Congressional Budget Office
Director's Blog

After the U.S. government assumed control of Fannie Mae and Freddie Mac—two federally chartered institutions that provide credit guarantees for almost half of the outstanding mortgages in the United States—CBO concluded that the institutions had effectively become government entities whose operations should be included in the federal budget. In contrast, the Administration, which ultimately determines what is included in the budget, considers Fannie Mae and Freddie Mac to be nongovernmental entities for federal budgeting purposes. Because of the differing budgetary treatments, CBO’s and the Administration’s budget estimates related to the entities were quite different for 2009 and over the 2010-2019 period. A background paper released today describes CBO’s budgetary treatment of Fannie Mae and Freddie Mac and the methods CBO used to estimate their costs.

Despite having a unique legal status and a long history linking them to the federal government, Fannie Mae and Freddie Mac have been considered private firms owned by their shareholders. However, with the entities facing substantial losses that threatened their solvency, the government took control of Fannie Mae and Freddie Mac through its authority under the Housing and Economic Recovery Act of 2008 (HERA). The federal government now exercises an extraordinary degree of management and financial responsibility over them. CBO believes—consistent with the principles outlined in the 1967 Report of the President’s Commission on Budget Concepts—that it is appropriate and useful to policymakers to account for and display the entities’ financial transactions alongside other federal activities.

CBO’s Approach

In the baseline budget projections it published in 2009, CBO accounted for the cost of the entities’ operations in the federal budget as if they were being conducted by a federal agency. That is, CBO treated the mortgages owned or guaranteed by Fannie Mae and Freddie Mac as loans and loan guarantees of the federal government. The operations of Fannie Mae and Freddie Mac added $291 billion to CBO’s August baseline estimate of federal outlays for fiscal year 2009 and $99 billion to the spending projected for the 2010–2019 period.

The estimated outlays for Fannie Mae and Freddie Mac represent the subsidy cost (in other words, the long-term cost to the federal government) of those entities transactions. CBO estimated that cost by projecting the net cash flows associated with the two entities’ mortgage commitments and converting those estimates into present values using risk-adjusted discount rates. (The discount rates reflect the expected rate of return that the government could earn on investments or securities of comparable risk.) That procedure is conceptually equivalent to the methods that private companies use to compute the fair value of certain assets and liabilities under generally accepted accounting principles.

The large 2009 figure reflects the recognition of substantial losses on the approximately $5 trillion in mortgages held or guaranteed by the entities at that time. Following the housing bust that began in 2007, Fannie Mae and Freddie Mac experienced unprecedented portfolio losses stemming largely from their holdings of risky private securities, such as securities backed by subprime and Alt-A mortgages that had historically high default rates. CBO’s $291 billion figure closely corresponds to the entities’ own estimates of the deterioration of their net worth when valued at market prices—from a surplus of $7 billion in June 2008 for the two entities combined to a deficit of $258 billion in June 2009. The estimated subsidy costs for the 2010-2019 period represent the projected costs of the entities’ new loan and guarantee commitments during that period.

Because of their federal backing, Fannie Mae and Freddie Mac provide capital and guarantees to the mortgage market at lower prices than private financial institutions can offer, which ultimately transfers risk from the two entities to taxpayers. The subsidy recorded for the entities’ mortgage commitments captures the value of that federal backing.

The Administration’s Approach

The Administration has taken a different approach to recording the impact of Fannie Mae and Freddie Mac on the federal budget. Following the enactment of HERA, the Treasury signed agreements with the two entities intended to ensure that they could continue to support the mortgage market. In exchange for making direct cash infusions into the entities, the Treasury received shares of their preferred stock and warrants to purchase their common stock. The Administration’s Office of Management and Budget (OMB) continues to treat Fannie Mae and Freddie Mac as outside the budget, and it records and projects outlays equal to the amount of those cash infusions. As a result, the Administration has not included in its budget figures subsidy costs that would be directly comparable to CBO’s $291 billion estimate of subsidy costs in 2009. Instead, because the Treasury provided a total of $95.6 billion in cash outlays to the two entities in fiscal year 2009, the government’s final report of spend¬ing for 2009 included that amount, which is similar to CBO’s August 2009 estimate of cash infusions for that year ($112 billion). OMB has estimated that cash outlays from the Treasury to the two entities will total another $65 billion over the 2010–2019 period.

This background paper was prepared by Damien Moore of CBO’s Macroeconomic Analysis Division.

The federal government commits substantial budgetary resources to support housing and mortgage markets through a combination of spending programs and tax provisions. During the crisis of the past two years, the commitment expanded—to about $300 billion in 2009—from the placement into conservatorship in September 2008 of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) and the creation of new housing programs. Today CBO released a brief describing, in broad terms, the array of federal activities that support housing and the recent expansion of particular programs.

As shown in the figure below, most of the federal government’s spending for housing supports homeownership. In fiscal year 2009, the federal government devoted almost four times the amount of budgetary resources to supporting homeownership (about $230 billion) as it devoted to improving rental affordability ($60 billion).

Federal Spending for Housing, 2009

(In Billions of Dollars)

The government supports homeownership by subsidizing the costs of owning a home (reducing down payments, mortgage insurance costs, and tax liability) and increasing the availability of mortgage loans. Until recently, the bulk of federal support for homeownership took the form of tax expenditures (that is, subsidies conveyed through reductions in taxes), which make it less expensive to own a home by reducing taxes for homeowners and investors.

As a result of recent actions to address the crisis, the government now provides roughly  equivalent amounts of support for homeownership through tax expenditures and spending programs. About 80 percent of the federal support for renters is provided by spending programs; the remainder is provided through tax expenditures. The federal government also shapes the housing and mortgage markets through regulation—as provided, for example, in the Truth in Lending Act and the Home Mortgage Disclosure Act.

This brief categorizes 28 federal housing activities by type of support (homeownership or rental), mechanism (spending or taxation), and budgetary cost in 2009. The largest single budgetary cost is associated with the tax deduction for mortgage interest, which resulted in an estimated revenue loss of $80 billion in 2009. On the spending side, in 2009 the Treasury Department initiated the Making Home Affordable program, which provides incentive payments to mortgage servicers and homeowners to facilitate the process of refinancing or modifying loans so that homeowners can move into lower-cost or fixed rate mortgages. The Treasury has committed up to $50 billion to that program, and Fannie Mae and Freddie Mac are expected to spend up to $25 billion—though only a very small portion of the $75 billion was spent in 2009.   

This brief was prepared by Elizabeth Cove Delisle of CBO’s Budget Analysis Division. 

Yesterday, CBO released a cost estimate of H.R. 1106, the Helping Families Save Their Homes Act, as introduced on February 23, 2008. CBO estimates that enacting H.R. 1106 would increase direct spending by about $8 billion over the 2009-2014 period, and would reduce direct spending by about $15 billion over the 2009-2019 period. Enacting H.R 1106 would increase revenues by $19 million over the 2009-2014 period and by $23 million over the 2009-2019 period.

The Helping Families Save Their Homes Act would:

• Authorize bankruptcy courts to modify the terms of some mortgages on principal residences during Chapter 13 bankruptcy proceedings;
• Allow the Federal Housing Administration and the Rural Housing Service to pay claims on losses stemming from the judicial modification of mortgage loans that they insure;
• Modify the Hope for Homeowners loan-guarantee program authorized by the Housing and Economic Recovery Act of 2008;
• Permanently increase the amount of deposits insured by the Federal Deposit Insurance Corporation and the National Credit Union Administration from $100,000 to $250,000 and modify other terms of both deposit insurance programs; and
• Protect mortgage servicers from legal liability if they perform loan modifications according to specific criteria established under the legislation.

CBO has completed several cost estimates since January 2009 for bills with provisions similar to those in the Helping Families Save Their Homes act, which provide more detail on CBO’s analysis of various provisions of this bill. Those cost estimates include:

• H.R. 200, the Helping Families Save Their Homes in Bankruptcy Act, as ordered reported by the House Committee on the Judiciary on January 27, 2009;
• H.R. 786, a bill to make permanent the temporary increase in deposit insurance coverage, as ordered reported by the House Committee on Financial Services on February 4, 2009;
• H.R. 787, a bill to make improvements in the Hope for Homeowners program, as ordered reported by the House Committee on Financial Services on February 4, 2009; and
• H.R. 788, a bill to provide safe harbor for mortgage servicers who engage in specified mortgage loan modifications, as ordered reported by the Committee on Financial Services on February 4, 2009.

CBO released a letter this morning that analyzes the Administration’s July 14th proposal to provide temporary authority to the Secretary of the Treasury to purchase obligations and other securities issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. The authority provided under this proposal would expire on December 31, 2009. (The Congress may consider a slightly modified version of the proposal, but it is unlikely that the modifications would have a significant effect on the estimated costs.)

1. CBO estimates the expected federal budgetary cost (that is, taking into account the probability of various possible outcomes) from enacting this proposal would be $25 billion over fiscal years 2009 and 2010.
2. Using historical and industry estimates of the expected losses on the different types of credit risk that the GSEs face in their current portfolios, CBO estimated the firms’ possible credit losses under thousands of possible future market conditions for housing prices. That analysis suggested that there was more than a 50 percent chance that the GSEs’ future losses would not exceed those already recognized, but there was almost a 5 percent chance that the added losses will total more than $100 billion. Given that distribution of possible future losses, CBO then evaluated how much assistance might need to be provided to the GSEs to allow them to continue operating in the capital markets.
3. In particular, CBO assumed that the Secretary would want the GSEs to continue to have the ability to tap the capital markets after the temporary authority expired and that financial markets would provide such capital to the GSEs only if market participants perceived the GSEs to be sufficiently capitalized in terms of the value of their assets relative to their liabilities. Evaluating what financial markets would view as “sufficiently capitalized” requires judgment; CBO’s approach is described in more detail in the letter. In other words, if the value of the GSEs’ assets was perceived to be insufficient relative to their liabilities, the Secretary would have to provide equity capital or subsidized debt to the GSEs before the temporary authority expired. CBO’s estimate of $25 billion in costs over the 2009–2010 period reflects a probability-weighted average of how large those injections might need to be, including zero as a potential outcome.

CBO’s estimate reflects the current budgetary treatment and existing scorekeeping conventions for federal credit assistance and equity purchases and does not necessarily measure the underlying change in the federal government’s financial condition as a result of this legislation. On the one hand, the acquisition of financial assets like equities is recorded as an outlay in the budget even though such purchases may not change the government’s underlying financial condition. On the other hand, even if enacting this legislation would not result in outlays over the near term, it might effectively strengthen the linkages between the GSEs and the federal government and thereby increase the government’s underlying exposure to the risks associated with the GSEs’ activities.

A final point to note is that a strong argument can be made that if the Treasury used the proposed authority, the GSEs’ operations should be incorporated directly into the federal budget. That is, the proposal, especially to the extent it would result in any government acquisition of an equity stake in the GSEs, raises a significant budgetary question. Currently, data on the GSEs are reported along with federal budget information each year, but the activity of those entities is not encompassed within the budget. That treatment could change if the federal government’s financial stake or control changes in a significant way. For the purposes of this cost estimate, CBO did not incorporate any change in the underlying budgetary treatment of the GSEs, in part because the proposed authority would be temporary; if it is not used, the relationship between the GSEs and the federal government would presumably return to one consistent with current budgetary treatment after the temporary authority expires.

CBO has issued a cost estimate for the Federal Housing Finance Regulatory Reform Act of 2008, as ordered reported by the Senate Committee on Banking, Housing, and Urban Affairs on May 20. CBO estimates that enacting the legislation would increase revenues by about $8.0 billion over the 2009-2018 period, net of income and payroll tax offsets. Over that period, we estimate that direct spending from those proceeds would total about $7.2 billion. The additional revenues would thus exceed direct spending by an estimated $800 million, decreasing future deficits (or increasing surpluses) by that amount over the next 10 years. In addition, implementing this bill would reduce net discretionary spending over the next 10 years by $31 million, assuming appropriation actions consistent with the bill.

This legislation would make a number of changes in federal housing policy. It would:

• Establish a single regulator—the Federal Housing Finance Agency (FHFA)—for government-sponsored enterprises (GSEs) involved in the home mortgage market. GSEs are privately owned, Congressionally chartered financial institutions created to enhance the availability of mortgage credit. The GSEs that would be regulated by FHFA include the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Home Loan Banks (FHLBs).

• Require Fannie Mae and Freddie Mac to annually pay amounts equal to 4.2 basis points on each dollar of unpaid principal balance of each enterprise’s total new business purchases (that is, 4.2 cents per $100 of the value of the new mortgages purchased or securitized in that year). These assessments would begin during fiscal year 2009 and would be deposited into new federal funds.

• Authorize—from October 1, 2008, through September 30, 2011—a new mortgage guarantee program under the Federal Housing Administration (FHA) that would allow certain at-risk borrowers to refinance their mortgages after the mortgage holder (lender or servicer) agrees to a write-down of the existing loan (that is, a reduction in the amount of loan principal). A portion of the GSEs’ assessments would be used to pay the cost of this new program.

• Require loan originators to participate in a Nationwide Mortgage Licensing System and Registry that would be administered by either a nonfederal entity or the Department of Housing and Urban Development  in coordination with the federal banking regulatory agencies.

• Authorize the appropriation of such sums as are necessary for the Treasury Department’s Office of Financial Education to provide grants to state and local governments, Indian tribes, and other entities to support financial education and counseling services.

Last month, I participated in an event on mortgage and housing markets with Alan Blinder of Princeton and Zanny Minton Beddoes of The Economist magazine. The event was co-hosted by the Woodrow Wilson School and The Economist, and video from it is now available here .

CBO has released a cost estimate of HR 5830, the FHA Housing Stabilization and Homeownership Retention Act of 2008. We estimate that the legislation would cost about $2.7 billion over the 2008-2013 period, assuming future appropriations consistent with the provisions in the bill. The bulk of that — about $1.7 billion — would be needed for the estimated subsidy cost of insuring mortgages under a new FHA program. (Loan guarantees are scored in the federal budget at their estimated subsidy cost.)

The value of the subsidy reflects the value of the insurance provided by the federal government net of the fees charged for that insurance. CBO estimates an estimated average subsidy cost under the new FHA loan-guarantee program of about 2 percent of the loan principal. We also estimate that FHA would insure about 500,000 loans over the 2008-2013 period under the program. The $1.7 billion cost comes from combining the 2 percent subsidy rate with the roughly 500,000 loans and an average loan amount of about $170,000 (after writedown of existing mortgages).

In addition, the legislation establishes an Office of Housing Counseling within the Department of Housing and Urban Development, authorizes appropriation of funds for the Department of Justice to support efforts to combat mortgage fraud, and includes other provisions.

Despite some suggestions in the press to the contrary, CBO has not yet issued a cost estimate for the FHA-related housing proposal that is under discussion in the House of Representatives. A bill sponsored by Mr. Frank was introduced late today and CBO is reviewing it. CBO will issue a cost estimate for the legislation soon after it is approved by the House Committee on Financial Services, and I will post a link to the cost estimate when we issue it.

In a report issued last week, CBO noted the following about many of the FHA-related proposals under discussion:

“The number of borrowers that could be assisted by such proposals would depend directly on the amount of mortgage insurance subsidy that the government provides. With moderate refinancing fees, as embodied in most recent proposals, the federal subsidy would probably amount to less than 5 percent of the new loan principal, on average. Given that scale of subsidy, CBO expects that perhaps several hundred thousand borrowers would benefit from expanded FHA-insured refinancings over the next few years. Generating higher levels of participation would require substantially deeper subsidies, which would in turn significantly increase the federal budget cost. (Under current law, any subsidy costs for FHA loan guarantees are subject to appropriation of the necessary funds. Annual appropriation acts also generally limit the dollar amount of new federal loan guarantees that FHA can enter into for a given year.)”

As you can imagine, CBO prides itself on its analytical capabilities — and its analysis is (justifiably, in my opinion!) widely respected. From time to time, though, criticisms of our analysis are raised. I won’t respond to most of these criticisms, but in some cases, it may be worth examining the issues raised in a critique of CBO’s analysis — and that’s what this post does.

A publication from a consulting firm claims that the discussion of housing price-rental ratios in recent CBO testimony was misleading.  (For an entry in the Wall Street Journal’s economics blog about the critique, see here.)  Those claims, though, rest on a number of misunderstandings, both of the CBO testimony and of the underlying data.

With respect to the testimony, CBO used a figure — showing the ratio of house prices to rents — as a short-hand indicator to support the idea that housing prices were high relative to underlying fundamentals, particularly in 2005-2006, and that there was a general expectation that housing prices would be weak in the future. The figure was not used to say that the ratio of housing prices would necessarily fall back to the average of earlier periods in the near future. Here is the section of CBO’s most recent testimony that referenced the figure:

“The outlook for home prices is highly uncertain, but it seems likely that house prices and, consequently, housing wealth will continue to fall next year. The inventory of unsold homes stands at high levels, which will place continued downward pressure on house prices in many regions of the country. Moreover, the ratio of housing prices to rents still seems very high relative to its history (Figure 4). To be sure, homebuyers’ expectations of home prices may deviate from long-term fundamentals for extended periods of time, and the price–rental ratio may therefore not provide a reliable guide to potential changes in prices over relatively short periods of time.”

The section then references a 2004 paper from the New York Federal Reserve that discusses the pros and cons of using the ratio to determine whether the economy was in the midst of a housing price boom at that time.

With regard to the data used in the chart, some measurement issues have indeed been raised with regard to both the numerator (the OFHEO price index for houses) and the denominator (the PCE price index for owner-occupied non-farm dwellings, which is essentially the same as the owners’ equivalent rent index in the CPI-U). The indexes used by CBO, however, are both widely accepted as useful indicators of what they purport to measure despite their limitations.

The critique of CBO’s presentation centers on the owners’ equivalent rent measure, so I will focus on that index. (For a brief explanation of the PCE rental measure, see here.) Although researchers have raised concerns about the index, little hard evidence exists about the magnitude of any problems associated with it — and it remains widely used by analysts and government agencies. As some examples, the Bureau of Labor Statistics (BLS) stands behind the index, the Bureau of Economic Analysis uses it as a price index for a large category of personal consumption expenditures, and it accounts for about 12 percent of the core PCE price index that the Federal Reserve has indicated plays an important factor in its policy decisions.

The critique suggests that the rent index is somehow distorted because “when capital gains are high, a low rent is adequate to make the profits from renting a house equal to the interest that could be earned by selling it and investing the proceeds.” That’s not a distortion, though: it is simply another way of saying that when house prices are rising a lot, we should expect to see a large discrepancy between house prices and rents, as the figure in CBO’s testimony illustrates.

Although the rental measure is widely used and thought to be a valuable indicator, researchers have raised some concerns about it. The most serious issue appears to be associated with its sample.

• The current BLS sample is based on 33,000 units and some cities are not included at all. (Data from cities that are sampled within a region are ascribed to similar-sized cities in the region.) Some researchers are concerned about the sample at the top end of the distribution. For example, the 2004 paper mentioned above found that a rent measure constructed for the 1990s using data from the American Housing Survey moved in concert with the BLS owners’ equivalent rent measure for the first half of the 1990s, but diverged during the second half. The paper’s summary noted that the differences may have occurred because the BLS sample of rental units is thin at the upper portion of the distribution. For the top-most portion of the distribution of home values, there are often few equivalent rental units in the same neighborhood.

• The BLS, though, argues that the sampling limitations do not undermine the usefulness of the index.

• A more significant concern may be that the sample was set in 1999 — and there has been no updating of the sample since then, so it may no longer be representative of the mix of renters. BLS is concerned about this, but has not received funding to create panels and rotate the sample. (Virtually all other samples in the CPI are continuously updated.)

The key point, again, is that CBO used widely accepted indexes, which are known to have limitations but are still viewed as valid indicators, as an illustration of how housing prices appear to have diverged from underlying fundamentals. Even then, the testimony did not suggest that the ratio of housing prices to rents was necessarily a reliable predictor of future price movements in the near term.

I am testifying before the House Budget Committee this morning on economic conditions and the budget. CBO will not be releasing an updated macroeconomic forecast until January, when we release our next Economic and Budget Outlook, so the testimony doesn’t have any specific projections for the macroeconomic outlook. Nonetheless, the testimony does discuss many of the cross-cutting factors affecting the macroeconomy — including difficulties in the housing market, the stabilization of the current account, turbulence in financial markets, oil price trends, and consumer confidence.

Marty Feldstein and Fred Bergsten are also on this morning’s panel. You can view the hearing through the House Budget Committee website.

CBO’s testimony was put together by our Macroeconomic Analysis Division, which is responsible for economic forecasting, policy analysis, and financial analysis of federal programs and is directed by Bob Dennis (who has been with CBO since 1979).

On the topic of macroeconomic forecasts, we have long evaluated our own forecasting accuracy with the thought that publishing such analysis of our own projections is an important form of transparency. And I was interested to learn from a paper released by two Federal Reserve economists on November 19 that CBO’s record on macroeconomic forecasting looks quite good, even compared to the Federal Reserve’s own outstanding (and larger) staff.  So kudos to our macro division!