Housing Finance Agencies

Housing finance agencies are institutions designed to help develop or support housing finance markets.[1] In general, their focus is limited to the market of the country in which they have been established. The approaches used by the housing finance agencies to achieve this objective differ considerably. Especially over time, most of the agencies have been given the additional tasks of promoting the development of domestic (mortgage) bond markets and/or of functioning as vehicle for the securitisation of housing finance.

Business lines, owner structure and sources of funding

Housing finance agencies are very diverse in regard to their owner structure and business lines though they share a common objective – the development or support of housing finance markets. Yet, most agencies have acquired over time the additional task to develop bond and/or securities markets.
Some agencies distribute their own loans to households, either directly or via other mortgage lenders, or they even operate as housing project developers.[2] Others function as a Mortgage Liquidity Facility by extending wholesale loans to the mortgage lenders collateralized by the lenders’ mortgage portfolios or by purchasing already originated mortgages of banks or other lenders. And yet others promote the securitisation of housing finance by getting involved in mortgage-backed-security (MBS) markets. However, also this involvement differs and ranges from the issuance of own MBSs and the provision of credit enhancements as well as trustee services for privately issued MBSs to the establishment of mortgage insurance services. Of course, all or some of these diverse tasks can be united under the roof of a housing finance agency.
There are essentially three choices for the ownership of a housing finance agency.[3] It might be owned by the government, owned as a cooperative, by member institutions, with or without the participation of government (institutions) as shareholders, or owned by the general public.
The last possibility is the least common and limited to the government-sponsored enterprises (GSE) Fannie Mae and Freddie Mac in the United States. Even if the housing finance agency is neither a government institution nor the government a shareholder, the government usually takes a lead role in the creation of the agency and often far beyond that point of time. The support provided by the government – irrespective of the ownership structure – regularly consists in a guarantee of the bonds/securities issued by the agency or the granting of special regulatory or tax treatments. It is noticeable, that a certain special status of the housing finance agencies can create the view in the market that the agencies have a strong but implicit government guarantee though a formal guarantee does not exist. Alongside direct grants, tax exemptions and favourable regulatory treatment, explicit or implicit government guarantees are the main source housing finance agencies’ subsidies are derived from.[4] 
The sources of funding are not as diverse as the business lines but still differ from agency to agency considerably. Though a few housing finance agencies offer various deposit account services similar to commercial banks, theses funds as well as direct grants are usually solely enough to carry out their tasks properly. Therefore, almost all agencies have to tap capital markets to augment their resource base. The most common instrument used is the issuance of general debt obligations.[5] This is especially due to the fact that they do not need – unlike covered bonds or securitisation – a specific legal and tax framework or (expensive) credit enhancement structures. Furthermore, agencies’ bonds usually receive a very high credit rating due to the (extreme) specialisation and the low risk nature of the housing finance agencies, which benefits from a number of safeguards (including implicit and explicit government guarantees) to protect it against the main risks it faces. But also if more elaborate capital markets exist housing finance companies usually continue to issue debt obligations as debt financing is regarded as a balancing alternative to other capital market instruments available. Nevertheless, housing finance agencies have often become important vehicles for the development and support of MBS markets.

Reasons for setting up a housing finance agency

In general, housing finance agencies are established in response to concerns that there is a shortage of housing finance in the economy or that there will be a shortage in the near future.
In many cases, the housing finance agencies are set up to address this concern by working as Liquidity Facilities for primary mortgage lenders (PML) so that these can reduce their vulnerability to the maturity mismatch between their liabilities and assets.[6] This is also the reason why most of the agencies have been given (over time) the additional task of promoting the development of domestic (mortgage) bond markets as capital market funding can contribute to overcome such mismatches and provides loan originators with an additional source of funding to complement deposits. In some cases it can be the only route for institutions with small or no deposit bases like non-bank specialized lenders or small banks but instruments to raise funds directly from the capital markets might be not available or too costly or complex given the stage of market development. Large commercial banks may not need an external source of cash, but they still have to be able to manage their liquidity if they extend long term loans using their deposits. Holding marketable bonds or being able to pledge loan portfolios for short term advances are ways to address this requirement. The major role of the Liquidity Facility is either to extend wholesale loans to the mortgage lenders collateralized by the lenders’ mortgage portfolios or by purchasing already originated mortgages from lenders. It finances these deals mainly by issuing general debt obligations. Hence, the core function of the Liquidity facility is to act as an intermediary between PMLs and the capital market. Due to the advantages of this funding method – mentioned above – Liquidity Facilities can be seen as ideally suited to relatively early stages of capital market development.
Later on, they are often used to achieve a higher level of sophistication in the market and to promote mortgage securitization once the proper conditions are fulfilled. However, it should be considered that the initial support ceases once the housing finance agency has reached a level of self-sufficiency as making special privileges a permanent feature will often result in considerable market distortions. 

Fannie Mae, Freddie Mac and Ginnie Mae

The bulk of literature on housing finance agencies relates to the United States. This no doubts reflects that housing finance agencies have been present in the United States for almost a century, that these agencies have grown to be among the largest US-American if not global financial institutions, and that the US-American housing finance and MBS markets are by far the largest in the world. Both, Fannie Mae and Freddie Mac, are most likely the globally best known (but not the sole) US-American housing finance agencies, a fact which is also due to their collapse in 2008 and the associated news coverage.  Fannie Mae was established in 1938 as a secondary market for newly-created Federal Housing Administration (FHA) loans, which were insured by the government but which during the crisis of the great Depression had trouble gaining acceptance by private investors. Fannie Mae, at this time a government agency, was authorized to purchase these government-insured mortgages from originators, to hold these loans in its portfolio, and to finance its purchases of mortgages with the debt issues in the capital market. By holding only government-insured mortgages Fannie Mae, on the one hand, accepted almost no credit risk but was, on the other hand, severely restricted in its secondary mortgage market activities. In 1968 because of budget pressures from the Vietnam War Fannie Mae was moved off budget and set up as a private, government-sponsored enterprise (GSE). Consequently, Fannie Mae ceased to be the guarantor of government-insured mortgages, and that responsibility was transferred to the newly created government agency Ginnie Mae. In 1970, the government created Freddie Mac, a GSE as well, to compete with Fannie Mae and, thus, facilitate a more robust and efficient secondary mortgage market. Ginnie Mae is backed by the “full faith and credit” of the government. Though Fannie Mae and Freddie Mac are neither government agencies nor enjoy a formal guarantee, they are viewed in the capital market as having “agency status” and having an “implicit” or “conjectured” government guarantee. This special status enabled Fannie Mae and Freddie Mac to borrow money in the bond market at lower rates (yields) than other AAA-rated financial institutions.The three institutes have been responsible for promoting the major innovation in secondary markets, the mortgage-backed securities (MBS). Ginnie Mae’s principal role in the market for MBSs is to guarantee investors the timely payment of principal and interest on MBSs backed by federally insured or guaranteed loans. Thus, Ginnie Mae does not issue MBSs or purchase mortgage loans. Therefore, Ginnie Mae’s balance sheet does not use derivatives to hedge or carry long term debt. Both Fannie Mae and Freddie Mac provide similar insurance guarantees but, in contrast to Ginnie Mae, are not limited to government-insured loans, they issue MBSs, they buy and sell mortgage loans, and they use derivatives to hedge long term debt. By offering financial guarantees Fannie Mae, Freddie Mac and Ginnie Mae take the credit risk on these mortgages; the interest-rate risk – that interest rates will rise and the mortgages will become less valuable, or that interest rates will fall and the mortgages will be prepaid and disappear – is taken by the holders of the MBSs. For their guarantee, the three agencies receive an annual fee as long as the pools remain in existence.In the other part of their business, Fannie Mae and Freddie Mac retain mortgage assets which are financed by debt and equity. In this case, they assume the credit and potentially expose themselves to greater interest rate risk.  The GSEs have incentives to finance mortgages or repurchase previously issued MBSs with debt because the difference between mortgage yields and borrowing costs generally exceeds MBS guarantee fees.The rise in the secondary markets came about largely because of the emergence of new, innovative products and especially because of the standardisation of pools of mortgages brought on by the three agencies. Since the 1990s and up to 2003, the agencies have owned or have been responsible for about half of the outstanding stock of residential mortgages. In the peak years of the housing boom, from 2004 to 2006, the agencies’ share on new mortgage originations decreased to around 30 per cent as the “private label” secondary market was expanding massively. In 2007, Fannie Mae and Freddie Mac guaranteed about 3 trillion US Dollar in (securitised) mortgages and their retained mortgages and assets were worth approximately 1.5 trillion US Dollar.In 2007, Fannie Mae and Freddie Mac began to experience large losses on their retained portfolios and the delinquency rate of the mortgages they guaranteed rose sharply. In 2008, the sheer size of their retained portfolios and mortgage guarantees led the Federal Housing Finance Agency (FHFA) to conclude that they would soon be insolvent. By September 6, 2008, it was clear that the market believed the firms were in financial trouble, and the FHFA put the companies into “conservatorship”. At this point, the implicit government guarantee had become an explicit one. The government supported the GSEs with grants worth billions so that they could continue to operate. In effect, the government uses the already distressed GSEs to bail out the mortgage market – and makes them even more insolvent. This fact is also reflected in the record 86.1 per cent of mortgages originated in the second quarter of 2009 which were financed through the agencies. This in turn shows that the mortgage market would collapse without the activity of the agencies; but this comes at a high cost – it is estimated that the cost of the GSE bailout will be between 25 to 300 billion US Dollar (whereby costs between 250 to 300 billion seem most realistic, some estimates assume costs even as high as 1.1 trillion US Dollar).

Critical Acclaim

Housing finance agencies have often played a constructive role in the development of domestic residential mortgage markets and usually also for the bond markets. In many countries they have not required large government subsidies to fulfil this mandate whereby the actual size of government support given to housing finance agencies varies considerably from country to country. Most agencies have also managed to transfer most of the benefit of their government support to either households or financial institutions whereby agencies that participate directly in the primary housing finance markets appear to have been most successful in passing on the government support.
However, many of the housing finance agencies have a large if not dominant or rapidly growing presence in their housing finance market which gives rise to policy concerns. Associated risks are the distortion of competition, the crowding out of private lenders and mortgage insurers, the hindering of market development, an increase in political influence on mortgage loan decision, and a growing risk exposure of the state. The GSEs Fannie Mae and Freddie Mac stand exemplarily for the risks associated with housing finance agencies in a dominant position: due to the enormous size of their portfolio the state exposure to risk became extremely high (which is shown by the enormous sums the bailout costs); their business decisions were influenced by policymakers; and according to some analysts Wall Street’s expansion into “exotic” mortgages took place in part in order to compete and take market share from Fannie Mae and Freddie Mac which enjoyed a favourable position in conventional mortgage markets due to their implicit government guarantee.  
However, irrespective of the potential risks, in many countries where private financial institutions have increased their supply of housing finance, the mandate of the agencies has been broadened as they struggle to remain in a relevant position. This usually results in housing finance agencies holding more risks. By contrast, it would be more reasonable to see a decline in the market share of housing finance agencies as a testimony to the role they have played in building the market. This would result in a fall of housing finance agencies’ shares of the financial risk associated with housing loans. In this context, governments should also scale back their involvement in markets. As this has proven to be often difficult, it is useful to explicitly outline exit strategies from the outset (e.g. through a sunset-clause).

Housing Finance Agencies in times of financial crises

 It is not possible to give a general statement to the role and stability of housing finance agencies in times of financial crisis as the design and business lines of agencies can differ considerably. They might exert a stabilising function and take on a counter cyclical role but they might as well be at least partially responsible for the occurrence of a crisis. It can be concluded from past experiences that the role of housing finance agencies in times of crises depends on both the specific design/position of the agency and the specific circumstances. A negative role of housing finance agencies can be prevented best if they do not hold too much risk, are not led in their business operations by political decisions, and/or distort the market. They might serve in times of crises best if their general role is mostly a back up function for the markets.&nb

[1] For the following cp.: Davies, Michael/ Gyntelberg, Jacob/ Chan, Eric: Housing finance agencies in Asia, Basel 2007, S. 4. In the following: Davies/ Gyntelberg/ Chan: Agencies.

[2] For the following cp. ibid, pp. 3-7.

[3] For the following cp.: Hassler, Olivier/ Walley, Simon: Mortgage Liquidity Facilities, in: Housing Finance International, 4/2007, pp. 16-22. Here: pp. 20-22. In the following: Hassler/ Walley: Liquidity Facilities.

[4] Cp. Davies/ Gyntelberg/ Chan: Agencies, p. 17.

[5] For the following cp.: Hassler/ Walley: Liquidity Facilities, pp. 18-19.

[6] For the following cp.: ibid.

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Housing Finance Agencies - boon or bane?