This file is a presentation of a Indiana University capstone project which examined the roll of government regulations in the collapse of the mortgage financial industry.

1. Financial Intermediaries
and Regulation:
A Look at Fannie and Freddie’s Role
in the Mortgage Market
Presented in V600 on April 12, 2010 by:
Jon Latson, Katherine Phillips, Heather
Phillips, Jason Oberle, and Suzie Witmer

2. Outline
• Overview of Fannie and Freddie
• Review of Current Literature for our Selection
of Variables
• The Method to our Madness
• The Regression
• What Effects
• Conclusion

3. Creation and Evolution
Fannie Mae Freddie Mac
• National Housing Act of 1934 • Chartered in 1970 to purchase
enabled chartering of national loans originated by Federal Home
mortgage associations Loan Bank System institutions
• National Mortgage Assoc. (Fannie – Shares of corporation held by
Mae) formed in 1938 to purchase FHLBs
FHA-insured loans from private
originators and VA loans • Converted from government
corporation to GSE in 1989,
• Housing Act of 1954 directs Fannie following S&L crisis
to provide liquidity in the mortgage
market • Issues first MBS in 1971
• In 1968, Fannie converts to a
private, publicly traded
organization
– Allowed Fannie’s debt obligations to be
deducted from U.S. Public Debt
• Issued first MBS in 1981

4. Purpose
• Provide stability in the secondary market
• Improve distribution of capital for residential
mortgage financing
• Later adopted purpose of providing liquidity
to target specific populations (low income,
targeted geographic areas, etc), as directed by
HUD
Note: The above purposes are used to justify GSEs; GSEs are corporations with profit duty to shareholders

5. Benefits Received
GSEs receive many benefits as federally chartered
organizations, including:
1. Exemption from all state and local taxes (except property)
2. Exemption from securities registration requirements
3. Access to $2.25 billion line of credit from the U.S. Treasury
4. Most importantly, is the implicit guarantee that they’re
backed by the Federal government! This provides increased
access to credit.

6. How Fannie and Freddie Work
Fannie and Freddie do two general things:
• Purchase loans from private institutions and place them in
their portfolio
– Private institutions receive cash and are able to originate additional
loans
– Receive the principal, interest and risk
• Purchase loans and issue mortgage-backed securities (MBSs)
– Securitization allows Fannie and Freddie to sell a low risk security to
the open market or directly back to financial institutions
– Guarantee principle and interest to investor, and receive fee for this
service

7. What is Their Competitive Advantage?
It’s all predicated on assumption of governmental support
• Implicit guarantee that Federal funds will back GSEs allow
access to credit at a rate lower than any competitors,
regardless of credit rating
• Because Fannie and Freddie can borrow at reduced rates, they
are able to purchase high volume of mortgages, and achieve
significant profits. They even purchase back their own MBSs,
adding additional liquidity to the market
• They are able to be highly leveraged due to their low capital
requirements; an advantage not enjoyed by private label
MBSs
• Issued MBSs are seen as essentially risk-free

8. Regulating Fannie and Freddie
• Federal Housing Enterprises Financial Safety and Soundness
Act of 1992
– Established regulatory structure
– Gave HUD Secretary authority over Fannie and Freddie except in
areas of financial safety and soundness, including:
• Establishment of affordable housing goals
• Monitoring compliance with fair lending practices
• Collection of loan data
– Established capital requirements
– Created Office of Federal Housing Enterprise Oversight (OFHEO)
• Independent office
• Headed by director independent of Secretary of HUD
• Conducts regulatory audits of operations
• Establishes additional risk-based capital requirements

9. Politics of Fannie and Freddie
• Issues of contention:
– Capital requirements
– Portfolio size/limitations
– Shifting affordable housing goals
– Authority and reach of HUD/OFHEO
• Ability to influence policy and legislation
– Donated to political campaigns of committee members during consideration of 1992 bill
– Members cross back and forth between GSEs and government
• Former CEO was prior head of OMB
– Expert power
• Unrivaled resources and expertise provide an advantage in policy process
– Extensive network of interested parties in health of Fannie/Freddie
• Realtors
• Mortgage banks
• Related construction industries
– Affordable housing mission allows GSEs ability large portfolios
• GSEs claim that regulation can negatively impact ability to lend to targeted populations, which
is unpopular
Bottom line: any legislation seeking to alter status quo could be met with significant
resistance

10. HUD’s Regulation Changes/Goals
• Low- and moderate-income goal
– For families with less-than-median income
• Special affordable goal
– Targeted income-based goal for housing that is
affordable to very low-income families and low-
income families in low-income areas
• Underserved areas goal
– Geographically targeted goal for housing in
underserved areas such as low-income and high-
minority census tracts

11. HUD’s Regulation Changes/Goals
• In 1996 HUD set a goal for Fannie and Freddie that at
least 42% of their purchases must be issued to low and
moderate income borrowers.
• In 2000 HUD would required them to dedicate 50% of
their business to low and moderate income families.

12. Mortgage Market Factors
• Recession
– The National Bureau of Economic research
declared that the recent recession began
December 2007
– Anticipated a correlation between the recession
and activity in the mortgage market
• Private Market
– Including: commercial banks, credit unions, and
other savings institutions
– Increased competition in home asset market

13. Accounting Scandals
• In January 2003, Freddie announced it had understated
its earnings for the past few years and was taking
corrective action
– Understated earning by about $5 billion
• Fannie’s accounting had been revealed as fraudulent in
2004.
– For a 6 year period, they doctored earnings so that
Executives could collect millions in bonuses.
– Understated earnings by about $10.6 billion.
• Greenspan became powerful opponent & called for
stricter regulation.
• In order to keep the support of Congress, presented
themselves as champions of affordable housing.

14. Regression & Analysis
Null Hypothesis: The Share of
Fannie and Freddie’s purchases
that were within special, targeted
purchase categories had no effect
on the total volume of
originations on the mortgage
market.

15. Dependant Variable
• MORTGAGE ORIGINATIONS = Estimate by
Mortgage Banker’s Association (MBA) of total
mortgage originations (1-4 family homes)
including refinancing in billions of dollars
(Chained 2008 dollars)
– MBA definition: Historical record of single-family,
1-4 unit loan origination estimates

16. Independent Variables
• GDP = Gross Domestic Product in billions of dollars (Chained
2008 dollars)
• FED = Change(s) in the federal funds rate (in basis points)
• PVT = Change(s) in the mortgage asset market share of
commercial banks, savings institutions, and credit unions
• RECESS = Binomial (dummy) variable for the start date of the
recession of 2007
• POLITICAL TROUBLE = Binomial (dummy) variable for the
investigation of reporting practices (account procedures) and
Mission of Fannie Mae and Freddie Mac

17. Variables of Interest
• Special Affordable Purchases = the average
change in purchase percentages of Fannie
Mae and Freddie Mac
• Geographically Targeted Area Purchases = the
average change in purchase percentages of
Fannie Mae and Freddie Mac
*Fannie Mae and Freddie Mac actual purchase percentages (not HUDs requirements)

18. Expectations of Independent Variables
• GDP = positive correlation
• FED = negative correlation
• PVT = positive correlation
• RECESS = negative correlation
• POLITICAL TROUBLE = positive correlation
• SPECIAL AFFORDABLE = positive correlation
• GEOGRAPHICALLY TARGETED = positive
correlation

19. The Final Regression Equation
MORTGAGE β4*(SPECIAL
ORIGINATIONS = Intercept + β1*(FED) + β2*(GDP) + β3*(RECESS) + AFFORDABLE )
(-2816.258) (- 0.96756) (+ 30.8737) (– 168.9933) ( – 63.25089)
(p=.001) (p=.035) (p=.0000) (p=.051) (p=.002)
+
β5*(GEOGRAPHIC
ALLY TARGETED) +
β6*(POLITICAL
TROUBLE) + β7*(PVT) + ε RROR TERM
(+ 18.97945) (+ 101.1088) (+ 48.85896)
(p=.015) (p=.097) (p=.013)

20. Regression Model Statistics
• N = number of observations = 64
• R-squared = “goodness of model fit” = .5693
• F = 22.4
• P-value = <0.0001

21. What about if we changed some stuff?
BETAs std mean +1s.d. M(y)-sd(y)
FED -0.968 54.257 -8.984 402 -52.5
GDP 30.874 3.750 107.048 570.3 115.8
RECESS -168.993 n.a. n.a. 623.5 169
SPECIAL
AFFORDABLE -63.251 1.506 1.171 359.3 -95.3
GEOGRAPHICALLY
TARGETED 18.979 2.933 0.992 510.2 55.7
POLITICAL
TROUBLE 101.109 n.a n.a 353.4 -101.1
PVT 48.859 1.877 1.642 546.2 91.7
INTERCEPT -2816.258 n.a n.a 454.5 0

22. HUD’s Regulation Changes/Goals
• Low- and moderate-income goal
– For families with less-than-median income
• Special affordable goal
– Targeted income-based goal for housing that is
affordable to very low-income families and low-
income families in low-income areas
• Underserved areas goal
– Geographically targeted goal for housing in
underserved areas such as low-income and high-
minority census tracts

23. Low and Moderate Income
• We found that this had no significance.
– We hypothesize that this is because
• these individuals, while having lower incomes would
likely be purchasing homes anyways, whether or not
Fannie was purchasing the loans.
• The standards for this category were also less stringent.

24. Special Affordable
• We found there was a negative correlation for
this variable in relation to total mortgage
originations.
– We hypothesize that this may have occurred because
these loans may have been of less value b/c loan
levels based on income, and the income requirements
were set at less than 60% Area Median Income, or
else 80% AMI in a low-income area. (e.g. increasing
purchase low $ loans may have decreased the total $
volume of origination on the market)

25. Geographically Targeted
• This had a positive correlation, which
is what we anticipated, because
–Easier to qualify loans under this
program
• no price cap on home loan $
• More inclusive

26. Questions?