After almost 20 years of the Community Reinvestment Act and anti-redlining and anti-discrimination laws, minorities are still less likely than whites to be approved for home mortgage loans. Certain inner-city neighborhoods still cannot generate the credit to bring appropriate properties into homeownership. In fact, homeownership rates have declined in the past decade for first-time homebuyers, working-class families, and households with children. The need for affordable rental housing is critical for the six million low-income families who pay more than half their income for rent.
Most grassroots activity around these issues is focused on government programs, banks and other lending institutions. But to get at the core of the issue, it is important to look at the industry as a whole and understand and influence the regulatory agencies and the secondary market.
On February 16, 1995, HUD released its proposed regulations for the secondary market Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac. The proposed regulations identify regulatory goals for low-and moderate income home purchases; alter the definition of underserved areas, focusing more on neighborhoods in need; and redefine special affordable housing goals.
What are these GSEs and how do the regulations affect you?
The Quid Pro Quo
In 1968, Congress created the Federal National Mortgage Association (Fannie Mae) as a stockholder-owned, privately managed corporation to provide a secondary market for home mortgages. In 1970, Congress chartered another GSE, the Federal Home Loan Mortgage Corporation (Freddie Mac).
As GSEs, Fannie and Freddie receive substantial benefits. They have access to a $2.25 billion line of credit from the U.S. Treasury; exemption from state and Securities and Exchange Commission registration requirements; exemption from all state and local taxes except property taxes; and higher demand for their securities, since the Government gives those securities the same preferred investment status as Treasury debt.
More importantly, the GSEs benefit from being perceived as having federal backing for their debt – although they do not. This has allowed the GSEs to borrow at near-Treasury rates and sell their securities at better rates than those of purely commercial firms.
How well is their business doing? In 1993, the two GSEs collectively purchased $543 billion in mortgages, or 70 percent of the mortgages originated in the conventional conforming loan market, and had combined profits of $2.7 billion.
In return for the GSEs’ competitive advantages, Congress demanded that they undertake certain public purpose activities, notably promoting access to mortgages in underserved urban and rural communities, in minority communities, and to low- and moderate-income families. The GSEs were also expected to help end discrimination in the lending industry.
Over the intervening two and a half decades, a number of significant regulatory changes have affected the GSEs, among them the 1989 act that brought Freddie Mac under the regulatory authority of HUD.
In 1992, Congress enacted the Federal Housing Enterprises Financial Safety and Soundness Act (FHEFSSA). This Act further separated HUD’s regulation of the GSEs’ public purposes activities from their safety and soundness components by revising the role of the Office of Federal Housing Enterprise Oversight, an independent financial regulator within HUD. It also established a set of interim regulations for the GSEs.
FHEFSSA, often referred to as the GSE Act, was motivated by concerns over safety and soundness, rather than affordable housing. Nevertheless, as a result of pressure from housing advocates, the interim regulations did prescribe certain affordable housing standards for the GSEs. The Act requires the Secretary of HUD to assure that the GSEs meet their housing goals and fair lending obligations. It also expanded HUD’s authority to do so. The Secretary was directed to evaluate the interim regulations Congress had crafted and develop new regulations governing the GSEs.
On February 16, 1995, the proposed regulations were published in the Federal Register. After a 75-day comment period ending May 2, HUD will be reviewing the comments and writing and implementing final regulations.
The New Rule
Although Fannie Mae and Freddie Mac have done an outstanding job of strengthening and providing stability to the secondary mortgage market, community activists have repeatedly voiced concerns that the GSEs were not doing all they could to benefit low-income families and those in underserved communities. To address these concerns, the GSE Act required the Secretary to “establish, monitor, and enforce” specific annual performance goals.
These goals were to be based on a number of factors. For the years 1993 and 1994, the GSE Act established a set of escalating performance goals that measured, as a percentage of the GSEs’ total business, the availability of housing financing for low- and moderate-income families; for very-low-income families; and for families living in central cities, rural areas, and other underserved areas. The Act directed HUD to examine these goals and the assumptions upon which they are based and then develop new goals for 1995, 1996, and beyond.
The proposed regulations set minimum acceptable activity in numerical terms for housing goals in each of the three categories. Goals are set in each category for both single family homeownership and multi-family mortgages. In each case, the proposed rule increases from the previous two years the level of affordable housing business each GSE must set.
The proposed regulations differ from the interim regulations in three significant ways: the definition of an underserved area; a requirement that the GSEs inform HUD of fair housing violations by lenders; and an expanded interpretation of when the GSEs are required to take new business activity for review and approval to the Secretary of HUD.
Underlying the new rule is a dispute over the issue of leadership in improving affordable housing lending. The proposed rule states that the GSEs are expected to be “Leaders in the Field,” and it attempts to define the role of leadership that the GSEs should serve.
It is clear that both Fannie Mae and Freddie Mac have an obligation to provide a public service in return for a guaranteed marketplace, and that they have taken some initiative to satisfy this obligation. But it is equally clear that much more can be done to foster loan activity in underserved areas and for minority families. What is appropriate and realistic to expect of Fannie Mae and Freddie Mac is in dispute.
HUD maintains that Congress intended for the GSEs to provide leadership in this area. According to Nicolas Retsinas, HUD Assistant Secretary for Housing, “Leadership means that the GSEs influence and affect where and how credit is available in this country.”
HUD’s position is that Fannie Mae and Freddie Mac should undertake new activities, outlined in the proposed rule, to further penetrate the underserved market. It is the intent of the proposed rule, Retsinas said, “to require that the GSEs increase their existing efforts to establish innovative products and create new lender relationships in order to expand their purchases of mortgages for working class families, first-time homebuyers, and residents of underserved communities. To the extent that the rule does this, those families will be able to benefit from the GSEs’ federally-provided franchise, resulting in greater access to homeownership for these families.” According to Retsinas, the proposed rule is thus a good example of a performance-based regulation that provides clear direction for the GSEs to expand the market.
In response to the assertion that they should do more to provide credit in underserved areas, both Fannie Mae and Freddie Mac point to their records over the last two years of the interim regulations. Each exceeded the interim regulation requirements in affordable housing lending, and Fannie exceeded the goal for loans purchased from central cities. Each also increased financial resources and staffing devoted to affordable housing lending.
Fannie Mae introduced its Showing America a New Way Home program, with its commitment to provide homeownership to 10 million families through innovative products and partnerships with government and community-based development organizations. Freddie Mac introduced its Discover Gold Through Expanding Markets program, and it is working to increase the lending community’s awareness of affordable housing loan products approved by Freddie Mac.
Barry Zigas, Vice President of the Housing Impact Division at Fannie Mae, speaking in March at a National Neighborhood Coalition forum in D.C., highlighted Fannie Mae’s performance. “We have exceeded in every category and sub-category, including multi-family mortgages and loans to very low income families,” Zigas said. For 1994, 46 percent of Fannie Mae’s total business was in low- and moderate-income mortgages, and 31 percent was in central cities.
Dan Russell, Vice President of Community Development Lending at Freddie Mac, pointed to Freddie’s performance in the market. “In 1994, loans to low and moderate-income households and in central-city properties exceeded 49 percent,” he explained. He also cited a new department within Freddie Mac that “in specific geographic communities will work intensively with lenders, community groups, and local government to develop mechanisms and resources to expand mortgage finance industries ability to meet specific needs.”
The dispute is not about taking leadership, Fannie Mae and Freddie Mac argue. Fannie Mae in particular has taken great exception to HUD’s characterization that it has not provided leadership. The questions that remain are how to best achieve the preferred ends and to what extent the leadership role should be defined through a regulation, rather than internally driven within each GSE.
Zigas indicated that the proposed rule contains regulatory requirements that inhibit rather than stimulate Fannie Mae’s attempts to increase support for affordable housing. The GSEs argue that, despite their performances in these areas, escalating interest rates and an adverse marketplace have led to a decline in homeownership among working families and minorities.
Yet HUD interprets the decrease in homeownership as an indication that stimulating the GSEs’ role is both appropriate and necessary in order to develop mainstream lending to low and moderate-income families and underserved communities.
The proposed rules raise from the interim regulations the percentage of affordable lending each GSE is required to achieve as a percentage of total business. Neither GSE has taken exception to the new percentages. But they both caution that in developing the new regulations, HUD should not establish a precedent of continuing escalation of goals. Both want reassurance that if they meet or exceed the goals, that will not serve simply as an invitation to raise them higher still.
HUD points out that there is no perfect number for the amount of affordable lending that the GSEs should achieve. The proposed regulations outline HUD’s best thinking but are open to comments, particularly pertaining to future goals.
Zigas also expressed concern about the fact that under the special affordable housing goal, rental property mortgages are counted towards the set goal only if they serve very low-income populations (under 60 percent of area median). This, he noted, appears to focus on the market that is most difficult to serve and needs subsidies to be viable; yet the regulations come at a time when Congress has rescinded billions from the HUD budget, and HUD is shifting dollars away from very-low-income projects and into a mixed-income strategy.
Definition of a Central City
The GSE Act requires that the GSE provide mortgage credit to central cities and underserved markets. Previous regulations used the Office of Management and Budget (OMB) definition of a central city to define underserved areas. Over the last two years, however, HUD conducted extensive research and discussed this issue with researchers, public interest groups, and other government agencies. The studies show that central cities as designated by OMB are not necessarily underserved by mortgage markets. HUD points out that OMB designations are unrelated to credit needs, because they include well-served central cities and well-served parts of central cities and they exclude many distressed cities.
OMB designations also create regional unfairness. Far fewer people in the urbanized East and Midwest live in central cities than in the West. For example, 12 percent of New Jersey residents live in OMB-designated central cities, compared to 55 percent of Arizonans. HUD’s analysis of census tract data concerning mortgage flows in metropolitan areas shows that the primary indicator of an underserved area is the concentration of minority population. Therefore, in the proposed rule, HUD defines central cities as those census tracts in cities and metropolitan areas that are working class (less than 80 percent of MSA median income) or minority (greater than 30 percent minority tracts with tract income less than 120 percent of MSA median income). Any mortgage purchased by GSEs in these areas counts toward the underserved goal. Rural underserved areas are defined under the new regulations as non-metropolitan communities that are low-income or minority (greater than 30% minority).
On their face, HUD’s new definitions seem more appropriate, and Freddie Mac has supported census tract targeting. Nonetheless, the GSEs have concerns about its impact on their business practices. Zigas has commented that the geographic designations are unnecessarily narrow, that Fannie Mae exceeded the interim regulation’s central city lending requirement, and that this proposed change significantly affects its business strategy. In addition, he said, separating specific census tracts within a city can create difficulty in marketing and processing loans and thus could have a negative impact on underserved areas. Zigas points out that the GSE Act specifically requires the GSEs to provide credit in both central cities and underserved areas. He argues that the narrowness of the proposed rule inhibits Fannie Mae’s ability to work comprehensively on central-city issues. Zigas argues that the proposed regulation is also particularly narrow in defining rural areas. As an example, he says the definition would cover only about 10 percent of the rural population of Idaho.
Fair Lending Issue
Through the GSE Act, Congress places an obligation on Fannie Mae and Freddie Mac to combat discrimination in the lending industry. The GSEs are prohibited from discriminating in any manner in the purchase of mortgages. Under HUD’s interpretation, the GSEs therefore have an obligation to provide information to the Secretary to assist in an investigation. The proposed rule requires that Fannie Mae and Freddie Mac supply HUD with data to determine whether mortgage lenders with which they do business have failed to comply with the Fair Housing Act. The rule also requires that the GSEs help investigate specific lenders suspected of violating fair housing laws.
Generally, both GSEs support the existing regulations concerning fair-lending practices. Again, they point to their record on fair lending. Zigas reports that Fannie Mae has publicly and repeatedly committed itself to making elimination of discrimination in mortgage lending its number one priority, and the company is proud of its initiatives in this area.
Both the GSEs re-affirm their commitment to fair housing goals and responsibility not to discriminate. Both say they will cooperate with the Secretary on remedies to specific complaints. Both, however, have serious problems with the requirement that they participate in the investigations. They are clearly concerned about their relationship with the lending community. Currently, Fannie Mae and Freddie Mac collect extensive data from the lenders with which they work. Most of this data has not been required by HUD. If the GSEs are required to provide data to HUD, the GSEs say this could interfere with business and inhibit their ability to collect the information they need.
Zigas calls this requirement “an unfair burden to the GSEs,” one that could foster a never-ending string of requests for information from HUD and other regulators investigating fair lending. He adds that “HMDA [Home Mortgage Disclosure Act] data required of lenders by the Community Reinvestment and Fair Lending Act, is a much richer and expansive database than the GSEs are required to have” and that the “GSEs are not enforcers or policemen or regulators, and should not be expected to be.”
Dan Russell similarly points out that while Freddie Mac supports and complies with all Fair Lending requirements, it is not appropriate for it to be the data source or enforcement mechanism for the Fair Housing Act. But if the Secretary notifies Freddie Mac that a Fair Housing violation has occurred and instructs the GSE to halt business with the lender, Russell said, it will certainly comply with and support the sanction.
New Program Approval
To ensure that the GSEs undertake only programs authorized by Congress, the proposed rule requires that the Secretary of HUD review all new programs, defined as “those significantly different from previously approved programs.” HUD points out that it has had this authority since 1978 for Fannie Mae and since 1989 for Freddie Mac; and it intends for the GSEs to continue to have sufficient latitude to develop innovative programs that respond quickly to changing market conditions and demands.
The GSEs say the requirement that the Secretary of HUD review new program initiatives has not been a problem. Both, however, take issue with the interpretation of what constitutes a new program. Zigas points out that the Secretary was not required by Congress to issue a regulation on new program approval, and requiring the GSEs to bring all new programs to HUD for approval will constrain the GSEs from developing innovative programs.
Dan Russell poses this question to illustrate the issue Freddie Mac has with the language in the proposed rule: “If Freddie Mac adopts a program that Fannie Mae is already doing, since this is new to Freddie, must it go to the Secretary for approval?” Both GSEs argue that they need flexibility to adjust products in response to changing needs without the bureaucracy of obtaining the Secretary’s approval.
Rather than taking more risk in business, says Zigas, “Fannie will do less innovation and do it more slowly. I don’t think it’s productive to go through the ringer on every new initiative.” It is also, he adds, “an extremely critical and fundamental part of the regulations, and central to Fannie Mae’s differences with HUD on the proposed rule.”
Why It’s Important
Affordable housing is one of the most important ways to strengthen families and communities and to promote economic opportunity and personal responsibility. Owning a home remains one of the main symbols of middle class success. Despite the increasing difficulty of attaining that goal, it remains a primary aspiration for most Americans.
Neighborhood groups, local governments and community-based developers are increasingly using homeownership programs as a key element in comprehensive neighborhood revitalization. The lack of mortgage credit to low-income families, especially in central cities, is a major issue in these efforts. Whether the new rule is effective in providing greater access to homeownership for deserving families is of great concern to neighborhoods and the local organizations that work in neighborhood revitalization.
Fannie Mae and Freddie Mac are key strategic tools in national policy supporting the homeownership goal. Together they buy about 70 percent of the conforming, conventional mortgages originated in this country. Homebuyers whose mortgages are eligible for purchase by Fannie Mae or Freddie Mac benefit from a reduced interest rate – about one-fourth to one-third of a point lower than the interest rate for mortgages not eligible for purchases.
But the figures suggest the benefits of a mortgage market supported and capitalized by the GSEs are not reaching the lower strata of the population. Today, the majority of consumers who benefit from Fannie Mae and Freddie Mac’s activities are families with incomes over 100 percent of the area median; the average income of a family whose home is financed by the GSEs is almost $70,000.
It seems that much more can be done, and that Fannie Mae and Freddie Mac can play a larger leadership role in expanding homeownership opportunities. To the extent that they reach below these income levels and to the extent that they approve products that have underwriting criteria that take into account ethnic and cultural differences, more capital will be available for low-and moderate income homeownership.
On the need to increase homeownership among lower-income groups, HUD and the GSEs agree. The issue currently in dispute in Washington is whether new, more stringent rules governing the conduct of Fannie and Freddie are required to accomplish those goals.
Politics both inside and outside the Beltway bear on this administrative debate. In Washington, HUD is widely perceived as an endangered species – one of the cabinet departments the Republican Congress wants to eliminate. Promulgating regulations that appear to be constraining the freedom of successful businesses like Fannie Mae and Freddie Mac isn’t likely to help HUD’s standing. But Retsinas points out that this kind of performance-based regulation is most important now. “As the Congress and the President continue to focus on how to shrink government, how to realign government, it becomes particularly important that we are sensitive and aware of those institutions and agencies that are not directly part of government, whether it is the Federal Home Loan Bank System or the GSEs. We need to do that prudently… and we are looking forward to your participation.”
For a copy of the rule, contact HUD at 202-708-2770. Send your comments to: Rules Docket Clerk, Office of General Counsel, Rm. 10276, Department of Housing and Urban Development, 451 Seventh Street, SW, Washington, DC 20410-0500.