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1 1 (January 13, 2022)

handle is hein.crs/govegfp0001 and id is 1 raw text is: Congressional Research Service Informing the Iegitive diebate since 1914 0 Updated January 13, 2022 Introduction to Financial Services: The Housing Finance System Background Prior to the Great Depression, U.S. residential mortgage markets operated at local levels and were highly sensitive to local conditions. Lenders funded mortgages by relying on local deposits, which were concentrated in heavily populated areas, such as Chicago and New York, rather than less populated areas in need of loans. Interstate banking restrictions made it difficult to move funds from geographical areas with large concentrations of deposits to areas with comparatively smaller amounts. The immobility of funds contributed to differences in mortgage rates and underwriting (loan qualifying) criteria across the nation. During economic downturns, frequent deposit withdrawals led to cash flow (liquidity) shortages that stymied lending. At the time, savings and loan associations (S&Ls)- nonprofit, member-owned cooperative financial institutions that relied on members' savings deposits to fund mortgages-were the primary sources of home financing during liquidity shortages. S&Ls were unable to borrow temporary funds from the Federal Reserve System because they were not eligible members. For this reason, the lending terms of residential mortgages were structured to reduce liquidity risks borne by S&Ls. For example, borrowers were required to make large down payments (e.g., 50%- 60%) to mitigate default risks and to reduce mortgage sizes, thereby reducing the amount of funds small lenders needed to collect to make loans. Mortgages typically had variable interest rates and 10- to 12-year maturities, thus mitigating cash flow disruptions due to frequent changes in local mortgage rates. Governmnent Interventions to Faciliate Mortgage Market Liquidity Over the years, Congress has addressed market liquidity issues, particularly for single-family mortgages (i.e., loans secured by residential dwellings having one to four separate units), by establishing federal agencies and government- sponsored enterprises (GSEs). Some of the key ones are listed below. * Federal Home Loan Bank (FHLB) System. Created in 1932 (P.L. 72-304), the FHLB System is a GSE that currently consists of 11 regional FHLBs. Each FHLB provides liquidity to member lending institutions in its district in the form of advances, which are temporary cash loans that must be collateralized (secured) by members' eligible assets that promote housing finance and community development (e.g., mortgages, mortgage-related assets, and certain small business loans). The FHLBs initially served as lenders of last resort for S&Ls. Congress expanded their membership in 1989 to serve in that role for banks and credit unions. The Federal Housing Finance Agency (FHFA) is the primary regulator of the FHLB System. * Federal Housing Administration (FHA). The National Housing Act of 1934 (P.L. 73-479) created FHA, now a Department of Housing and Urban Development (HUD) agency. FHA insures private lenders against the default risks on mortgages meeting certain criteria. FHA introduced fixed-rate mortgages with maturities of 20 years or more, evolving into the 30-year fixed rate mortgages commonly used today. * Department of Veterans Affairs (VA). Congress created the VA home loan program in 1944 (P.L. 78- 346). Similarly to FHA, the VA loan guaranty program insures private lenders against the default risks on mortgages made to veterans who meet certain criteria. Unlike FHA, VA does not insure 100% of a loan's default risk; a percentage of the default risk is guaranteed based on the loan's principal balance. * Fannie Mae (Federal National Mortgage Association). Title III of the National Housing Act of 1934 initially established Fannie Mae as a federal agency to purchase federally insured mortgages from lenders. By holding residential mortgages on its balance sheet, Fannie Mae extended the risk-bearing capacity of the mortgage market when small lenders lacked capacity and access to funds. In 1968, Congress split Fannie Mae into two distinct organizations (P.L. 90-448). The private-sector organization retained the Fannie Mae name and operated like an interstate lender, purchasing mortgages and funding them by issuing debt securities. * Ginnie Mae (Government National Mortgage Association). Congress created the federal agency Ginnie Mae in 1968 after splitting Fannie Mae. Ginnie Mae sells to private investors the interest rate risks linked to mortgages that are federally insured against default risk by FHA or VA. * Freddie Mac (Federal Home Loan Mortgage Corporation). Congress created Freddie Mac in 1970 (P.L. 91-351) as a GSE and subsidiary of the FHLB System. Freddie Mac was authorized to buy conventional mortgages, which are mortgages without insurance provided by a federal government agency. Freddie Mac largely purchased mortgages from S&Ls and funded them by issuing debt securities. Following passage of P.L. 101-73 in 1989, the business models and missions of Fannie Mae and Freddie Mac (F&F) were harmonized, allowing them to purchase mortgages and sell mortgage-backed securities (MBS)

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