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The system for financing the construction and purchase of housing has changed significantly in recent years. In the context of this still-evolving housing finance system, the Congress is now considering proposals to alter further the federal role. This paper, requested by the Subcommittee on Housing and Community Development of the House Committee on Banking, Finance, and Urban Affairs, describes recent changes in the housing finance system and analyzes options for further legislation. In accordance with the mandate of the Congressional Budget Office (CBO) to provide objective and impartial analysis, this paper contains no recommendations.
Wilhelmina A. Leigh of CBO's Human Resources and Community Development
Division prepared this paper under the supervision of Nancy M. Gordon and
Martin D. Levine. Numerous people at federal agencies--including the Federal
Home Loan Bank Board, the Federal Home Loan Mortgage Corporation, the Federal
National Mortgage Association, and the Government National Mortgage Association--and
other organizations provided valuable information for the preparation of
this report. Robert Buckley, Bernadette Caldwell, James Carr, Andrew Carron,
Frank DeStefano, Diane Dorius, Julia Gould, Jack Guttentag, Thomas Hook,
A. Thomas King, Warren Lasko, Warren Matthews, Barbara Miles, Robert Seller,
Cynthia Simon, Wilson Thompson, John Tuccillo, James Verdier, and Kevin
Villani reviewed earlier drafts of the report and provided helpful comments.
Many members of the CBO staff, including Roberta Drews, Alfred Fitt, Robert
Hartman, Marilyn Moon, Larry Ozanne, Lisa Potetz, Frederick Ribe, Pearl
Richardson, and Brent Shipp also contributed useful comments and necessary
information. Francis Pierce edited the paper. Mary Braxton efficiently
and painstakingly typed the many drafts and prepared the paper for publication.
Rudolph G. Penner
Director
October 1983
SUMMARY
CHAPTER I. INTRODUCTION
CHAPTER II. THE DEVELOPMENT OF THE HOUSING FINANCE SYSTEM AND CURRENT ISSUES
CHAPTER III. CURRENT HOUSING FINANCE PROGRAMS
CHAPTER IV. RECENT CHANGES IN THE MARKET AND IN FEDERAL POLICY
CHAPTER V. POLICY OPTIONS
APPENDIX A. ADDITIONAL INFORMATION ON FEDERAL HOUSING FINANCE INSTITUTIONS
APPENDIX B. RECENT HOUSING FINANCE LEGISLATION AND CHRONOLOGY OF REGULATORY ACTION
APPENDIX C. ALTERNATIVE MORTGAGE INSTRUMENTS
APPENDIX D. ADDITIONAL INFORMATION ON SOURCES AND FLOWS OF MORTGAGE
FUNDS
| TABLES | |
| 1. | HOUSING FINANCE-RELATED POLICIES AND PROGRAMS |
| 2. | PERCENTAGE DISTRIBUTION OF INTEREST-BEARING LIABILITIES AT SAVINGS AND LOAN ASSOCIATIONS, SELECTED YEARS, 1966-1982 |
| 3. | PERCENTAGE SHARE OF MORTGAGE LOAN ORIGINATIONS, NET ADDITIONS TO OUTSTANDING MORTGAGE DEBT, AND OUTSTANDING MORTGAGE DEBT HELD BY SELECTED CREDIT SOURCES, 1978-1982 |
| 4. | OUTSTANDING FEDERALLY UNDERWRITTEN MORTGAGE-BACKED SECURITIES, 1970-1982 |
| B-1. | RECENT HOUSING FINANCE LEGISLATION |
| B-2. | CHRONOLOGY OF RECENT HOUSING FINANCE REGULATIONS |
| C-1. | SUMMARY OF ALTERNATIVE MORTGAGE INSTRUMENTS |
| D-1. | ORIGINATIONS OF FEDERAL HOUSING ADMINISTRATION-INSURED AND VETERANS ADMINISTRATION-GUARANTEED RESIDENTIAL MORTGAGE LOANS BY PROPERTY TYPE, 1970-1982 |
| D-2. | GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA) MORTGAGE-BACKED SECURITIES PROGRAM-COMMITMENTS AND SECURITIES GUARANTEED, 1968-1982 |
| D-3. | FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA) PURCHASES AND SALES OF ONE- TO FOUR-UNIT MORTGAGES, 1968-1982 |
| D-4. | FEDERAL HOME LOAN MORTGAGE CORPORATION (FHLMC) MORTGAGE ACTIVITY: PURCHASES, SALES, AND HOLDINGS BY TYPE, 1970-1982 |
| D-5. | DISTRIBUTION OF ORIGINATIONS OF LONG-TERM MORTGAGE LOANS ON ONE- TO FOUR-UNIT HOUSES BY TYPE OF FINANCIAL INSTITUTION, 1970-1982 |
| D-6. | DISTRIBUTION OF NET ADDITIONS TO HOME MORTGAGE DEBT, BY TYPE OF INSTITUTION, 1970-1982 |
| D-7. | DISTRIBUTION OF HOME MORTGAGE DEBT OUTSTANDING, BY TYPE OF INSTITUTION, 1970-1982 |
The housing finance system--the complex
system of mortgage lending that enables buyers of houses to finance their
purchases--is currently undergoing a transition. After operating as a highly
regulated segment of the credit sector during a long period of relative
economic stability, the housing finance system was jolted in recent years
by rising interest rates. The federal response has been to ease the regulations
that formerly governed mortgage lenders, reducing the insulation of housing
finance from broader credit markets. Issues now arise as to whether further
changes in federal policy might smooth the ongoing transition, and what
the government's future role ought to be in the allocation of credit to
housing.
DEVELOPMENT OF THE HOUSING FINANCE SYSTEM
The present housing finance system developed over the past half-century through a series of changing federal policies. These policies had to do with the regulation of private lending institutions, the issuance of mortgage insurance and other services, and tax provisions affecting housing.
The Early Years
Federal intervention in the housing finance system began in the 1930s in response to the widespread defaults and foreclosures that occurred during the Depression. Initially, the government offered federal charters to the existing private savings and loan associations and gave them the mission of providing funds for mortgage loans. It also insured their deposits, thereby encouraging savers to place their funds in mortgage lending institutions. Also, mortgage insurance programs were instituted to reduce the risk faced by lenders in making mortgage loans.
These policies, together with previously enacted federal income tax provisions allowing homeowners to deduct mortgage interest and property tax payments from taxable income, contributed to a sharp rise in home-ownership--from 48 percent to 63 percent of all households between 1930 and 1970. They also resulted in a system of mortgage finance characterized by long-term, fixed-rate mortgage loans provided mainly by savings and loan associations and mutual savings banks out of funds in their short-term deposit accounts.
Recent Developments
This system operated well for many years, but by the middle of the 1960s rising interest rates and policy responses to them began to create difficulties. Higher interest rates on short-term deposits at mortgage lending institutions led to higher mortgage interest rates. To hold down interest expenses for the major mortgage lending institutions the federal government in 1966 established an interest rate ceiling on their deposit accounts. The limit was set higher than a comparable ceiling governing accounts at commercial banks to give mortgage lending institutions an advantage in attracting the deposits of small savers. Although the ceiling was increased gradually, depositors withdrew their money from the mortgage lending institutions at times when interest rates on other investments rose well above the cap.
During the late 1960s and early 1970s, in part to help mortgage lenders replenish their loanable funds, the federal government expanded its role in the "secondary" mortgage market through which lenders sell mortgages or mortgage-backed securities (MBSs) to investors. In 1968, an existing agency--the Federal National Mortgage Association (FNMA)--was partitioned, creating a tax-paying, federally chartered quasi-private FNMA with a line of credit to the U.S. Treasury, and a new government agency, the Government National Mortgage Association (GNMA), which guaranteed privately-issued MBSs backed by government-insured or -guaranteed mortgage loans. The government also established the Federal Home Loan Mortgage Corporation (FHLMC)--a publicly managed corporation under the aegis of the Federal Home Loan Bank Board and capitalized through the sale of stock to the Federal Home Loan Banks--to facilitate secondary market transactions for the savings and loan associations. These secondary market agencies have expanded the sources of credit for housing by transforming mortgage loans into more liquid and more marketable instruments, thereby enhancing the efficiency of the housing finance system.
Although the programs of these credit entities fostered an active secondary market in mortgages during the 1970s, they did not redress the problems mortgage lending institutions had in attracting and holding deposits. What is more, with interest rates continuing to rise through the 1970s, and with rates paid on deposits by savings and loan associations approaching the yields on their portfolios of fixed-rate long-term mortgages, mortgage lending institutions began to find their profitability threatened in the early 1980s.
The federal government responded to these problems by partially deregulating federally chartered depository institutions in several steps. First, mortgage lending institutions were allowed to pay market-determined interest rates on selected deposit accounts to help them compete for funds, and they were authorized to offer adjustable-interest-rate mortgages to help them match their investment returns with their interest expenses. Subsequently, their lending authority was broadened to cover a wider range of assets other than residential mortgages, and incentives provided through the tax system for them to invest in residential finance were reduced.
Even with deregulation initially exacerbating the profit squeeze for
mortgage lenders because their cost of funds rose more rapidly than the
yields on their investments, the longer-run effect has been to integrate
more fully the housing credit sector with broader credit markets. Although
savings and loan associations continue to originate more than one-third
of all new mortgages, they now sell a high proportion of them in the secondary
market, often through the federally sponsored credit entities operating
there. As a result, depository institutions now provide a smaller proportion
of all net additional mortgage credit, while other sources--mainly investors
in mortgage pools--provide an increasing share.
ISSUES AND OPTIONS
Two issues now arise regarding future federal housing finance policies. The first is how to increase the efficiency of the housing finance system. Although recent market and policy changes have lessened the insulation of the housing credit sector, impediments may remain that increase the cost of the mortgage lending process. A second issue is whether adjustments are warranted for the present system of federal subsidies to housing--to reduce the overall advantages of housing compared with other investments such as business plant and equipment, and/or to make it easier for low- and moderate-income households to afford housing in a high-interest-rate environment.
Increasing Market Efficiency
Numerous proposals have been made recently to increase the efficiency of the partially deregulated housing finance system. Specific options reflect differing views regarding the net impact of present federal policies, but none would involve returning to the highly regulated system of the past. Also, while some actions might improve the efficiency of the housing finance system, housing would remain a highly cyclical sector of the economy, since it is necessarily sensitive to interest rate fluctuations.
Expanding Federal Housing Credit Activity. One set of options would involve expanding federal mortgage insurance or secondary market programs to cover certain credit subsectors that are not now served, because they developed or expanded only recently, after federal programs were already in place.
Similarly, the federal government could raise the limit on the value of mortgages purchased under programs of federally sponsored credit agencies--currently $108,300 for a loan on a single-family home. This would expand the market penetration of these programs but could supplant the activity of private-sector institutions currently operating in the market for large mortgages.
Encouraging Housing Credit Activity by the Private Sector. Another; approach would be for the government to encourage private-sector housing credit activity by removing statutory or regulatory impediments to the issuance of private MBSs that are backed by pools of conventional mortgages--that is, mortgages neither insured nor guaranteed by a federal agency. Although several impediments to the development of private conventional MBSs have been eliminated recently, one major hindrance remains--the provisions of the federal tax code under which mortgage-backed securities, unlike corporate securities, are subject to taxation both at the level of the holder of the security and at the level of the party managing the pool of assets backing the MBS. This double taxation can be avoided only if MBSs are passively managed; however, to maximize profitability, MBSs must be actively managed, involving, for example, the substitution of new loans for prepaid ones and the reinvestment of principal payments.
Amending the federal tax code to do away with double taxation of actively managed privately issued MBSs would eliminate a disadvantage they now suffer compared to privately issued nonhousing securities, which are taxed only at the shareholder level. This could do a great deal to encourage the use of privately issued conventional MBSs, which might in turn increase investment in mortgages by a greater number of credit sources, particularly pension plans. On the other hand, depending on how issuing requirements were structured, amending the federal tax code could induce some smaller securities issuers to undertake a new activity for which they might not be adequately prepared. Also, to the extent that such a change increased the overall flow of capital to housing, it would divert investments into a sector of the economy that already enjoys many advantages provided through the federal tax system, unless these advantages for housing investment are modified.
Reducing Direct Federal Housing Credit Activity. A third approach that has been suggested is to reduce federal mortgage insurance or secondary market programs in the hope of stimulating the development of private-sector alternatives. Proposals of this sort reflect the view that federal programs impede the efficient operation of the market by discouraging the private sector and do not lower mortgage interest rates significantly. But if the federal government withdrew, there is no assurance how quickly private institutions would or could fill the void. Therefore, any sharp reduction in the federal role might seriously impede the operation of the housing credit sector in the short run. Cutting back federal activity only gradually or only for selected submarkets would reduce but not eliminate this risk, and might raise mortgage rates slightly in the long run.
Altering Federal Subsidies
Regardless of what changes might be made to improve the efficiency of the housing finance market, the Congress might want to address the related issue of the role of subsidies to housing--particularly those provided through the tax system. Here, two quite different concerns arise. First, despite substantial existing subsidies, low- and moderate-income households find it increasingly difficult to afford to purchase housing in the current high-interest-rate environment. On the other hand, the recent decline in productivity growth has raised concerns that the United States may be allocating too much capital to housing at the expense of other sectors of the economy.
Several changes could be made in federal tax provisions to target subsidies on households that would otherwise find it difficult to afford to purchase homes. Specific options include: extending a more targeted version of tax-exempt revenue bonds to finance single-family mortgages beyond the currently scheduled expiration date of December 31, 1983; establishing a partial tax credit for mortgage interest payments in addition to, or in place of, the deductibility of such payments from taxable income now available to homeowners who itemize; and authorizing tax-subsidized savings accounts to make it easier to accumulate funds for a down payment. These changes would aid those homebuyers who now benefit least (or not at all) from current tax subsidies, but at the expense of larger revenue losses to the government. Repealing the "sunset" on mortgage revenue bonds, for example, could increase federal revenue losses by $2.8 billion over the fiscal year 1984-1988 period.
Other changes could be made to reduce untargeted subsidies for housing--either as a means of financing greater targeted subsidies, or independently, as a means of encouraging the flow of capital to areas of the economy other than housing. One option would be to establish a ceiling on the deductibility of mortgage interest payments from taxable income, or to allow only a fixed proportion of interest payments to be deducted. Such a change would raise the after-tax costs of homeownership for some owners who itemize deductions. While it could be designed to concentrate adverse effects on those in the best position to bear them, it would be difficult to avoid treating similar households differently, because the additional tax burden would depend, among other things, on when the house was bought and, therefore, the interest rate on the mortgage.
Another approach would be to modify favorable tax treatments now available to savings and loan associations and mutual savings banks that invest certain proportions of their assets in mortgages. Such a change would reduce the incentives that these institutions now have to provide funds for mortgages, thereby possibly diminishing the supply in the long run. To the extent that the total supply of mortgage funds was reduced, this approach could also result in somewhat higher mortgage interest rates, while reallocating funds from housing to other sectors of the economy.
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