United States
Selected Issues

This Selected Issues paper analyzes the current state of housing finance in the United States. Although a number of important steps have been taken to address the structural weaknesses exposed by the crisis in mortgage markets, comprehensive housing finance reform remains the largest piece of unfinished business. Mortgage markets, even eight years after the start of the crisis, continue to function with extensive government support. Reform of the government-sponsored enterprises, which remain in conservatorship, has stalled—generating uncertainty and complicating other policy initiatives. However, there has been progress in building other components for a well-functioning housing finance system.


This Selected Issues paper analyzes the current state of housing finance in the United States. Although a number of important steps have been taken to address the structural weaknesses exposed by the crisis in mortgage markets, comprehensive housing finance reform remains the largest piece of unfinished business. Mortgage markets, even eight years after the start of the crisis, continue to function with extensive government support. Reform of the government-sponsored enterprises, which remain in conservatorship, has stalled—generating uncertainty and complicating other policy initiatives. However, there has been progress in building other components for a well-functioning housing finance system.

Housing Finance

While a number of important steps have been taken to address the structural weaknesses exposed by the crisis in mortgage markets, comprehensive housing finance reform remains the largest piece of unfinished business. In particular, it is not clear when Fannie Mae and Freddie Mac will exit conservatorship and what an end point for a reformed housing finance system will look like. This creates not only fiscal but also financial risks: moral hazard from coverage of credit losses by the government or the government-sponsored enterprises, a distorted competitive landscape due to the dominant footprint of Fannie Mae and Freddie Mac, and large subsidies for homeownership that create incentives to take on excessive levels of household debt.

A. The Current State of Housing Finance

1. Mortgage markets are integral to the overall stability of the U.S. financial system, and were the epicenter of the 2008–09 crisis. Home mortgages, at some $10 trillion, are the largest component on nonfinancial private sector debt (chart 1). Securitization is the dominant funding source for mortgages in the United States, generating strong interconnections not only with the rest of the U.S. financial system but also with the rest of the world.1 Securitization allows lenders to transfer interest rate risk and provides a mechanism (especially for small depository institutions) to gain access to liquidity and to avoid over-exposure to regional housing markets. In the United States, public guarantees—directly from the federal government or through Fannie Mae and Freddie Mac2—play an important role in the securitization process, especially in transferring and managing the risks of longer-term loans.3 This subsidized system features a product that is unusual by comparison with other countries: namely, the 30-year fixed-rate mortgage with no prepayment penalty—which puts interest rate and prepayment risks squarely on the lender—although the vast majority of borrowers sell their homes and pay the mortgage or refinance in less than 10 years.4,5


Private Nonfinancial Sector Debt, 2014Q4

Citation: IMF Staff Country Reports 2015, 169; 10.5089/9781513514307.002.A001

Sources: Flow of Funds; staff calculations.

2. Mortgage markets, even eight years after the start of the crisis, continue to function with extensive government support. The federal government dominates the market, standing behind more than 60 percent of the stock of loans and backing almost 80 percent of new single-family loan originations through Federal Housing Administration (FHA) insurance, U.S. Department of Veterans Affairs (VA) guarantees, and the activities of Fannie Mae, Freddie Mac, and Ginnie Mae (chart 2). Private-label securitization (PLS) has largely disappeared (chart 3). The factors behind the disappearance of PLS are multi-faceted and include both cyclical (e.g., legacy issues from the crisis) and structural forces (e.g., new regulations, regulatory and legal uncertainty, or changed investor preferences and demand). Insurance and guarantees provided or back-stopped by the government are at times priced based on social policy objectives—rather than risk or long-term cost recovery—and the high loan limits for qualifying mortgages mean that government cover is available to most new loans. All of these factors create disincentives for the private sector to enter the market and leaves the government with significant fiscal risk. Moreover, given the exposure to agency- and GSE-backed securities elsewhere in the domestic and international system, this constitutes a point of vulnerability both for the U.S. and the global financial system.


Mortgage Debt by Holder

(percent of total outstanding)

Citation: IMF Staff Country Reports 2015, 169; 10.5089/9781513514307.002.A001

Sources: Federal Reserve Board; staff calculations.

3. The current system hampers the functioning of mortgage markets. There is rather broad agreement that a housing finance system should aim to foster a stable and competitive mortgage market where (i) risks are priced appropriately, (ii) incentives are set to mitigate moral hazard from all financial intermediaries involved in the housing finance chain (originator, servicer, insurer, securitizer, guarantor, etc.), and (iii) the involvement of public monies and the risks being borne by the public balance sheet are minimized and properly accounted for (see, for instance, Ellen et al., 2010; Acharya et al., 2011; GAO, 2014). At the same time, there is a political support for the system to meet social objectives linked to broad homeownership and access to affordable housing (see, for example, various Congressional hearings). There is an economic argument for, and some evidence of positive externalities from, homeownership and affordable housing (see, among others, Rossi-Hansberg, 2010; Coulson and Li, 2013; Bratt, 2002) and, hence, additional justification for the government to pursue these social goals. However, the current system falls short in achieving these objectives and, in doing so, creates unwelcome side effects.

  • Competitive landscape and pricing. While there is rather robust competition in mortgage origination, the “special status” of the GSEs has hindered effective competition in the secondary mortgage market. Financial markets always anticipated that there were implicit government guarantees on any debt issued by Fannie Mae and Freddie Mac—and these expectations were confirmed during the crisis.6 In addition to being able to borrow at cheaper rates because of this guarantee, the GSEs faced lower capital requirements for holding similar risks as many of their private counterparts and are exempt from state and local taxes (opening the door for regulatory capital arbitrage and giving them a favored competitive position).7 On a fair-value basis, federal subsidies for the new loan guarantees by Fannie Mae and Freddie Mac—covering the period from 2015 to 2024—are estimated to be $19 billion dollars (CBO, 2014a). Post-crisis, the dominance of the GSEs continues to demonstrate the difficulty for private institutions to effectively compete against them. Similarly, insurance provided by the FHA is priced largely on the basis of social goals rather than the underlying risk of the loans. Such pricing practices create a challenge for private mortgage insurers to break into some segments of the market.

  • Moral hazard. With investors believing that they have the federal government standing behind GSE liabilities and taxpayers providing insurance or guarantees on a large set of mortgage loans, moral hazard is inevitable. Prior to the crisis, the GSEs had leverage ratios of the order of 25 to 1, and their incentives for excessive risk taking likely contribute to moral hazard elsewhere in the system. This may manifest as less incentive to properly screen borrowers by loan originators or lack of due diligence by the final investors themselves (Berndt and Gupta, 2009; Keys et al., 2010; Ashcraft and Schuermann, 2008). Of course, frictions in securitization are also important, but the structure of the GSEs compounds the problem. Perhaps more strikingly, the GSEs have tremendous power in dictating evolving industry standards given their near-monopoly of the automated underwriting systems (Bubb and Kaufman, 2014)—which could actually be leveraged to set standards for prudential purposes.8

  • Risks to public balance sheet. The crisis starkly demonstrated that the implicit guarantee on the GSE liabilities carried a big risk to the public balance sheet. Although positive net worth from the GSEs is now accruing to the Treasury through senior preferred stock dividends, the current structure of housing finance continues to create significant contingent liabilities for the taxpayer that are potentially larger than the flow of profits that Fannie Mae and Freddie Mac generate.

  • Costs of achieving social goals. Housing affordability and homeownership rates in the U.S. are broadly in line with other OECD countries, but are achieved at a significantly higher cost in terms of implicit public subsidies (including through mortgage interest deductions in the personal income tax and the quasi-fiscal costs borne by the GSEs, chart 4). Also, the benefits of these implicit fiscal costs for the most part accrue to the upper-income households (Poterba, 1992; Poterba and Sinai, 2008; Fischer and Huang, 2013; Hilber and Turner, 2014). From a financial stability perspective, social goals often get conflated with prudential goals and the subsidized pricing of risks leads to distorted incentives and increased risk taking. Availability of the 30-year fixed-rate mortgage loan with no prepayment penalty is often championed as a social goal, but there is little economic rationale for such a goal. Moreover, the prepayment risk is priced into the mortgage rate, making this product more costly for borrowers than alternatives, and MBS investors will not bear that risk without proper compensation.


Residential Mortgage-Backed Security Issuance

(billion dollars)

Citation: IMF Staff Country Reports 2015, 169; 10.5089/9781513514307.002.A001

Sources: SIFMA, Federal Reserve Board; staff calculations.

Government Involvement and Homeownership

Citation: IMF Staff Country Reports 2015, 169; 10.5089/9781513514307.002.A001

Source: Chapter 3 in April 2011 Global Financial Stability Report.

4. Reform of the GSEs, which remain in conservatorship, has stalled—generating uncertainty and complicating other policy initiatives. Several legislative proposals have been introduced in Congress (Table 1), but momentum appears to have been lost amidst political disagreements on the details. In the meantime, the status of the GSEs creates uncertainties. For instance, the GSE-patch—which exempts loans purchased by the GSEs from the QM rule until January 10, 2021 or the end of conservatorship (whichever happens first)—affects how binding and effective QM will be. Another risk is that the move to a single security and common securitization platform in an environment of GSE dominance could increase the obstacles to restarting PLS by concentrating the standard-setting power Fannie Mae and Freddie Mac enjoy.

5. However, there has been progress in building other components for a well-functioning housing finance system. Spearheaded by Title XIV (Mortgage Reform and Anti-Predatory Lending) of the Dodd-Frank Act with an important role for the newly-established CFPB, this progress has involved actions by the FHFA and other agencies:

  • Ability to repay and QM: The CFPB requires lenders to make a reasonable and good-faith determination, based on documented and verified information specified in the regulation, that the borrower can meet her payment obligations in connection with consumer credit transactions secured by a dwelling. In addition, a loan that meets certain criteria is deemed to be a Qualified Mortgage (QM) and enjoys special protections—a safe harbor for loans that are not higher-priced mortgages—from legal liability. These rules went into effect in January 2014.

  • Consumer protection: A series of rules to curb abusive practices have been issued by the CFPB. These include loan originator compensation requirements, high-cost mortgage provisions (effective January 2014), and integration of mortgage disclosure requirements under RESPA and TILA (effective August 2015).

  • National mortgage servicing standards: The CFPB servicing rules govern how servicers are to process payments, notify borrowers of interest rate changes, resolve errors, and provide monthly statements, among other servicing functions. It also establishes a highly detailed timeline for communicating with delinquent borrowers and processing loss mitigation applications.

    These have increased the emphasis on compliance in the servicing business. In addition, certain provisions create new borrower rights that are enforceable through a private right of action. These rules went into effect in January 2014.

  • Risk retention and QRM: Regulators finalized the risk retention rule in October 2014 to implement Title IX of the Dodd-Frank Act, which also includes definition of a Qualified Residential Mortgage (QRM). The final rule exempts a covered transaction that is backed by pools consisting only of QRM loans from the 5-percent risk retention requirement (included in the Dodd-Frank Act for other securitization products). The QRM definition was aligned with the QM standard implemented earlier in 20149 and will be reviewed four years after it becomes effective (December 2015), and then every five years thereafter.

  • Credit rating agency reform: CRAs play a crucial role in the securitization process by doing the due diligence and evaluating the quality of underlying assets in a pool of loans or securities. The crisis revealed deficiencies in CRA business models and their inherent conflicts of interest. The SEC issued new rules, as part of implementation of Title IX of the Dodd-Frank Act, in August 2014 to boost ratings quality and increase CRA accountability. The rules spell out what credit rating agencies should do to contain conflicts of interest including erecting strict boundaries between sales staff and employees that determine the ratings, having procedures to conduct look-back reviews, reviewing annually their internal controls and disclosing credit rating performance statistics. The rules became effective in late 2014 and January 2015.

  • FHFA actions: Under the conservatorship, the agency has strengthened the regulatory oversight of GSEs, reduced their retained portfolio, promoted credit-risk sharing transactions (“Connecticut Avenue Securities” issued by Fannie Mae and the “Structured Agency Credit Risk” from Freddie Mac), provided clarity on reps and warrants, issued private mortgage insurance eligibility requirements, and has been working on a single security and common securitization platform.

Table 1.

Legislative GSE Reform Proposals

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B. The Road Ahead

6. A desirable end-point would be a hybrid public-private market.10 This option would balance the advantage of reducing costs and risks to the taxpayers with the desire to maintain a certain level of credit access and circumscribed government involvement. The components of such a system would include:

  • A public utility that builds on the existing infrastructure put together in the GSEs and the work already done by the FHFA during the conservatorship. Such a utility would leverage the government’s role in the market (including via the GSEs) to support standardization and computerization of mortgage data and enforcement of prudential standards.

  • Transformation of Fannie Mae and Freddie Mac into an entity with a smaller footprint by reducing the scope of loans eligible for GSE securitization, shifting risk to private investors, and undertaking their remaining operations on a level playing field with other large, interconnected financial institutions. To move to this downsized role, the current investment portfolio would need to be sold off gradually.11

  • A sizeable first-loss risk that is borne by private capital. This would require implementation and diligent enforcement of sound, clear rules for all participants in the mortgage business, from origination to credit enhancement to servicing.

  • An explicit government backstop—funded by risk-based guarantee fees and strictly limited to catastrophic events—so as to support the system and maintain access to credit during times of crisis. This provision is included on the basis that, pragmatically, refusing any public backstop in a crisis would not be credible.12 Making the backstop explicit would at least allow pricing of this insurance and appropriate accounting in the public balance sheet.

  • Social housing goals (linked to homeownership rates and access to credit by low-income and low-net-worth families) separated from public interventions that are aimed at ensuring a liquid and well-functioning mortgage market. With an explicit and transparent accounting of the costs of pursuing those social objectives, policymakers could make a clear choice on the fiscal trade-offs in promoting homeownership and affordable housing.

  • Reduced cross-subsidization through the proper pricing of and separate charging of the prepayment provision in fixed-rate mortgages.13

7. While there is a legitimate reason for wanting to preserve the to-be-announced (TBA) market, the need for a 30-year pre-payable FRM is less clear-cut.14 There is little evidence that the 30-year FRM raises the utility of households or insulates them from interest rate volatility. In fact, the average household holds their 30-year mortgage for only about 6–7 years and pays a duration premium in doing so (relative to obtaining a 15-year FRM or an ARM). Although uncertain, analysis suggests that this mortgage product could survive, albeit possibly with a higher cost, even in the absence of a public subsidy (Fuster and Vickery, 2012). Serious consideration should be given to ending cross-subsidization and making the pricing of the fixed-rate prepayment option explicit to the borrower.

8. Further actions are needed in some areas to address the weaknesses revealed during the crisis. PLS needs to be revived if securitization is to remain the main funding source and taxpayer support is to be reduced. Adjustment to new regulations and rebuilding of confidence in the market will inevitably take some time but there are steps that can be taken to expedite the return of PLS:

  • Dealing with legacies. While foreclosures and delinquencies have decreased significantly, there are still some legacy loans. For instance, Bank of America still has assets from its 2008 acquisition of Countrywide Financial and estimates that it will get back to a “normal level of delinquent loans” only by 2016. The process of moving these loans through the pipeline (through sale, restructuring, or foreclosure) has been slow. Reducing litigation risks (e.g., by expediting remaining PLS cases and settlements through the courts) and expediting loan workouts would help.

  • Put-back risk has been a widely-quoted reason for banks’ reluctance to get back in the mortgage origination and securitization business. Lack of transparency on repurchase exposure and liability has led to stringent credit overlays. The FHFA has taken several steps since 2012 to provide clarity and relief by offering sunsets (Table 2). While lenders continued to express concern after the early attempts, there is some nascent evidence that the most recent clarifications may be helping. Other possible actions may include a shortening of the current three-year sunset period (most underwriting errors will be detected soon after origination) and providing alternative dispute resolution processes and cure mechanisms for non-material mistakes and lower-severity defects that do not directly affect mortgage default probability (FHFA is already considering such options).

Table 2.

FHFA Reps and Warrants Policies

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Opportunity to re-establish acceptable history as of the 60th payment, provided that there were no more than 2 delinquencies of 30 days or less in the first 36 months and the 60th payment is not delinquent.

Delinquencies have to be for 30 days or less and the 36th payment cannot be delinquent.

Exclusions fall into six categories (misrepresentations, misstatements, and omissions; data inaccuracies; charter compliance issues; first-lien priority and title matters; legal compliance violations; unacceptable mortgage products). Also established is a minimum number of loans that must be identified with misrepresentations and data inaccuracies to trigger the exclusion.

9. While legislative action to establish such a system is being contemplated, a great deal can be achieved through administrative actions. These actions—some of which FHFA has started to implement—include:

  • Undertaking a more significant shift of credit risk to private investors through an expansion of credit-risk sharing transactions and implementing up-front risk sharing operations as well as back-end risk sharing transactions;15

  • Ensuring the guarantees provided by the government are appropriately priced and aligned with the underlying risk;16

  • Reducing the conforming loan limits so as to encourage banks to hold more assets on balance sheets or to tap into private forms of securitization;

  • Bringing the prudential standards for the (smaller) GSEs closer to that for other large, interconnected financial institutions;17

  • Moving toward a common securitization platform and data infrastructure for standardization of loan application and closing processes;18

  • Setting clear and common underwriting, credit-risk mitigation, and servicing standards (based on the QM and QRM rules and the work done on private mortgage insurer eligibility requirements and regulatory guidelines for servicers);

  • Explicitly account for and provide direct subsidies to support access to affordable housing (including rentals).19

C. Financial Stability Considerations

10. Emerging risks—including those from unpredictable reactions to a changing regulatory environment—should be monitored carefully. In particular:

  • The interaction of new regulations has been changing the mortgage business and new safeguards may be needed with respect to nonbank originators or specialized mortgage servicers. For instance, there has been a notable increase in nonbanks’ share of mortgage originations as banks have moved away from certain mortgage market segments. Similarly, the increased regulatory burden and legal liabilities associated with the CFPB’s new servicing rules, combined with Basel III’s capital treatment of mortgage servicing assets, appears to be resulting in consolidation in the servicing industry and a shift of assets to nonbank servicers. As a result, more banks now elect to sell mortgages into the secondary market “servicing released” or to divest their servicing portfolios. Still other servicers opt to employ sub-servicers or component servicers to improve the economic value of their servicing rights. These developments will need to be monitored closely to ensure that risks remain contained. The FHFA has started work on revision and alignment of servicer eligibility requirements. Actions by other agencies may be necessary given the complexity of the regulation of nonbank entities. As such, coordination across multiple regulators and agencies will be crucial. In this regard, regular stress testing of the GSEs, with the results publicly disseminated, may prove a valuable exercise in understanding and mitigating potential emerging risks.20

  • Greater clarity is needed in the mortgage insurance market. The role to be played by private mortgage insurers in a reformed system requires them to hold sufficient capital and liquid assets to meet obligations under a stress scenario. Currently, there is very limited capacity in private mortgage insurers: only 3 percent of the entire insurance industry is for mortgage guarantees (7 companies). While the capital requirement for mortgage insurers is a risk-in-force-to-capital ratio of not more than 25 to 1, the industry is under pressure from various directions, including ratings agencies and potential new regulations. FHFA has just issued revised private mortgage insurer eligibility requirements: they will come into effect on December 31, 2015 and insurers will face the prospects of raising capital reserves to meet the new requirements ahead of a March 1, 2016 deadline to certify their compliance. NAIC formed a working group to introduce risk-based capital requirements for mortgage insurers.21 Effects of these new and upcoming regulations need to be monitored carefully, given that the complex system is prone to regulatory arbitrage, and stress tests should be conducted to ensure that the insurers remain well capitalized as the market conditions evolve.

  • Regular revisiting of the QM and QRM rules. Finalization of QM and QRM rules is welcome and has helped move the industry away from the certain risky practices of the past (e.g., low-doc loans). However, these restrictions are untested and a regular reassessment of the design of these rules should take into account evolving standards and practices in underwriting and securitization. There is an important role for the FSOC to play here analyzing the possible use of QM and QRM for macroprudential purposes across a range of agencies. Some thought should also be given to whether other tools, such as LTV requirements, may be useful and (if so) how they would be operationalized.

United States: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.