GSE Reform

Determining the fate of Fannie Mae and Freddie Mac

Before the recent financial crisis, Fannie Mae and Freddie Mac held roughly $1.6 trillion in debt, almost one-third of the total corporate debt in the entire U.S. economy. Fannie and Freddie, the two housing Government-Sponsored Enterprises, purchase mortgages from lenders, bundle them into groups of mortgages and then sell shares of the groups of mortgages (mortgage-backed securities) to the private market in a process known as securitization. They also hold a significant number of loans in their own portfolios.

Fannie and Freddie failed when the housing economy collapsed, leaving U.S. taxpayers on the hook for more than $180 billion in mortgage-related losses. Lack of meaningful regulation and significant undercapitalization led to their failure, and due to the implicit guarantee that the federal government would never let these GSEs fail, Fannie and Freddie had to be placed into conservatorship in late 2008, during the height of the financial crisis. Together, the GSEs own or guarantee more than half of the $10 trillion U.S. mortgage market. The conservatorship dramatically increased the risks to the government--and taxpayers--because the government has now taken full responsibility for the GSEs' liabilities.

Initial steps to reform:

  • Raise the base guarantee fee to encourage development of the private market and to begin to repay the government's investment in Fannie Mae and Freddie Mac.
  • Lower loan limits for GSE purchases. This will help in the development of a private market, reducing the government's role (and liability) in housing finance.

The issue:

  • The guarantee fees (G-fees) that lenders pay to the GSEs for buying, bundling and using mortgage-backed securities are too low. The compensation paid for what amounts to full government backing is simply not priced correctly. This creates an entry barrier for private capital seeking to compete with the GSEs to carry out securitization in the secondary market. This drives business to the GSEs and adds ever-higher levels of risk to the government.
  • The loan limits for mortgages that the GSEs can purchase are too high. The average mortgage loan was $235,000 in 2012; the current maximum loan limit of $625,500 in high-cost areas and $417,000 in all other areas is dramatically higher than necessary for the purchase of a moderately priced home. Such high limits have made it possible for the GSEs to hold too large a share of the housing finance market.