of the first conventional mortgage-backed security in 1971 to the introduction of automated underwriting in 1995, Freddie Mac demonstrates that the companies invest in innovations that broaden the base of mortgage investors, reduce mortgage rates, improve the lending process and expand the market to new borrowers.
Home-financing opportunities are steadily expanding. Freddie Mac and Fannie Mae serve diverse homebuyers and renters. Through ongoing refinement of underwriting guidelines and other actions, they extend the reach of the secondary market to more borrowers and communities. In 1995, Freddie Mac’s and Fannie Mae’s purchases financed homes for one million low- and moderate-income families.

Freddie Mac and Fannie Mae provide these public benefits at no public cost:

Freddie Mac and Fannie Mae receive no taxpayer dollars. Neither company has received any taxpayer dollars. In addition, no taxpayer funds are needed for their safety and soundness regulator; Freddie Mac and Fannie Mae pay all costs associated with the Office of Federal Housing Enterprise Oversight (OFHEO).
Freddie Mac and Fannie Mae pay substantial taxes. As Fortune 500 companies, Freddie Mac and Fannie Mae pay sizable federal income taxes--more than $1.3 billion combined in 1995 alone.
Stringent capital tests ensure continued safety and soundness. Numerous government studies have concluded that the risk of insolvency is minuscule. Sound management and adequate capital protect taxpayers and enable the companies to continue providing public benefits. The industry’s toughest, most dynamic risk-based capital requirements and an exclusive regulator--two initiatives taken by Congress in 1992--essentially eliminate any taxpayer risk.

Repeal of Freddie Mac’s and Fannie Mae’s charters would impose the weaknesses of the jumbo market on all conventional borrowers, jeopardizing the benefits that American families have come to rely on--low-cost credit to finance their housing dreams:

Mortgage rates would rise. If Freddie Mac’s and Fannie Mae’s charters were repealed, mortgage interest rates would rise by at least one-half of a percentage point. This means that instead of paying 7.5 percent for their mortgages borrowers would pay 8.0 percent or more. Steeper increases in mortgage rates would occur during cyclical downturns in mortgage and housing markets.

Homeownership rates would fall, especially for low-income and minority families. If Freddie Mac’s and Fannie Mae’s charters were repealed, conventional low-down-payment mortgages would be less available. Combined with higher mortgage costs, this would cause homeownership rates for lower-income and minority families to decline by about 5 percent; younger families, including many first-time homebuyers, would experience an estimated 20-percent decline.

Families would bear more risk. If Freddie Mac’s and Fannie Mae’s charters were repealed, higher rates on fixed-rate mortgages would drive more consumers to adjustable-rate mortgages (ARMs). This would shift interest-rate risk to households and away from institutional investors, who have the tools to manage such risk. More Americans would lose their homes through default as a result.

Regional disparities in mortgage rates would return. If Freddie Mac’s and Fannie Mae’s charters were repealed, home mortgage lending would take on characteristics of the current jumbo mortgage market and the pre-1970 market for all conventional loans. Mortgage rates would vary with the business cycle and across both regional and local markets.

Home values would decline. If Freddie Mac’s and Fannie Mae’s charters were repealed, higher mortgage rates would cause home values to decline. In turn, this would reduce state and local real estate tax revenues.

Government risk and involvement in housing finance would increase. If Freddie Mac’s and Fannie Mae’s charters were repealed, the government and the taxpayer would be at greater risk--not less risk. The Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the Rural Housing Service (RHS) and federally insured depositories--all of which enjoy explicit government guarantees--would garner a much larger share of the mortgage market. Moreover, Congress could be pressured to address the subsequent disruption in the nation’s financial markets with new programs.

America’s housing finance system is the best in the world. As a result of the commitment, focus and service of Freddie Mac and Fannie Mae, mortgage borrowers have come to rely on a stable supply of low-cost mortgages. Each day, these companies provide vital, demonstrable public benefits at no public cost. Repealing the charters of Freddie Mac and Fannie Mae would trade these known benefits for adverse consequences for families and taxpayers.

Freddie Mac and Fannie Mae are congressional success stories. They represent the culmination of decades of effort to "bring the entrepreneurial skills and judgments of the private sector to bear on accomplishment of public purposes relating to housing."1 Maintaining their charters ensures a stable housing finance system and continued benefits

Footnotes:
1. S. Rep. No. 282, 102d Congress, 2d Session 25 (1992).