GSE Reform: A New Affordable Housing Fund

GSE Reform: A New Affordable Housing Fund
N. Eric Weiss
Analyst in Financial Institutions
Government and Finance Division
Summary
One key feature of the government-sponsored enterprise (GSE) reform bill that the
House passed in the 109^th Congress (H.R. 1461) was the requirement that Fannie Mae
and Freddie Mac give part of their profits to create new affordable housing funds. Based
on the GSE’s average profits from 2000 to 2003, the amount would have been about
$390 million annually during the first two years and $580 million in subsequent years.
The requirement would have expired after five years.
The chairmen of the House Financial Services Committee and the Senate Banking
Committee have said that GSE reform, including an affordable housing fund, will be a
priority in the 110^th Congress.
The affordable housing fund would have helped lower-income homeowners and
renters and given priority to the victims of natural disasters such as Hurricanes Katrina
and Rita. Funds from Fannie Mae and Freddie Mac would have gone to affordable
housing organizations, which would have then worked directly with the beneficiaries.
Nonprofits would have faced controversial restrictions on election and political
activities. The bill also would have modified existing GSE housing goals to concentrate
on lower-income families. It would have set the housing goal targets in the law,
replacing the existing targets set by regulation.
This report will be updated as legislative events warrant.
Background on Housing GSE Mission
Fannie Mae and Freddie Mac purchase mortgages from lenders and package them
into mortgage-backed securities that they either hold in their portfolio or sell to investors.
Congress chartered Fannie Mae and Freddie Mac as stockholder-owned, government-
sponsored enterprises (GSEs) with the mission of supporting home ownership by
enhancing mortgage market liquidity and providing assistance to lower-income families

and underserved areas.¹ In exchange, the GSEs receive several advantages, such as the
right to borrow $2.25 billion each from the U.S. Treasury, exemption from state and local
taxes, and exemption from the requirement to register securities offerings with the
Securities and Exchange Commission.
The Office of Federal Housing Enterprise Oversight (OFHEO) regulates the GSEs
for safety and soundness, whereas the Department of Housing and Urban Development
(HUD) monitors adherence to their mission goals. H.R. 1461 would have combined
OFHEO and HUD’s regulatory division into a new, independent regulatory agency called
the Federal Housing Finance Agency (FHFA).
The Federal Housing Enterprise Financial Safety and Soundness Act of 1992 (GSE
Act)² gives HUD the authority to set specific goals for serving low-income families and
underserved markets. The 2005 to 2008 goals establish a minimum percentage of
mortgages in three income and geographic categories of homes for the GSEs to purchase
based on the origination of similar mortgages. A fourth goal sets a minimum dollar
volume of purchases.³ H.R. 1461 would have repealed the 2005-2008 goals and replaced
them with three new sets: (1) housing goals, which were similar to the repealed goals but
set in law instead of regulation; (2) a duty to serve underserved markets; (3) and an
affordable housing fund.⁴ The new goals would have targeted slightly lower-income
families than the current goals and raised the percentage goals.
Housing Goals. The new housing goals would have required the GSEs to
purchase on a percentage basis at least as many mortgages for very low- and extremely⁵
low-income families as are generated by the primary market. The GSEs could have
requested a reduction in the percentage. The affordable housing funds could not have
been used to meet the housing goals.
Duty to Serve Underserved Markets. The duty to serve underserved markets
set no specific guidelines, goals, or targets, but the new FHFA would have been required
to evaluate the GSEs annually and report to Congress. The GSEs would have been
required to lead the industry in creating new mortgage products for manufactured housing
and in preserving affordable housing developed under various HUD rental programs.
Affordable Housing Fund. The new affordable housing fund provisions would
have required each of the GSEs to contribute 3.5% of profits in the first two years and 5%

¹ In this report, Fannie Mae and Freddie Mac are referred to by name, as GSEs, and as the
enterprises. The Federal Home Loan Banks are also GSEs and covered by these bills, but
because they are covered in a different section, they are excluded from discussion here.
² 12 U.S.C. 11.
³ U.S. Department of Housing and Urban Development, “HUD’s Housing Goals for the Federal
National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation
(Freddie Mac) for the Years 2005 — 2008 and Amendments to HUD’s Regulation of Fannie Mae
and Freddie Mac,” 69 Federal Register 63587, Nov. 2, 2004.
⁴ H.R. 1461, Sections 125, 126, and 128.
⁵ Very low-income families have incomes at or below 50% of area median family income;
extremely low-income families have incomes at or below 30% of area median family income.

in the next three years. After five years, the fund would have expired. Based on the
GSEs’ average profits from 2000 to 2003, the affordable housing funds could have
received $390 million annually during the first two years and $580 million annually
during the next three years. The House bill did not indicate how the funds would have
been managed.
The fund would have had five general goals: (1) to increase home ownership by
families at or below 50% of area median income; (2) to increase mortgage funds in
designated low-income areas; (3) to increase the supply of rental and owner-occupied
housing for families at or below 50% of area median income; (4) to increase investment
in public infrastructure in connection with related affordable housing goals; and (5) to
leverage funding from other sources.⁶
H.R. 1461 would have earmarked the affordable housing fund. Twenty-five percent
(initially about $98 million) would have gone to the Federal Home Loan Banks’
REFCORP.⁷ At least 10% (initially about $39 million) would have gone toward home
ownership activities. No more than 12.5% (initially about $48 million) would have gone
toward public infrastructure associated with financed affordable housing projects. The
bill set no minimum for rental housing support.
The bill would have included major additional provisions:
^!Any profit from affordable housing fund activities would have reduced
the allocation in the following year.
^!The FHFA director would have issued regulations to prevent Fannie Mae
and Freddie Mac from making the return on the funds for nongrants
(which could have reduced their liability to provide funding in future
years) the primary consideration in awarding funds.
^!Funds could not have been used by the GSEs or recipients for
administrative or outreach purposes, except as allowed by the FHFA.
Other restrictions would have applied to home ownership. First, only first-time
home buyer families with incomes at or below 50% of the area median income would
have been eligible.⁸ Second, the price of the home purchased could not have exceeded
95% of the area median for comparable dwellings. Third, the homeowners could have
resold the house only to low-income families, and resale profits would have been subject
to recapture for 10 years under certain conditions.⁹ Any recaptured profits would have
been divided equally between the entity that sold the home to the family and HUD, not
the GSE that provided the funds used to purchase the home.

⁶ H.R. 1461, Section 128(a).
⁷ CRS Report RS20197, Community Reinvestment Act: Regulation and Legislation, by Walter
W. Eubanks, explains REFCORP.
⁸ First-time home buyers are home buyers who have not owned a home in the past three years.
Exceptions to this criteria exist for certain groups that have owned a home more recently.
⁹ H.R. 1461, Section 128, refers to section 215(b)(3) of the Cranston Gonzalez National
Affordable Housing Act (42 U.S.C. 12745[b][2]). The 10-year time limit and other resale
provisions are in 42 U.S.C. 12745(b)(3).

There would have been no restrictions on the funding mechanism: grants, market rate
loans, interest rate buy-downs, downpayment assistance, closing cost aid, and equity
investments were allowed, but the funding would have gone to for-profit and nonprofit
developers of affordable housing. Funding could have gone only to an organization,
agency, or other entity with experience in similar affordable housing activities. An
organization with experience running affordable rental housing might not have been
eligible to build owner-occupied units. Funding could not have gone directly to a family.
Restrictions on Sponsors. The primary business activity of those directly
funded would have to have been the provision of affordable housing. The funds could not
have been used for political activities, advocacy, lobbying (directly or indirectly),
counseling services, travel expenses, preparing or providing advice on tax returns,
administrative costs, or outreach. If the entity was a nonprofit, it would have further
restrictions on political and election activities:
^!The nonprofit could not have engaged in federal election activities or
lobbying for a period starting 12 months before submitting an application
for funding.
^!The nonprofit could not have been affiliated with any organization,
agency, or entity that did not comply with these electioneering and
lobbying limitations. Affiliation was defined in terms of overlapping
boards of directors, executives, staffs, shared resources, and funding.
^!If the recipient was a national nonprofit, the funds could not have been
distributed to another nonprofit.
^!The funds could not have replaced or freed up other funding.
The restrictions on election-related activities would prevent many groups, such as
the Association of Community Organizations for Reform Now (ACORN), and the¹⁰
National Council of La Raza, from receiving funding as they are currently constituted.
More than 100 nonprofits — including three local chapters of Habitat for Humanity, the
League of Women Voters, United Way of America, labor organizations, and religious
groups — sent House members a letter objecting to what they term the “gag” provision.
The restriction preventing national nonprofits from redistributing funding would
have prevented the GSEs from using a related organization, such as the Fannie Mae
Foundation, as an intermediary in distributing affordable housing fund monies. It also
would have prevented Habitat for Humanity from passing affordable housing funds on to
local affiliates. (In FY2004 Habitat gave local affiliates nearly $64 million.¹¹) The bill
would not, however, have prevented funds from going directly to local affiliates, as
already occurs in a similar program run by the Federal Home Loan banks.
Advisory Affordable Housing Board. The funds would have been monitored
by an advisory Affordable Housing Board that would have been appointed by, and

¹⁰ Republican Study Committee, Legislative Bulletin, Oct. 26, 2005, p. 7. See
[http://johnshadegg.house.gov/rsc/GSE%20Legislative%20Bulletin.pdf]. Viewed Jan. 5, 2007.
¹¹ Habitat for Humanity International, Inc., Audited Consolidated Financial Statements, Years
Ended June 30, 2004 and 2003 with Report of Independent Auditors, page 5. See
[http://www.habitat.org/giving/report/2004/FINANCIALS.pdf]. Viewed Jan. 5, 2007.

reported to, the FHFA director. The board would have determined extremely low- and
very low-income housing needs. It would have advised the director on establishing
selection criteria and changes to the program. It would have reviewed the quarterly
reports from the enterprises and informed the director if the funding activities complied
with the regulations setting funding priorities. The board would have been considered a
federal advisory board, meaning that meetings must have been publicly announced and
open. Committee records, including minutes, would have been available for public
inspection and subject to the Freedom of Information Act (FOIA).
The board would have included the director of the FHFA, the Secretaries of HUD
and Agriculture, two persons from for-profit affordable housing companies, and two
persons from nonprofit affordable housing organizations. The first three members could
have designated others to have been on the board in their places. The director could have
appointed up to four other persons to the board.
The GSEs would have had some enforcement and compliance responsibilities. If
Fannie Mae or Freddie Mac were to have determined that a recipient had misused
affordable housing funds, the recipient would have had to repay the funds and would have
been permanently barred from program participation. There would have been no lesser
penalty. This debarment authority would not be shared with FHFA.
Priorities. The director would have issued regulations with specific criteria for
selecting projects. The bill would have established a series of priorities. During the first
two years, the top priority would have gone to the areas and persons affected by
Hurricanes Katrina and Rita. The next levels of priority would have been (1) other
presidential disaster areas, (2) the greatest impact, (3) geographic diversity, and (4) the
ability to obligate the funds and undertake the activities quickly. “Greatest impact” and
“geographic diversity” were not defined in the bill. For rental projects, additional
priorities would have been (1) affordability for families with incomes below 30% of area
median income and (2) the duration that rental projects would have remained affordable
to extremely low-income families. In rental housing projects, only families with incomes
at or below 50% of the area median income could have benefitted from the funds. These
criteria differed from the housing goals, which would have counted units that would have
been affordable to families of the target income regardless of actual tenant incomes.
Historically, housing goals have used the latter approach because it is difficult for the
GSEs to determine the income of rental tenants. In addition, Fannie Mae and Freddie
Mac would have been prohibited from making affordable housing fund assistance
preferential or conditional on obtaining financing or underwriting from the enterprise.
Policy Analysis. H.R. 1461 raised a number of policy issues. First was the
question of incentives and unintended consequences. Connecting the size of the
affordable housing fund to GSE profits may result in unintended incentives. The
connection between profits and fund size would have given affordable housing developers
a stake in the GSEs’ profitability. The GSEs have two major profit centers: packaging
individual mortgages into mortgage-backed securities and holding large portfolios that
consist mainly of mortgage-backed securities. Both profit centers present risks that would
have been regulated by FHFA (or OFHEO under current law). Large portfolios are more
profitable for the companies but mainly benefit the GSEs, their stockholders, and senior
management whose compensation is tied in part to corporate profitability rather than
supporting the mortgage market. Large portfolios also represent systemic risk to the

financial system as a whole.¹² Nevertheless, because increasing the size of the portfolios
would have increased profits and thus the affordable housing funds, recipients and
potential recipients would have had reasons to support portfolio growth, which may or
may not have been what Congress intended.
A related issue was the potential for the GSEs to use their affordable housing funds
in ways that further their corporate goals. The director would have been mandated to
issue regulations to prevent the GSEs from making the return of funds the primary
consideration in awarding funds, which would have reduced their future contributions.
The bill would have prohibited them from tying the funds to other transactions with the
enterprise, but nonpecuniary and nonfinancial returns to the GSEs were not addressed.
H.R. 1461 did not address the question of the legal, accounting, and tax relationships
between the GSEs and their affordable housing funds. Were the funds separate,
independent legal entities? Who would have controlled the money in the funds before it
was released to the recipients? What type of investments would have been allowed for
the $400 million to $600 million or more added each year? Who was responsible if the
funds incurred losses? What were the tax liabilities of the funds? If a fund made a loan,
what happened if the borrower defaults? Profits were returned to the fund and reduced
the funding required the following year, but what about losses? Were recaptured profits
of first-time homeowners returned to the GSEs, and if so, did this reduce the amount that
they must contribute? H.R. 1461 stated that the GSEs do not need to hold risk-based
capital against the affordable housing funds, but what about minimum capital
requirements?
In addition to the persons named in H.R. 1461, up to four others could have been
named to the Affordable Housing Board. Could these have been from the GSEs? The
Fannie Mae Foundation (but not the Freddie Mac Foundation) promotes affordable
housing for extremely low- and very low-income families. Could someone from the
Fannie Mae Foundation have been appointed to the board? The board was charged with
overseeing the distribution of funds. Would there have been a conflict of interest if an
organization with an employee or officer on the board applied for funding? Would there
have been a conflict of interest if a fund applicant had an existing business relationship
with the GSE?
Legislative Developments
^!H.R. 1461 was reported by the Committee on Financial Services to the
House with an Affordable Housing Fund provision on July 14, 2005.
^!H.R. 1461 was passed by House by a vote of 331 to 90 and sent to the
Senate on October 30, 2005.
^!S. 190 was reported by the Committee on Banking, Housing, and Urban
Affairs to the Senate without an Affordable Housing Fund provision on
July 28, 2005.

¹² CRS Report RS22307, Limiting Fannie Mae’s and Freddie Mac’s Portfolio Size, by Eric
Weiss, summarizes some of the concerns that many analysts have about the size of the GSEs’
portfolios.