January 25, 2022

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Housing Finance System: Future Reforms Should Consider Past Plans and Vulnerabilities Highlighted by Pandemic

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<div>What GAO Found The COVID-19 pandemic highlighted three vulnerabilities in the housing finance system—although thus far mitigated by federal actions and market conditions—that remain relevant to the debate about future system reforms. Federal fiscal exposure. Exposure to potential mortgage credit losses during an economic crisis is substantial. The government directly or indirectly backs $8 trillion in single-family mortgages, in part due to the ongoing federal conservatorships of Fannie Mae and Freddie Mac (enterprises). Nonbank liquidity risks. Nonbanks, which service more than 50 percent of federally backed mortgages, faced significant liquidity risk—that they would be unable to meet their financial obligations—at the onset of the pandemic because they were not receiving loan payments but had to continue paying mortgage investors. Failures of nonbanks could constrain mortgage credit. Market instability. In March 2020, the pandemic's economic shock temporarily disrupted the mortgage-backed securities (MBS) market by causing many investors to sell assets. This overwhelmed market intermediaries and created conditions where MBS could not be sold. Continued market dysfunction could have limited mortgage availability and caused other credit markets to freeze. GAO analysis of the 2019 housing finance reform plans issued by the Department of the Treasury and Department of Housing and Urban Development (HUD) identified recommendations that align with these vulnerabilities and GAO's 2014 housing finance reform framework. The plans made 81 administrative recommendations to agencies and 35 legislative recommendations to Congress. The plans contained 34 recommendations focused on federal fiscal exposure, three related to nonbank liquidity risks, and one related to MBS market stability. Regarding fiscal exposure, the recommendations included steps to help ensure the enterprises and the Federal Housing Administration's (FHA) mortgage insurance programs are financially sound. Some steps, such as strengthening the enterprises' capital framework, were implemented. Others, including certain recommendations to improve the financial viability of FHA's program for reverse mortgages (a loan against home equity), were not. Each of the plans' recommendations aligned with an element of GAO's framework, and the recommendations collectively addressed all the elements to some degree (see figure below). The elements include control of fiscal exposure, alignment of policies with goals, capacity to manage risks, and borrower protections and access to mortgages. As of January 2021—the latest point at which Treasury and HUD systematically tracked implementation—agencies implemented or took partial action on 57 of 81 administrative recommendations, focusing primarily on framework elements for control of fiscal exposure and capacity to manage risks. For example, FHA substantially implemented a recommendation to develop and integrate automated tools for managing mortgage origination risks. As of September 2021, Congress had not enacted legislation to implement any of the 35 legislative recommendations. Alignment and Status of Recommendations in 2019 Housing Finance Reform Plans, by GAO Framework Element (Administrative Actions as of January 20, 2021, and Legislative Actions as of September 30, 2021) While the current administration has stated its interest in helping shape future reforms, it has not issued its own plans, or performed an analysis similar to GAO's. GAO's analysis showed that the 2019 reform plans are relevant to future planning efforts. Although the plans were issued shortly before the pandemic, they contain implemented and unimplemented recommendations relevant to vulnerabilities the pandemic highlighted. While mitigated by federal actions and market conditions thus far, the vulnerabilities remain relevant for risk assessments that may support future Treasury and HUD planning efforts. Considering recommendations from the 2019 plans could help agencies identify options for mitigating the vulnerabilities and aid assessment of steps already taken. The plans also contain recommendations related to each element of GAO's framework. Attention to each framework element is important for establishing an effective housing finance system. While future housing reforms may emphasize different policy goals, considering the prior plans in the context of the framework could help identify actions that would cover all the framework elements. As Treasury and HUD develop future reform plans, considering the recommendations in the 2019 plans and addressing all GAO framework elements could help ensure the plans address key risks, are comprehensive, and account for prior actions that complement or diverge from current policy priorities. Why GAO Did This Study Since 2013, GAO has designated the federal role in housing finance as a high-risk area because of the significant risks the current role poses. In September 2019, Treasury and HUD began implementing housing finance reform plans, which included steps to transition the enterprises from federal conservatorship. But pandemic-related strains on the housing finance system and the transition to a new administration have increased uncertainty about the future of reform. The CARES Act includes a provision for GAO to monitor federal efforts related to COVID-19. Congress also included a provision in statute for GAO to annually review financial services regulations. This report examines (1) vulnerabilities in the housing finance system highlighted by the pandemic, and (2) the nature and status of recommendations in the 2019 reform plans and the extent to which they align with system vulnerabilities and GAO's housing finance reform framework (GAO-15-131). GAO reviewed housing finance system research and regulations and agency documents on system reforms and pandemic responses. GAO aligned recommendations in the 2019 plans with system vulnerabilities and its 2014 framework elements. GAO also analyzed information on the status of the plan recommendations and interviewed agency and industry representatives.</div>
Fast Facts

In 2019, the Departments of the Treasury and Housing and Urban Development issued plans to reform the housing finance system. The system has been on our High Risk list since 2013.

The agencies partially implemented these plans, but the COVID-19 pandemic and the transition to a new Administration have made future reforms uncertain. We found that the recommendations in the 2019 plans are relevant to future planning efforts.

As Treasury and HUD develop future plans, we recommend considering the 2019 plan recommendations to 1) help address housing finance concerns that the pandemic highlighted, and 2) address elements of our 2014 reform framework.

Highlights

What GAO Found

The COVID-19 pandemic highlighted three vulnerabilities in the housing finance system—although thus far mitigated by federal actions and market conditions—that remain relevant to the debate about future system reforms.

  • Federal fiscal exposure. Exposure to potential mortgage credit losses during an economic crisis is substantial. The government directly or indirectly backs $8 trillion in single-family mortgages, in part due to the ongoing federal conservatorships of Fannie Mae and Freddie Mac (enterprises).
  • Nonbank liquidity risks. Nonbanks, which service more than 50 percent of federally backed mortgages, faced significant liquidity risk—that they would be unable to meet their financial obligations—at the onset of the pandemic because they were not receiving loan payments but had to continue paying mortgage investors. Failures of nonbanks could constrain mortgage credit.
  • Market instability. In March 2020, the pandemic’s economic shock temporarily disrupted the mortgage-backed securities (MBS) market by causing many investors to sell assets. This overwhelmed market intermediaries and created conditions where MBS could not be sold. Continued market dysfunction could have limited mortgage availability and caused other credit markets to freeze.

GAO analysis of the 2019 housing finance reform plans issued by the Department of the Treasury and Department of Housing and Urban Development (HUD) identified recommendations that align with these vulnerabilities and GAO’s 2014 housing finance reform framework. The plans made 81 administrative recommendations to agencies and 35 legislative recommendations to Congress.

  • The plans contained 34 recommendations focused on federal fiscal exposure, three related to nonbank liquidity risks, and one related to MBS market stability. Regarding fiscal exposure, the recommendations included steps to help ensure the enterprises and the Federal Housing Administration’s (FHA) mortgage insurance programs are financially sound. Some steps, such as strengthening the enterprises’ capital framework, were implemented. Others, including certain recommendations to improve the financial viability of FHA’s program for reverse mortgages (a loan against home equity), were not.
  • Each of the plans’ recommendations aligned with an element of GAO’s framework, and the recommendations collectively addressed all the elements to some degree (see figure below). The elements include control of fiscal exposure, alignment of policies with goals, capacity to manage risks, and borrower protections and access to mortgages. As of January 2021—the latest point at which Treasury and HUD systematically tracked implementation—agencies implemented or took partial action on 57 of 81 administrative recommendations, focusing primarily on framework elements for control of fiscal exposure and capacity to manage risks. For example, FHA substantially implemented a recommendation to develop and integrate automated tools for managing mortgage origination risks. As of September 2021, Congress had not enacted legislation to implement any of the 35 legislative recommendations.

Alignment and Status of Recommendations in 2019 Housing Finance Reform Plans, by GAO Framework Element (Administrative Actions as of January 20, 2021, and Legislative Actions as of September 30, 2021)

Alignment and Status of Recommendations in 2019 Housing Finance Reform Plans, by GAO Framework Element (Administrative Actions as of January 20, 2021, and Legislative Actions as of September 30, 2021)

While the current administration has stated its interest in helping shape future reforms, it has not issued its own plans, or performed an analysis similar to GAO’s. GAO’s analysis showed that the 2019 reform plans are relevant to future planning efforts.

  • Although the plans were issued shortly before the pandemic, they contain implemented and unimplemented recommendations relevant to vulnerabilities the pandemic highlighted. While mitigated by federal actions and market conditions thus far, the vulnerabilities remain relevant for risk assessments that may support future Treasury and HUD planning efforts. Considering recommendations from the 2019 plans could help agencies identify options for mitigating the vulnerabilities and aid assessment of steps already taken.
  • The plans also contain recommendations related to each element of GAO’s framework. Attention to each framework element is important for establishing an effective housing finance system. While future housing reforms may emphasize different policy goals, considering the prior plans in the context of the framework could help identify actions that would cover all the framework elements.

As Treasury and HUD develop future reform plans, considering the recommendations in the 2019 plans and addressing all GAO framework elements could help ensure the plans address key risks, are comprehensive, and account for prior actions that complement or diverge from current policy priorities.

Why GAO Did This Study

Since 2013, GAO has designated the federal role in housing finance as a high-risk area because of the significant risks the current role poses. In September 2019, Treasury and HUD began implementing housing finance reform plans, which included steps to transition the enterprises from federal conservatorship. But pandemic-related strains on the housing finance system and the transition to a new administration have increased uncertainty about the future of reform.

The CARES Act includes a provision for GAO to monitor federal efforts related to COVID-19. Congress also included a provision in statute for GAO to annually review financial services regulations. This report examines (1) vulnerabilities in the housing finance system highlighted by the pandemic, and (2) the nature and status of recommendations in the 2019 reform plans and the extent to which they align with system vulnerabilities and GAO’s housing finance reform framework (GAO-15-131).

GAO reviewed housing finance system research and regulations and agency documents on system reforms and pandemic responses. GAO aligned recommendations in the 2019 plans with system vulnerabilities and its 2014 framework elements. GAO also analyzed information on the status of the plan recommendations and interviewed agency and industry representatives.

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    In U.S GAO News
    What GAO Found In January 2018, the Consumer Financial Protection Bureau (CFPB) announced a reorganization of its fair lending activities that moved its Office of Fair Lending and Equal Opportunity (Fair Lending Office) from the Supervision, Enforcement, and Fair Lending Division to the Office of the Director and reallocated certain of its responsibilities (see figure). As CFPB planned and implemented the reorganization, it did not substantially incorporate key practices for agency reform efforts GAO identified in prior work—such as using employee input for planning or monitoring implementation progress and outcomes. GAO identified challenges related to the reorganization (including loss of fair lending expertise and specialized data analysts) that may have contributed to a decline in enforcement activity in 2018. However, CFPB has not assessed how well the reorganization met its goals or how it affected fair lending supervision and enforcement efforts. Collecting and analyzing information on reorganization outcomes would help CFPB determine the impact of the changes and identify actions needed to address any related challenges or unintended consequences. Key Changes in Fair Lending Responsibilities under CFPB's 2018 Reorganization As of February 2019, CFPB stopped reporting on performance goals and measures specific to fair lending supervision and enforcement—such as the number of completed examinations and the percentage of enforcement cases successfully resolved. Without these goals and measures, CFPB is limited in its ability to assess and communicate progress on its fair lending supervision and enforcement efforts, key components of CFPB's mission. CFPB has used additional Home Mortgage Disclosure Act data that some lenders have had to report since 2018 to support supervisory and enforcement activities and fair lending analyses. CFPB incorporated these new loan-level data into efforts to identify and prioritize fair lending risks and support fair lending examinations. For example, the new data points improve CFPB's ability to compare how different institutions price loans, which helps its staff identify potentially discriminatory lending practices. Why GAO Did This Study Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, CFPB is responsible for two federal fair lending laws that protect consumers from discrimination: the Equal Credit Opportunity Act and the Home Mortgage Disclosure Act. In January 2019, CFPB completed a reorganization of its fair lending activities. GAO was asked to review issues related to CFPB's oversight and enforcement of fair lending laws. This report examines how CFPB has (1) managed the reorganization of its fair lending activities, (2) monitored and reported on its fair lending performance, and (3) used Home Mortgage Disclosure Act data to support its fair lending activities. GAO reviewed CFPB documents related to its fair lending activities (such as strategic and performance reports, policies and procedures) and to the reorganization of its Fair Lending Office. GAO evaluated implementation of this reorganization against relevant key practices identified in GAO-18-427. GAO also interviewed CFPB staff.
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    In Crime News
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  • Small Business Administration: COVID-19 Loans Lack Controls and Are Susceptible to Fraud
    In U.S GAO News
    In April 2020, the Small Business Administration (SBA) moved quickly to implement the Paycheck Protection Program (PPP), which provides loans that are forgivable under certain circumstances to small businesses affected by COVID-19. Given the immediate need for these loans, SBA worked to streamline the program so that lenders could begin distributing these funds as soon as possible. For example, lenders were permitted to rely on borrowers' self-certifications for eligibility and use of loan proceeds. As a result, there may be significant risk that some fraudulent or inflated applications were approved. Since May 2020, the Department of Justice has publicly announced charges in more than 50 fraud-related cases associated with PPP funds. In April 2020, SBA announced it would review all loans of more than $2 million to confirm borrower eligibility, and SBA officials subsequently stated that they would review selected loans of less than $2 million to determine, for example, whether the borrower is entitled to loan forgiveness. However, SBA did not provide details on how it would conduct either of these reviews. As of September 2020, SBA reported it was working with the Department of the Treasury and contractors to finalize the plans for the reviews. Because SBA had limited time to implement safeguards up front for loan approval, GAO believes that planning and oversight by SBA to address risks in the PPP program is crucial moving forward. SBA's efforts to expedite processing of Economic Injury Disaster Loans (EIDL)—such as the reliance on self-certification—may have contributed to increased fraud risk in that program as well. In July 2020, SBA's Office of Inspector General (OIG) reported indicators of widespread potential fraud—including thousands of fraud complaints—and found deficiencies with SBA's internal controls. In response, SBA maintained that its internal controls for EIDL were robust, including checks to identify duplicate applications and verify account information, and that it had provided banks with additional antifraud guidance. The Department of Justice, in conjunction with other federal agencies, also has taken actions to address potential fraud. Since May 2020, the department has announced fraud investigations related to the EIDL program and charges against recipients related to EIDL fraud. SBA has made or guaranteed more than 14.5 million loans and grants through PPP and EIDL, providing about $729 billion to help small businesses adversely affected by COVID-19. However, the speed with which SBA implemented the programs may have increased their susceptibility to fraud. This testimony discusses fraud risks associated with SBA's PPP and EIDL programs. It is based largely on GAO's reports in June 2020 (GAO-20-625) and September 2020 (GAO-20-701) that addressed the federal response, including by SBA, to the economic downturn caused by COVID-19. For those reports, GAO reviewed SBA documentation and interviewed officials from SBA, the Department of the Treasury, and associations that represent lenders and small businesses. GAO also met with officials from the SBA OIG and reviewed OIG reports. In its June 2020 report, GAO recommended that SBA develop and implement plans to identify and respond to risks in PPP to ensure program integrity, achieve program effectiveness, and address potential fraud. SBA neither agreed nor disagreed, but GAO believes implementation of this recommendation is essential. For more information, contact William B. Shear at (202) 512-4325 or shearw@gao.gov.
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  • Missile Defense: Opportunity to Refocus on Strengthening Acquisition Management
    In U.S GAO News
    What GAO FoundThe Department of Defense's (DOD) Missile Defense Agency (MDA) has made some recent progress gaining important knowledge for its Ballistic Missile Defense System (BMDS) by successfully conducting several important tests. In addition, the agency made substantial improvements to the clarity of its cost and schedule baselines since first reporting them in 2010, and declared the first major deployment of U.S. missile defense in Europe operational in December 2011. MDA also took steps to reduce acquisition risk by decreasing the overlap between technology and product development for two of its programs.MDA faces considerable challenges in executing acquisition programs; strengthening accountability; assessing alternatives before making new investment commitments; developing and deploying U.S. missile defense in Europe and using modeling and simulations to understand capabilities and limitations of the BMDS. The appointment of a new director for MDA provides an opportunity to address these challenges. More specifically:Interceptor production for three of MDA's systems has been significantly disrupted during the past few years due to high-risk acquisition strategies which have resulted in delaying planned deliveries to the warfighter, raising costs, and disrupting the industrial base. Further, MDA continues to follow high-risk acquisition strategies for other programs. For example, its Targets and Countermeasures program is adding risk to an upcoming complex, costly operational flight test involving multiple MDA systems because it plans to use unproven targets.While MDA made substantial improvements to the clarity of its reported cost and schedule baselines, MDA's estimates are not comprehensive because they do not include costs from military services in reported life-cycle costs for its programs. Instability due to MDA's frequent adjustments to its acquisition baselines makes assessing progress over time using these baselines extremely difficult and, in many cases, impossible.While MDA has conducted some analyses that consider alternatives in selecting which acquisitions to pursue, it did not conduct robust analyses of alternatives for two of its new programs, both of which were recently proposed for cancellation.During the past several years, MDA has been responding to a mandate from the President to develop and deploy new missile defense systems in Europe for the defense of Europe and the United States. GAO's work continues to find that a key challenge facing DOD is to keep individual system acquisitions synchronized with the planned deployment time frames.MDA has also struggled for years to develop the tools--the models and simulations--to understand the capabilities and limitations of the individual systems before they are deployed. While MDA recently committed to a new approach that could enable them to credibly model individual programs and system-level BMDS performance, warfighters will not benefit from this effort until after the first two of the currently planned three phases for U.S. missile defense in Europe have been deployed in 2011 and 2015 respectively.Why GAO Did This StudyIn order to meet its mission, MDA is developing a highly complex group of systems comprised of land-, sea-, and space-based sensors to track missiles, as well as ballistic missile interceptors and a battle management system. These systems can be integrated in different ways to provide protection in various regions of the world. Since its initiation in 2002, MDA has been given a significant amount of flexibility in executing the development and fielding of the ballistic missile defense system. This statement addresses recent MDA progress and the challenges it faces with its acquisition management. It is based on GAO's April 2013 report and reports on missile defense issued from September 2008 through July 2012.
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