Traditionally, mortgages were relatively simple transactions between lenders and borrowers. However,
in recent decades, the mortgage market has grown in size and complexity. As the market has evolved,
the number of market participants—both public and private—has greatly expanded.
U.S. Government
With a few exceptions, the federal government does not directly lend money for mortgages.7 Rather,
it promotes homeownership through a variety of other mechanisms. Most notably, the federal government offers preferential tax treatment of mortgage interest, property taxes, and capital gains on
owner-occupied homes. In addition, the federal government affects the mortgage market by increasing capital liquidity, providing credit enhancements, and overseeing mortgage-market participants.
Liquidity. The federal government promotes homeownership by increasing the availability of mortgage capital through the secondary market activities of the Government-Sponsored Enterprises
(GSEs) of Fannie Mae and Freddie Mac. The GSEs do not lend directly to borrowers but rather
purchase mortgages that meet certain criteria (called “conforming loan standards”) from private lenders. Once purchased, the GSEs pool the mortgages into investment securities, called mortgage-backed
securities (MBSs), backed by the payment streams from the loan pools. This creates capital liquidity in the market; without this secondary market, private lenders would be able to extend far fewer
mortgages, since much of their capital would be inaccessible until loans were repaid. By selling the
mortgages to the GSEs private lenders’ capital is replenished, allowing them to make new loans.
The GSEs are technically “publicly chartered private corporations,” and their securities are not
explicitly guaranteed by the federal government. Nevertheless, there has always been a widespread
public perception that the federal government would not allow these institutions to fail. As a result of
this implicit guarantee, the GSEs have been able to gain access to funds at lower rates and sell their
securities at higher prices than they might have been able to do otherwise, leading to greater liquidity
in the mortgage markets. Currently, both Fannie Mae and Freddie Mac are in conservatorship under
the federal government, and their future is unclear. Still, there is no question that the GSEs help
enhance access to the residential mortgage market by facilitating the constant and stable supply of
capital for single-family and multi-family loans.
Another way the federal government increases liquidity is through deposit insurance and by providing funding through the Federal Home Loan Bank system. By insuring deposits up to $250,000, the
Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration help
private depository institutions maintain a steady supply of capital for making home loans. The 12
Congressionally chartered Federal Home Loan Banks—collectively called the Federal Home Loan
Bank System—offer advances to their member-banks at lower rates than they would receive without
the implicit guarantee provided by the federal charter. These funds are used to fund mortgage and
community development lending.
Credit Enhancements. The federal government also provides credit enhancements to promote home
lending through a variety of programs:
• Federal Housing Administration (FHA): The FHA provides insurance on loans that meet FHA
loan guidelines, which generally are more flexible than underwriting standards for conventional
prime loans. FHA loans, which can only be originated by approved lenders, require relatively low
down payments but borrowers are charged insurance premiums. In the event that a borrower
defaults, the FHA reimburses the lender for losses. The FHA is entirely self-funded, since its
capital reserves have been adequate to cover losses and program administration.
• Veterans Affairs (VA) Loan Program: Like the FHA, the VA loan program insures loans issued by
approved private lenders. However, only U.S. military veterans are eligible to receive VA loans
and, rather than purchasing insurance through a premium, the borrower pays a VA loan funding
fee, the size of which depends on the size of the loan down payment.
• Rural Housing Service (RHS) Program: The Rural Housing Service was created by the Department of Agriculture to promote homeownership in rural parts of the U.S and provides a loan
guarantee for low-income borrowers who cannot find financing elsewhere. Like the FHA program,
borrowers obtain loans from private lenders and the loan is guaranteed by RHS.8
• Ginnie Mae (Government National Mortgage Association)
: Ginnie Mae insures timely payments
on securities backed by government-insured mortgages (VA, FHA, and RHS). The federal guarantee on these payments allows the issuers of these securities to receive better prices on these loans.
Oversight. The federal government regulates the mortgage market by passing, interpreting, and
enforcing lending laws and by supervising financial institutions that participate in the mortgage
market. Several agencies share the responsibility for overseeing lenders: the Federal Reserve Board
(the Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), and the Consumer Financial Protection Bureau (CFPB or Bureau).
In addition, the Federal Housing Finance Agency (FHFA) oversees Fannie Mae, Freddie Mac, and
the 12 Federal Home Loan Banks, ensuring their safety and soundness and guaranteeing that they are
fulfilling their charters.
Private Lenders
Despite the strong role the federal government plays in promoting a robust housing market, private
lenders relying on private capital fund almost all U.S. mortgages. These lenders generally fall into two
basic categories:
• Portfolio Lenders: Portfolio lenders are financial institutions that accept deposits, and include
commercial banks, savings banks, and credit unions. Their deposits allow them to hold at least
some loans as part of their overall investment portfolio. Some portfolio lenders, such as banks,
engage in a wide variety of lending activities, while others, such as thrifts, use funds primarily for
residential mortgages. These entities are chartered under state and federal law.
• Mortgage Companies: Mortgage companies (also called mortgage banks) do not accept deposits
and instead rely on investments to finance the mortgages they extend and on the sale of their
mortgages to the secondary market to finance payments to investors (Guttentag, 2000). Generally,
mortgage companies are chartered under state law.
Brokers and Private Securitizers
Over the last few decades, two major developments in the mortgage market fundamentally have
altered how it operates. First, lenders began to rely on third-party originators (mortgage brokers).
Using brokers enabled lenders to lower their fixed costs and expand operations into new markets
without having to hire new loan officers, acquire office space, or invest heavily in consumer marketing. In 2005, at the height of the housing boom, half of all mortgage originations and 71% of
subprime originations were brokered (Mortgage Bankers Association, 2006).
Second, Wall Street financial companies began issuing their own mortgage-backed securities (called
private label securities) and selling these directly to investors. Unlike Fannie Mae and Freddie Mac,
private companies did not have to limit their loan purchases to those meeting the standards set by
the GSE regulators. As a result, the growth in the private-label securities market was heavily driven
by subprime loans, which the GSEs were not allowed to purchase directly. Between 1995 and 2005,
the volume of private-label securities backed by subprime loans increased from $18 billion to
$465 billion. Meanwhile, the private-label market for “Alt–A” loans,9 virtually nonexistent in
1995, reached $334 billion by 2005.10
The combination of increased reliance on mortgage brokers and private securitization sparked
dramatic changes in the composition of mortgage originations. Between 2001 and 2006, the share of
the overall mortgage market comprised by subprime and Alt–A lending increased from 10% to 39%.11
Meanwhile, the market share of government-backed loans (FHA/VA) and GSE-purchased loans
declined tremendously. This change in market composition is particularly notable because of the
degree to which it represented a shift away from regulated underwriting and standard products to
unregulated ones.