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August 23, 2017

At the New York Fed: The Appropriate Government Role in U.S. Mortgage Markets

While the U.S. mortgage finance system was at the center of the recent financial crisis, it remains largely untouched by legislative reforms. At the center of these conversations are Fannie Mae and Freddie Mac—both of which were placed into federal conservatorship in September 2008. Now, nearly nine years later, the fate of these two government-sponsored enterprises (GSEs) and the prospect of related changes to the mortgage finance system are once again a focus of policy discussion. In this post, we summarize the main themes of a recent New York Fed workshop where policymakers, academics, and practitioners gathered to consider the future structure of the U.S. housing finance system.

The April 27-28 workshop “The Appropriate Government Role in U.S. Mortgage Markets” was organized by the New York Fed in association with the Board of Governors, the Atlanta Fed, the Anderson School of Management at UCLA, and the Wharton School at the University of Pennsylvania. The conference agenda, with links to the presentation slides, is available online. The workshop was designed around broad themes that are relevant for mortgage finance reform, rather than comparisons of specific reform proposals. What follows is a summary of these broad themes.

Several presenters set the stage for our discussions. U.S. home prices nearly doubled between 2000 and early 2006, and then rapidly declined by about one-third as the financial crisis and the Great Recession unfolded. Paul Willen shows that the ratio of house prices to annual rents rose substantially during the housing boom—a pattern consistent with the view that speculative demand was driving house price appreciation. Susan Wachter notes that, during the same time, there were real estate booms and busts across many countries with different mortgage finance systems. This suggests a common underlying macro-financial dynamic. Atif Mian summarizes research across countries and periods on the connection between mortgage debt overhangs created by housing busts and subsequent economic performance.

The Government’s Role in Mortgage Finance

The U.S. government’s primary role in this market has been to provide mortgage insurance programs and secondary market guarantees (explicit and implicit) for mortgage-backed securities (MBS).

Government mortgage insurance programs are operated by the Federal Housing Administration (FHA), Department of Veteran’s Affairs, and the Rural Housing Service and facilitate lending to borrowers with little-to-no down payment and weak credit histories. Virtually all such loans are securitized, with cash flows guaranteed by Ginnie Mae—a government corporation.

Fannie Mae and Freddie Mac, on the other hand, are GSEs—quasi-private/quasi-public companies chartered by Congress to facilitate liquidity in the broader secondary conforming-conventional mortgage market. Like Ginnie Mae, Fannie Mae and Freddie Mac guarantee principal and interest payments on MBS, and investors have long viewed these two institutions as benefitting from an implicit government backstop. Securities guaranteed by Ginnie Mae, Fannie Mae, and Freddie Mac are often collectively referred to as “Agency MBS.”

As discussed by W. Scott Frame, the GSEs have been tasked with many policy goals over the years, including establishing a nationally integrated mortgage market, promoting homeownership, and, more recently, enhancing financial stability.

Wayne Passmore discusses the pre-crisis prescriptions for GSE reform and the degree to which they were attained by the Housing and Economic Recovery Act (HERA) of 2008. The most important remaining area to address is whether the government should move away from implicit guarantees for the GSEs (or their replacement) and shift to an explicit and priced government guarantee for catastrophic mortgage credit risk.

Jane Dokko points out the tradeoffs involved in designing government policy to support affordable housing—such as that between risk-based pricing to better align guarantee premiums to default risk and cross-subsidization to lower premiums for more constrained households (see Kris Gerardi’s presentation for a detailed discussion and analysis in the context of GSE credit guarantees).

Barry Zigas emphasizes that any reformed system should maintain a clear focus on ensuring that mortgage credit is accessible and affordable, suggesting a three-pronged approach including quantitative and qualitative assessments.

Private Sector Capital and Mortgage Credit Risk

A second theme concerns how housing finance can bring in more private sector capital to bear mortgage credit risk, while maintaining the liquidity benefits from the “to be announced” (TBA) forward market for Agency mortgage-backed securities.

James Vickery points out two key requirements for a functional TBA market are standardization and credible guarantees against mortgage default.

Aurel Hizmo finds that TBA market liquidity reduces mortgage rates to borrowers by 20 basis points, on average.

Andrew Davidson argues that private capital can be attracted to the secondary mortgage market through the rapidly developing credit risk transfer (CRT) market. However, he believes that to do so, housing finance reform must accomplish the following objectives: (1) limit the number of securitizers to maintain standardization and reduce “race to the bottom” dynamics; (2) establish an explicit government tail-risk guarantee designed using a vintage model; and (3) ensure risk retention by originators to maintain proper underwriting incentives.

Bolstering Program Evaluation

A third theme emerging from the workshop is that program evaluation needs to be given greater emphasis. This would enable policymakers to better assess whether government programs are meeting their goals and to learn how to improve programs over time, based on experience.

Deborah Lucas stresses that any housing subsidies should be well targeted, on budget, and funded through broad-based taxes. This stands in very sharp contrast to the existing GSE model. The extent of government subsidies to housing needs to be evaluated holistically given the multiple sources of subsidy; and the expected cost to the government from these subsidies should account for covariance across risks for different government programs (see the presentation by Brent Ambrose and Zhongyi Yuan for more).

Donghoon Lee and Joseph Tracy illustrate how new data capabilities allow for more extensive analysis of government housing goals such as “sustainable homeownership.” This is particularly important for FHA mortgage insurance.

Foreclosure Prevention

A fourth theme, as stressed by Karen Dynan, is that financial stability would be enhanced by having effective foreclosure prevention programs in place in case housing markets come under stress again in the future. This involves two distinct elements.

First, as emphasized by Itzhak Ben-David, it is important to have clear ex ante delegation of responsibility for mortgage interventions. He specifically notes that incentive conflicts, such as those between first- and second-lien holders, need to be avoided.

Second, we should learn from the crisis about the types of interventions that worked best to reduce foreclosures. Chandler Lutz provides such an analysis of the California Foreclosure Prevention Laws.

Improving Mortgage Design

A final theme is to consider variants of the thirty-year fixed-rate mortgage that may better support financial stability. Indeed, this was the theme of a previous New York Fed conference. Affordability concerns have led to government support for very low down-payment mortgages by the FHA, but at a cost of high default rates. More up-front equity by the borrower would reduce the default rate, but would require the borrower to provide more cash at closing.

Stephen Oliner describes a new mortgage product that reduces this tension by increasing the rate at which borrowers build equity over time. This should reduce the default rate while not requiring the borrower to provide more cash at closing.

Morten Nielsen, stepping in for Jesper Berg, discusses how in Denmark low default rates are supported by stronger recourse and shorter foreclosure timelines.


The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

W. Scott Frame is a financial economist and senior advisor in the Research Department of the Federal Reserve Bank of Atlanta.

Joseph Tracy is an executive vice president and senior advisor to the president of the Federal Reserve Bank of New York.

How to cite this blog post:

W. Scott Frame and Joseph Tracy,, “At the New York Fed: The Appropriate Government Role in U.S. Mortgage Markets,” Federal Reserve Bank of New York Liberty Street Economics (blog), August 23, 2017,

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