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CBO Calculates Mortgage Subsidy Costs To US Taxpayer

by Mike Godfrey,, Washington

06 June 2011

In testimony before the United States House of Representatives Committee on the Budget, the Congressional Budget Office (CBO) has calculated the budgetary cost of Fannie Mae and Freddie Mac, and looked at the options for a future role of the federal government in the secondary mortgage market.

Firstly, it was pointed out that, historically, support for the mortgage market has been part of a broader federal policy aimed at encouraging home ownership and, to a lesser extent, at making housing more affordable for low- and moderate-income families. The activities of Fannie Mae and Freddie Mac have been an important aspect of that policy.

In 2010, Fannie Mae and Freddie Mac owned or guaranteed roughly half of all outstanding mortgages in the US, and they financed 63% of the new mortgages originated that year. Including the 23% of home loans insured by federal agencies, such as the Federal Housing Administration, about 86% of new mortgages made in 2010 carried a federal guarantee.

Until recently, the largest federal subsidies for home ownership generally came from the favourable tax treatment for housing. The obligations of Fannie Mae and Freddie Mac had no official backing from the federal government, nor were any costs associated with them reflected in the federal budget.

Nevertheless, the CBO noted that because of their size, federal charter, and major role in the mortgage market, most observers believed that the government would not allow Fannie Mae and Freddie Mac to default on their obligations. That implicit federal guarantee, which lowered their borrowing costs and increased the price that investors paid for their guarantees, represented a federal subsidy to them.

However, when, starting in 2007, their losses mounted sharply as housing prices dropped and foreclosure rates climbed, the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into federal conservatorship in September 2008, and the Treasury entered into agreements with them to provide sufficient capital to keep their net worth from falling below zero.

Between November 2008 and the end of March 2011, the CBO confirmed that the government provided about USD154bn in capital to Fannie Mae and Freddie Mac and, in return, received preferred stock and warrants that make the US Treasury their effective owner. Having received more than USD24bn in dividends on its preferred stock, that results in net payments to the government-sponsored enterprises of USD130bn. CBO expects additional net cash payments from the government over the next several years.

In CBO’s judgment, therefore, the federal “conservatorship” of Fannie Mae and Freddie Mac make the two entities effectively part of the government, and implies that their operations should be reflected in the federal budget. Hence, in its baseline budget projections, the CBO accounts for the cost of their operations as though they are being conducted by a federal agency, showing the annual subsidy costs of their new mortgage guarantees.

In August 2009, CBO estimated that the cost of all Fannie Mae and Freddie Mac’s mortgage commitments made through the end of 2009 would total USD291bn on a fair-value basis. Since then, CBO has not updated its estimate of the cost of those past commitments, but their financial reports suggest that losses on those obligations may have increased somewhat since that time because of the continued deterioration of conditions in the housing market.

Looking forward, in its March 2011 baseline projections, the CBO also estimates that the new guarantees Fannie Mae and Freddie Mac will make over the next decade will cost the government USD42bn on a fair-value basis. It adds that, although the average subsidy rate for their new business has fallen since the peak of the financial crisis, the subsidy rate will remain positive as long as Fannie Mae and Freddie Mac provide guarantees on mortgages at prices below those offered by private financial institutions.

Finally, the CBO looked at the wide range of proposals being contemplated for a future federal role in the secondary mortgage market in general, for the future of Fannie Mae and Freddie Mac in particular, and for the transition to a new model. The broad options include moving to a hybrid public/private approach that would involve explicit federal guarantees of some privately issued mortgage-backed securities; establishing a fully federal agency that would purchase and guarantee qualifying mortgages; or promoting a fully private secondary mortgage market with no federal guarantees.

It concluded that any new approach would need to confront major design issues – “if the approach included federal guarantees, how to structure and price them; whether to support affordable housing and, if so, by what means; and how to structure and regulate the secondary market.”

TAGS: tax | investment | economics | real-estate investment | fiscal policy | real-estate | budget | United States

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