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This report on the desirability and feasibility of privatizing the two largest government-sponsored enterprises (GSEs)--the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac--satisfies part of section 1355 of the Federal Housing Enterprise Safety and Soundness Act of 1992. That statute directed the Secretary of the Treasury, the Secretary of Housing and Urban Development (HUD), the Comptroller General, and the Director of the Congressional Budget Office (CBO) to study the desirability and feasibility of repealing the charters of the GSEs, eliminating federal sponsorship of the enterprises, and permitting them to operate as fully private entities. The legislation directed the studies to address the effects of privatization on costs to the enterprises, cost of capital, home ownership, secondary market competition, capital requirements for GSEs, secondary market liquidity, and other factors deemed appropriate.

In addition, the House Banking Committee's Subcommittee on Capital Markets, Securities, and Government-Sponsored Enterprises has requested that the studies provide:

• An analytic framework;
  
  
• Policy options for improving the balance of public benefits and costs; and
  
  
• A comparison of the benefits and costs of three alternatives: maintain the status quo, adjust the activities or responsibilities of the GSEs, or privatize them.

Marvin Phaup of CBO's Special Studies Division prepared this study with the assistance of Marlies Dunson and Matt Eyles, under the supervision of Robert W. Hartman. The author is greatly indebted to CBO staff for support, insight, and assistance, especially Douglas Hamilton, James Blum, Gail Del Balzo, Robert Dennis, Stanley L. Greigg, Ellen Hays, Kim Kowalewski, Dan Kowalski, Mary Maginniss, Angelo Mascaro, Neal Masia, Jay Noell, David Torregrosa, Rae Roy, Nathan Stacy, David Gaffney, Lenny Skutnik, and David Rafferty.

CBO also acknowledges the contribution of Franklin D. Raines, Vice Chairman of Fannie Mae, and Robert B. Zoellick, Executive Vice President, General Counsel, and Secretary of Fannie Mae, who briefed CBO staff while this report was being prepared. In addition, Leland C. Brendsel, Chairman of Freddie Mac, commented extensively on the study. Fannie Mae and Freddie Mac staff also produced helpful reviews of a draft of this study under a severe time constraint.

The staff of the Office of Federal Housing Enterprise Oversight--especially Patrick Lawler, Christopher Lewis, David Pearl, and Robin Seiler--offered a number of helpful comments and suggestions. Susan E. Woodward contributed a useful critique. Edward J. Kane, Ben E. Laden, and John C. Weicher served as external reviewers of the CBO study.

Five contract studies were prepared in support of this and the other agencies' reports and are cited frequently in this report. They are:

• Brent Ambrose and Arthur Warga, Implications of Privatization: The Costs to FNMA and FHLMC.
  
  
• Robert Cotterman and James Pearce, The Effects of FNMA and FHLMC on Conventional Fixed-Rate Mortgage Yields.
  
  
• Benjamin Hermalin and Dwight Jaffee, The Privatization of Fannie Mae and Freddie Mac: Implications for Mortgage Industry Structure.
  
  
• Susan Wachter, James Follain, Peter Linneman, Roberto Quercia, and George McCarthy, Implications of Privatization: The Attainment of Social Goals.
  
  
• Thomas H. Stanton, Restructuring Fannie Mae and Freddie Mac: Framework and Policy Options.

The Department of Housing and Urban Development is publishing those supporting papers as Studies on Privatizing Fannie Mae and Freddie Mac (May 1996). In this report, that volume is referred to as HUD Studies. CBO acknowledges the contributions of the interagency working group that planned and coordinated the preparation of those studies, including William Kruvant, William Shear, Mitchell Rachlis, Fred Evans, and Paul Thompson from the General Accounting Office; Harold Bunce, John Gardner, and Stephanie Smith from HUD; and Joan Affleck-Smith, Edward DeMarco, and Mario Ugoletti from the Treasury Department.

Paul L. Houts edited this report. Christian Spoor provided editorial and production assistance. Kathryn Quattrone prepared the report for final publication.
 

June E. O'Neill
Director
May 1996
 
 

SUMMARY

ONE - UNDERSTANDING THE HOUSING GSEs: WHAT, WHY, HOW?

• Reviewing the Purpose and Function of the Housing GSEs
• How the Housing GSEs Segment the Secondary Market
• Alternative Funding Strategies and Risk
• The Necessity of Congressional Oversight

TWO - THE FEDERAL COSTS OF FANNIE MAE AND FREDDIE MAC

• What Does GSE Status Mean?
• The Credit Enhancement of Government-Sponsored Enterprises
• Annual Costs of the GSEs
• Estimating the Annual Funding Savings to the GSEs
• Benefits, Subsidies, and Value Added to the GSEs
• Assessing the Estimates
• Sensitivity Analysis
• Summing Up

THREE - THE PUBLIC BENEFITS OF THE HOUSING GSEs

• Providing Lower Interest Rates to Home Buyers
• Providing Market Stability
• Advancing Technology
• Extending Low-Income Home Ownership
• Summing Up

FOUR - THE CONGRESS AND THE GSEs: WEAK CONTROL AND INCOMPATIBLE INTERESTS

• Choosing a GSE or Non-GSE Structure
• Examining the Role and Limitations of the Office of Federal Housing Enterprise Oversight
• Taking into Account Subsidized Profits and Political Risks

FIVE - OPTIONS FOR IMPROVING THE GSE COST-BENEFIT BALANCE FOR TAXPAYERS

• Increase Public Benefits
• Reduce Public Costs
• Improve the Ability of Government to Monitor the GSEs
• Privatize
• Fairness for the Housing GSEs
• Remaining Questions

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