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Cityscape: Volume 6 Number 1


Fannie Mae and Freddie Mac in the Housing Finance System: II

Volume 6, Number 1

Valerie F. Dancy


Fannie Mae and Freddie Mac in the Housing Finance System: II

Advisory Board

Managing Editor: Valerie F. Dancy

Guest Editor: John L. Gardner and Paul B. Manchester

Elijah Anderson
University of Pennsylvania

Roy Bahl
Georgia State University

Ann Bowman
University of South Carolina

Henry Coleman
Rutgers University

Greg Duncan
University of Michigan

Amy Glasmeier
Pennsylvania State University

Norman J. Glickman
Rutgers University

Harvey Goldstein
University of North Carolina

Jane Gravelle
Congressional Research Service

Steven P. Hornburg
Research Institute for Housing America

Helen F. Ladd
Duke University

Wilhelmina A. Leigh
Joint Center for Political and Economic Studies

Laurence E. Lynn, Jr.
University of Chicago

Sandra Newman
Johns Hopkins University

John Tuccillo
National Association of Realtors

Avis Vidal
The Urban Institute

Don Villarejo
California Institute for Rural Studies

Cityscape: A Journal of Policy Development and Research strives to share HUD-funded and other research on housing and urban policy issues with scholars, government officials, and others involved in setting policy and determining the direction of future research.

Cityscape focuses on innovative ideas, policies, and programs that show promise in revitalizing cities and regions, renewing their infrastructure, and creating economic opportunities. A typical issue consists of articles that examine various aspects of a theme of particular interest to our audience.

Guest Editor's Introduction

John L. Gardner
Paul B. Manchester
U.S. Department of Housing and Urban Development
Office of Policy Development and Research

In 1992 Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act (FHEFSSA). This legislation called for the U.S. Department of Housing and Urban Development (HUD) to establish affordable housing goals for Fannie Mae and Freddie Mac, the two large government-sponsored enterprises (GSEs) that purchase home mortgages in the secondary mortgage market. In response to FHEFSSA, the Secretary of HUD set minimum percentage-of-business targets for the GSEs' purchases of mortgages on housing for low-income families and housing in underserved geographical areas. Since they were established in 1993, these goals have led Fannie Mae and Freddie Mac to finance mortgages that have enabled hundreds of thousands of low-income borrowers and borrowers in high-minority and low-income neighborhoods to purchase homes.

The articles in this second Cityscape volume on Fannie Mae and Freddie Mac provide additional research regarding the GSEs' responses to the housing goals during the first years they were in effect. Articles in this issue and a previous issue1 are based on studies of GSE activities prepared under 11 research grants funded by HUD's Office of Policy Development and Research (PD&R) in 1997. In 2001 the Department funded an additional six research grants to expand studies on the GSEs.

The Role of Fannie Mae and Freddie Mac and HUD's Housing Goals

Fannie Mae and Freddie Mac play a major role in our housing finance system. They fund mortgages either by purchasing loans from primary market mortgage originators (including mortgage bankers and depository institutions) and holding these loans in their portfolios, or by acting as an intermediary and issuing mortgage-backed securities (MBSs), which are sold in the capital markets to a wide variety of investors. They are the two largest sources of housing finance in the United States. In 2001 they purchased a total of $515 billion in mortgages for their own portfolios and issued an additional $579 billion in MBSs. At the end of 2001, their combined retained mortgage portfolios totaled $1.2 trillion, and an additional $1.5 trillion in GSE-issued MBSs was held by investors.

As federally chartered GSEs, Fannie Mae and Freddie Mac receive significant benefits from the government. In return, Congress established certain public purposes for the GSEs, which are spelled out in their charter acts. Explicit benefits received by the GSEs include exemption from all State and local taxes other than property taxes, exemption from the securities registration requirements of the Securities and Exchange Commission and the States, and conditional access to a $2.25 billion line of credit from the U.S. Treasury. However, the most important benefit Fannie Mae and Freddie Mac receive from their GSE status is implicit: Their borrowing costs are lower than the costs for comparable financial institutions because investors perceive an implied Federal guarantee of GSE securities.

The public purposes of the GSEs are to increase the liquidity of mortgage investments and improve investment capital distribution for residential mortgage financing to:

  • Provide stability in the secondary market for residential mortgages.
  • Respond appropriately to the private capital market.
  • Provide ongoing assistance to the secondary market for residential mortgages (including activities relating to mortgages on housing for low- and moderate-income families involving a reasonable economic return that may be less than the return earned on other activities).
  • Promote access to mortgage credit throughout the Nation (including central cities, rural areas, and underserved areas).

FHEFSSA established the current regulatory structure for the GSEs in 1992. This legislation gave the Secretary of HUD general regulatory authority over Fannie Mae and Freddie Mac in all areas other than their financial safety and soundness. FHEFSSA called for the Secretary to establish three affordable housing goals for each enterprise:

  • A low- and moderate-income goal for families with incomes totaling less than area median income.
  • A geographically targeted goal for housing located in underserved areas, such as low-income and high-minority census tracts and counties.
  • A special affordable goal targeted to housing for very low-income families and lowincome families in low-income areas.

In addition, the Secretary's specific authority includes monitoring compliance with fair lending principles and review of the GSEs' proposals for new programs to determine whether such programs are in the public interest and consistent with their charter acts.

Before the passage of FHEFSSA, Congress expressed concern about the "disturbing lack of empirical information" regarding the GSEs' activities and anticipated that the legislation would alleviate this information vacuum by mandating the creation of "modern, state-of-the-art data systems at both enterprises."2 In response, HUD requires the GSEs to provide loan-level data on all of the mortgages they purchase, which the Department has used to create and distribute annual extracts in the form of a public use database (PUDB).

In addition, HUD has taken steps to alleviate the information vacuum regarding the GSEs' activities by publishing analyses of many aspects of their activities. Such analyses were published in October 2000 in conjunction with HUD's establishment of the affordable housing goals for the GSEs for 2001–03.3 PD&R has initiated a series of inhouse studies, titled "Working Papers in Housing Finance," and has published a number of papers in this series to date.4 The office has funded studies by outside researchers on various topics, including issues related to proposals for privatizing the GSEs and to the GSEs' underwriting guidelines.5

Studies in This Issue of Cityscape

The articles in this issue of Cityscape analyze various features of the GSEs' mortgage purchase activities and their impacts. The analyses draw from GSE data and data from other mortgage market databases, such as mortgage lending data generated under the Home Mortgage Disclosure Act (HMDA), census data, and Federal Housing Administration (FHA) data. Two articles analyze mortgage markets nationwide; the other two present local-area case studies. By supplementing the GSE data with other data resources and examining a cross-section of geographic areas, HUD believes that these studies will improve understanding of the GSEs' role at both the national and local levels.

The remainder of this section presents brief summaries of the articles included in this volume.

In "Spatial Variation in GSE Mortgage Purchase Activity," Bradford Case, Kevin Gillen, and Susan M. Wachter provide a descriptive analysis of GSE purchases in 44 metropolitan areas between 1993 and 1996. The study compares the GSEs with the primary mortgage market along several dimensions of borrower and neighborhood characteristics. This analysis shows that during that period, compared with mortgages originated in the primary market, the GSEs were less likely to purchase loans made to:

  • Lower income borrowers relative to higher income borrowers.
  • Minority borrowers relative to White borrowers.
  • Borrowers in lower income neighborhoods relative to those in higher income neighborhoods.
  • Residents of central cities relative to those in suburbs.

Case, Gillen, and Wachter find that Fannie Mae provided a relatively higher proportion than Freddie Mac of total GSE funding for mortgage lending to lower income and minority borrowers and to borrowers living in lower income, predominantly minority, centralcity, and geographically targeted areas. The authors also report on a regression analysis that looked at the influence of specific borrower and neighborhood characteristics on the probability that a loan was purchased by the GSEs. The results generally support the findings of the descriptive analysis.

Case, Gillen, and Wachter extend their regression analysis to test for changes in the GSEs' purchasing behavior over the 1993–96 period. Although some changes in the GSEs' purchasing activity were observed, no systematic time trend was found. One explanation given for this is that changes in GSEs' purchase patterns over time might be related to changes in overall mortgage originations or to changes in HMDA reporting during the period of the study rather than to changes in purchasing behavior by either GSE. The study includes an analysis of clustering patterns that concludes that, for a group of California and east coast metropolitan areas, the GSEs were more likely to have purchased relatively small loans and less likely to have purchased mortgages from relatively lower income borrowers during the study period.

Samuel L. Myers, Jr., in "Government-Sponsored Enterprise Secondary Market Decisions: Effects on Racial Disparities in Home Mortgage Loan Rejection Rates," analyzes racial disparities in mortgage lending as related to the rates at which minority and nonminority first-time homebuyer loans are sold to the GSEs in the 23 largest metropolitan statistical areas (MSAs). Earlier studies found that members of racial minority groups, particularly Blacks and Hispanics, were less likely to be approved for home mortgage loans than were nonminority applicants. These disparities in reported loan denial rates may reflect differences in credit risk or property values. Lenders have also cited the difficulty of selling loans to the GSEs on the secondary market as a factor accounting for higher rejection rates of applications from members of racial minority groups. This issue of the saleability of loans in the secondary market has essentially been unaddressed in previous research studies.

In analyzing these issues, Myers uses the residual difference approach, which separates racial gaps in loan rejection rates into components that can and cannot be explained by racial differences in characteristics. Myers interprets the unexplained component as reflecting "discrimination." The residual difference method permits the estimation of what minority loan rejection rates would be if those applicants had been treated the same as equally qualified White applicants. Myers's analysis uses variables from HMDA data, HUD's GSE PUDB, and the 1990 U.S. census.

Myers finds that the probability that a loan will not be sold on the secondary market systematically increases the probability that a loan application will be rejected by the lender. Loans taken out by Blacks and Hispanics are less likely to sell on the secondary market than are loans taken out by Whites.

However, Myers concludes that no consistent evidence supports the hypothesis that GSE decisions systematically explain observed racial disparities in loan rejection rates. In many MSAs, the GSE effect can account for some of the high rejection rates of Blacks and "others." Among other racial groups, however, there are as many MSAs where there is no such finding as there are MSAs where the effect seems to hold. Even in those cases in which the effect seems to hold, the amount explained is small. Myers finds that the impact is so small that even large differences in actual probabilities that loans are not sold to GSEs cannot explain the substantial racial difference in loan rejection rates.

David M. Harrison, Wayne R. Archer, David C. Ling, and Marc T. Smith, in "Mitigating Information Externalities in Mortgage Markets: The Role of Government-Sponsored Enterprises," present an empirical analysis based on the theory of information externalities, which suggests that property transactions in a particular market area generate information that makes similar future transactions in that same market area less risky for prospective lenders. Specifically, home sales generate information that enables independent appraisers to generate more precise value estimates. This increased precision, in turn, reduces the uncertainty (risk) faced by lenders, thereby potentially increasing acceptance rates for mortgage applications and increasing the flow of mortgage funds to the given market area. The authors assert that "[t]he existence of such externalities suggests that narrowly tailored government intervention, such as percentage-of-business goals targeted at regions exhibiting relatively low historical transaction levels, may enhance the efficiency of underwriting decisions for lenders, stimulate the flow of credit to economically disadvantaged neighborhoods, and further government housing policy objectives by increasing homeownership rates."

Harrison and colleagues estimate census tract regression equations that relate GSE mortgage market share to real estate transaction volume, demographic characteristics, housing market characteristics, and mortgage market characteristics. The authors employ various data sources, including the GSE PUDB, HMDA, the 1990 U.S. census, and data on sales transaction volume and appreciation rates from the Florida Department of Revenue (DOR). GSE market shares are calculated both as a percentage of the conforming conventional mortgage market as measured in HMDA and as a percentage of real estate transaction volume as measured by DOR.

Using a sample of GSE purchasing activities in 12 Florida counties, the authors find some evidence that both Fannie Mae and Freddie Mac are more active in neighborhoods with historically low transaction volume than they are in other neighborhoods. A similar result is found when the analysis is restricted to loans with high imputed payments relative to borrowers' income.

In addition, they find that Fannie Mae is more active than Freddie Mac in neighborhoods with high vacancy rates and in lower priced neighborhoods, a result generally consistent with previous literature that suggested Fannie Mae outperformed Freddie Mac in historically underserved market segments in 1993–95.

Calvin Bradford, in "The Patterns of GSE Participation in Minority and Racially Changing Markets Reviewed From the Context of the Levels of Distress Associated With High Levels of FHA Lending," presents a case study comparison of the Chicago and Washington, D.C. mortgage markets. Bradford places his review in the context of historical patterns of high FHA market shares in minority and racially changing market areas. He asserts that high levels of FHA lending, especially in minority and racially changing areas, historically have been linked to high levels of FHA defaults and foreclosures in these same areas. These defaults and foreclosures have been viewed as community distress factors around which policy efforts have been developed to increase conventional lending and create a balance of FHA and conventional lending that is similar in comparable White, minority, and racially changing housing markets.

Bradford finds that, although the Chicago and Washington, D.C. areas had similar proportions of minorities in their populations, minority areas in the Chicago market had lower levels of GSE purchases than did White areas, but minority areas in the Washington, D.C. market had about equal, and sometimes higher, levels of GSE purchases relative to White areas. Bradford interprets this finding as partially resulting from the large minority population in the Washington area living in rapidly growing new development and suburban locations when compared to the minority population distribution in the Chicago market. In both markets, the GSEs have tended to concentrate their purchases in rapid-growth sections, which are generally more attractive to lenders and secondary market investors.

Bradford also finds that the role of individual lenders is an important factor in explaining the disparate racial patterns between the Chicago and Washington, D.C. study areas. In the Washington, D.C. market, the largest lenders originating FHA loans, selling loans to the GSEs, and doing business in minority markets tended more than in the Chicago market to be the same lenders; lenders in Chicago tended more to specialize in FHA loans or loans sold to the GSEs. Bradford contends that the parity in sales of loans to the GSEs from the minority and White areas in the Washington, D.C. market could disappear and be replaced by levels of disparity comparable to those in the Chicago market if a handful of large GSE lenders doing business in the minority areas reduced their levels of mortgage sales to the GSEs to the norm for the entire market.

Background for These Studies

These studies were funded through research grants competitively awarded by HUD's Office of Policy Development and Research in 1997. The selection factors for the competition included the originality of the proposed research, the creativity of the research design in using various data sources, the adequacy of the proposed methodology relative to the issues specified for analysis, the significance of the selected policy issues to GSE oversight concerns, and the overall quality of expertise and the management capability of the research team. Absence of substantial conflict of interest was a requirement for selection as the recipient of a research grant. The authors were requested to identify any prior or current relationships with Fannie Mae or Freddie Mac, and these are disclosed in an endnote.6

One purpose of the grants was to demonstrate research uses of HUD's PUDB on characteristics of loans funded by these GSEs. This database provides detailed information on the borrowers and census tract locations of properties backing these loans. It was also hoped that the studies would provide useful background information that could assist HUD in revising the affordable housing goals that were established for the GSEs by the HUD Secretary in 1996. This hope was realized when HUD published the goals for the 2001–03 period on October 31, 2000.


The articles in this issue of Cityscape, along with those in Cityscape: Fannie Mae and Freddie Mac in the Housing Finance System: I, document the progress achieved and highlight the challenges that remain in extending mortgage credit to lower income borrowers and underserved neighborhoods in the first years after HUD's establishment of income- and geographically based housing goals for Fannie Mae and Freddie Mac. Anyone interested in mortgage markets and the role of Fannie Mae and Freddie Mac should find rich insight in these articles.


John L. Gardner received a Ph.D. in economics from the University of Minnesota, after which he held positions as research associate at the Center for Urban Studies, University of Chicago, and visiting assistant professor of economics at Roosevelt University in Chicago. He joined HUD as a staff economist in 1975 and currently is director of the Financial Institutions Regulation Division in HUD's Office of Policy Development and Research (PD&R). He has been involved in work related to the Department's regulation of Fannie Mae and Freddie Mac since the mid-1980s.

Paul B. Manchester has served as an economist in the Financial Institutions Regulation Division of PD&R since 1991, where his work has focused on a wide variety of topics related to the Department's regulation of Fannie Mae and Freddie Mac. He received his Ph.D. in economics from the University of Minnesota and subsequently taught economics at Mary Washington College and The Catholic University of America. Prior to joining HUD, he worked as a senior economist with the Joint Economic Committee of Congress and the Office of Thrift Supervision.


We wish to thank Theresa DiVenti, an economist in the Financial Institutions Regulation Division, and William Segal, formerly an economist in the Financial Institutions Regulation Division, for helping bring these studies to fruition through their service as Government Technical Representatives.


1. Cityscape: Fannie Mae and Freddie Mac in the Housing Finance System: I, Volume 5, Number 3, 2001. The articles were "The Effects of the GSEs, CRA, and Institutional Characteristics on Home Mortgage Lending to Underserved Markets," by Richard A. Williams, Eileen McConnell, and Reynold Nesiba; "The Twin Mandates Given to the GSEs: Which Works Best, Helping Low-Income Homebuyers or Helping Underserved Areas?" by Kirk McClure; "Performance of the GSEs at the Metropolitan Level," by Patrick Boxall and Joshua B. Silver; "Fannie Mae and Freddie Mac in Nonmetropolitan Housing Markets: Does Space Matter?" by Heather I. MacDonald; and "Fannie Mae and Freddie Mac Mortgage Purchases in Low-Income and High-Minority Neighborhoods: 1994–96," by James E. Pearce. The authors of two additional studies chose not to have their articles published in Cityscape. One of these studies, "Local Economic Risk Factors and the Primary and Secondary Mortgage Markets," by Brent W. Ambrose and Anthony Pennington-Cross, was published in Regional Science and Urban Economics, Volume 30, Issue 6, December 2000. The other study, "The Spatial Distribution of Affordable Home Loan Purchases in Major Metropolitan Areas," by Joseph Gyourko and Dapeng Hu, is forthcoming in Regional Science and Urban Economics.

2. Senate Report No. 282, 102d Congress, 2d Session, page 39 (1992).

3. See the Federal Register, Vol. 65, No. 211, October 31, 2000.

4. For example, see Harold Bunce, An Analysis of GSE Purchases of Mortgages for African-American Borrowers and Their Neighborhoods, Working Paper HF–011, released in December 2000; and The GSEs' Funding of Affordable Loans: A 2000 Update, Working Paper HF–013, released in April 2002. Papers in this series are available at

5. These studies include two studies prepared by the Urban Institute: A Study of the GSEs' Single-Family Underwriting Guidelines, February 1999, and An Assessment of Recent Innovations in the Secondary Market for Low- and Moderate-Income Lending, June 2000; and two studies prepared by Abt Associates Inc. in August 2001: Study of the Use of Credit Enhancements by Government-Sponsored Enterprises and An Assessment of the Availability and Cost of Financing for Small Multifamily Properties.

6. The Department routinely discloses past or current relationships that authors of its funded studies have had with Fannie Mae or Freddie Mac. For this purpose, the following disclosures are made with respect to the authors of these articles, as of the time of their work on the articles:

David M. Harrison has presented previous research at a Freddie Mac seminar. Wayne R. Archer is a former employee of the Federal Home Loan Bank Board and has given presentations on mortgage finance issues at both Fannie Mae and Freddie Mac. David C. Ling has received research funding from Fannie Mae. Marc T. Smith has coordinated lecture and training programs for Fannie Mae. Archer, Ling, and Smith have all written and reviewed academic articles for publications sponsored by Fannie Mae, the Fannie Mae Foundation, and Freddie Mac.

Susan M. Wachter has served on the advisory committee for Fannie Mae's Office of Housing Policy Research and has received research funding from Fannie Mae.

Neither Bradford Case, Kevin Gillen, Samuel L. Myers, Jr., or Calvin Bradford has had any current or prior relationships with Fannie Mae or Freddie Mac.

Spatial Variation in GSE Mortgage Purchase Activity
by Bradford Case, Kevin Gillen, and Susan M. Wachter

Government-Sponsored Enterprise Secondary Market Decisions: Effects on Racial Disparities in Home Mortgage Loan Rejection Rates
by Samuel L. Myers, Jr.

Mitigating Information Externalities in Mortgage Markets: The Role of Government-Sponsored Enterprises
by David M. Harrison, Wayne R. Archer, David C. Ling, and Marc T. Smith

The Patterns of GSE Participation in Minority and Racially Changing Markets Reviewed From the Context of the Levels of Distress Associated With High Levels of FHA Lending
by Calvin Bradford



Cityscape is published three times a year by the Office of Policy Development and Research (PD&R), U.S. Department of Housing and Urban Development (HUD). Portions of the journal may be reprinted if proper credit is given.

Opinions expressed in the articles are those of the authors and do not necessarily reflect the views and policies of HUD or the U.S. Government.

Inquiries may be addressed to the Managing Editor at: Office of Policy Development and Research, Room 8126, U.S. Department of Housing and Urban Development, 451 Seventh Street SW, Washington, DC 20410; tel. (202) 708–0544.

Visit PD&R's Web site,, to find this report and others sponsored by PD&R. Other services of HUD USER, PD&R's research information service, include listservs, special interest and bimonthly publications (best practices and significant studies from other sources), access to public use databases, and a hotline (800–245–2691) for help accessing the information you need.


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