Federally Sponsored Mortgage Passthrough Programs

Two main factors have contributed to the initial success and subsequent massive growth of the agency pass-through programs: the guarantee of timely payment of principal and interest1 and the high degree of standardization imparted to the securities. At the same time, the expanding market for pass-throughs has promoted competition and innovation among mortgage lenders and the development of automated underwriting and other applications of technology to mortgage origination and servicing. As a direct result of competition, innovation, and increased efficiency, borrowing costs, including closing fees and related expenses, along with the "hassle cost" of obtaining a mortgage, have been reduced dramatically. Thriving markets for prime jumbo and alternative lending criteria mortgages (alt-A) and a range of other asset-backed securities, most important those backed by subprime residential mortgages, have grown on the solid, broad base of the agency pass-through market. The existence of this agency pass-through market also enabled housing finance to weather the "thrift crisis" of the 1980s because mortgage bankers were able to step quickly into the breach opened by the failure of hundreds of savings and loan companies and mutual savings banks.

Generally, the market classifies agency pass-throughs into two groups: those guaranteed by Ginnie Mae and backed by government-insured or -guaranteed loans and those guaranteed by Freddie Mac and Fannie Mae and backed by "conventional" mortgages that "conform" to the government-sponsored enterprises' (GSEs') loan amount and underwriting standards.

Government loans may be prepaid at any time without penalty to the borrower. However, in contrast to most nongovernment or conventional loans, they generally need not be repaid in full when the house is sold but instead may be assumed by a new buyer. The objective of the eligible federal residential loan programs is to expand housing finance to targeted groups. The Federal Housing Administration (FHA) program is geared to first-time and other buyers with limited resources for the down payment, as well as those with less pristine credit histories than required by prime conventional lenders. Borrowers may finance approximately 97% of the purchase price; in return, they pay an upfront insurance premium (it can be included in the loan) as well as an annual fee. Government loans are subject to dollar limits that are reviewed annually. For example, for 2005, FHA loan limits on one-unit single-family houses range from $160,176 to $290,319, depending on location; the maximum original loan amount on a Veterans Administration (VA) loan that may be pooled is $359,650. Demand for government loans—or perhaps lenders' willingness to make them—has fallen

1. With some form of government sponsorship behind it.

dramatically with the growth of private subprime lending. As a direct result, the volume of Ginnie Mae securities has dropped sharply.

Conventional loans, in contrast, are made to borrowers with good credit. They are generally due on sale and freely prepayable at any time without penalty to the borrower (exceptions would be pooled separately). From this universe, only loans within the conforming loan limit (by practice, the same at both GSEs) may be included. For 2005, that limit was $359,650.

Fannie Mae and Freddie Mac actively compete for business from the same universe of residential mortgage lenders. Likewise, they securitize from the same universe of conventional loans to borrowers with good credit histories under very similar underwriting criteria. Loan approval mechanisms are now predominantly automated and model-based, making direct comparison of underwriting criteria difficult. However, the array of loan characteristics disclosed at the pool level and aggregated across broad groupings of the GSEs' pass-throughs indicates that Fannie Mae and Freddie Mac pass-throughs continue to be generally fungible.

The agencies enjoy different ties to the U.S. government. Ginnie Mae is an agency in the Department of Housing and Urban Development (HUD); its guarantee carries the full faith and credit of the U.S. government. By contrast, Freddie Mac and Fannie Mae are GSEs, created pursuant to government housing policy. They exist as federally chartered for-profit corporations (their stock is traded on the New York Stock Exchange) that are taxed at the full corporate rate and are regulated by the federal government. As such, their guarantee does not carry the full faith and credit of the U.S. government. Instead, it is backed by emergency drawing rights on the U.S. Treasury. However, the rating agencies consider Freddie Mac and Fannie Mae securities to be eligible collateral for triple-A securities "due to their close ties with the U.S. government." The market generally treats "Freddies" and "Fannies" as if they were triple-A or government agency issues.

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