The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are the two of the largest government-sponsored enterprises (GSEs) in the U.S., tasked with providing sufficient credit for lenders to supply mortgages to eager homebuyers.
For those unfamiliar with the functioning of these GSEs, here’s a very brief summary (for a more thorough analysis of Fannie and Freddie’s operations, see this guide from CBO): When a bank makes a loan to a homebuyer, the mortgage is often sold on the “secondary market,” where they are bundled into mortgage-backed securities (MBSs). Fannie and Freddie were (and still are) important actors in the secondary market, purchasing qualifying mortgages and bundling them into MBSs, which were in turn guaranteed against losses from default and sold on the secondary market. To help cover the guarantees and administrative costs, the GSEs collect “guarantee fees” from MBS purchasers.
After the housing bubble burst, Fannie and Freddie went into conservatorship after they were unable to meet their guarantees against MBS defaults (though not formally guaranteed, investors perceived them as being backed by the federal government) and have remained in this situation for the past decade.
Much ink has been spilled on the merits of Fannie and Freddie, how to reform them, and even whether or not it’s a good idea to privatize or phase them out altogether. But, for the time being, the taxpayer is stuck with them. How does the federal government account for the value of these GSEs? A new report from the Congressional Budget Office summarizes the two different accounting methods used to calculate the cost of conservatorship and the implications of choosing one or the other.
The budgetary treatment of Fannie Mae and Freddie Mac is complex, as is the treatment of policy options for the housing finance system that the Congressional Budget Office analyzes. The budgetary treatment of the GSEs involves two different accounting approaches: fair-value estimating of the costs of the GSEs’ mortgage guarantees [CBO’s method] and cash-based estimating of the GSEs’ transactions with the Treasury [OMB’s method].
Essentially, CBO uses a measurement that incorporates the market value (which represents the “up-front payment that a private entity…would require to assume the federal government’s responsibility for the GSEs’ obligations”) of the government guarantees the GSEs provide, while OMB uses a measurement based on the actual dollars and cents coming in and going out.
The advantages and disadvantages of CBO’s accounting method are fairly straightforward: The method better captures the risk to the taxpayers of maintaining these programs and provides an accurate measure of the government’s involvement in the mortgage market.
The main downside, on top of creating some inconsistencies in the way the federal government keeps its books for Fannie and Freddie compared to other programs, is that the inclusion of a risk premium means outlays likely won’t equal the budgetary effect. This makes the budgeting more difficult, but it’s not clear that this is a downside of the accounting methodology per se, rather than a problem with the projected cost of the GSEs.
What’s the budgetary difference between the two methods? Using a fair-value basis, “the $12 trillion of new loan guarantees that the GSEs are projected to make between 2019 and 2028 would have a total cost to the government of $19 billion,” whereas OMB’s estimates “show a total savings of $172 billion” because Fannie and Freddie’s fees, though still below market rates, cover projected losses.
CBO’s report proposes a more market-friendly auction system to determine which mortgages the GSEs should securitize, passing on some of the cost of the government guarantee to the investors and compensating the taxpayers for taking on the risk. CBO estimates this policy would reduce the value of new mortgages insured by $8 trillion over the next decade. On CBO’s market-value accounting basis, this would make Fannie and Freddie $11.7 billion cheaper over that period, while by OMB’s accounting would cost $103.8 billion due to the decline in guarantee fees that come from selling MBSs.
Americans are “operationally liberal but ideologically conservative.” We like government programs, but we don’t like the idea of government programs. This paradox has created what Suzanne Mettler calls “the submerged state,” where government benefits are delivered in a way that obscures the reality that the state itself is conferring these benefits. The CBO’s accounting method would help to address this issue by putting a more accurate price tag on the government’s involvement and exposure to risk in the mortgage market.