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

Susan M. Wachter, The Wharton School of the University of Pennsylvania.

In path breaking legislation, Congress in 1992 established a system of affordable housing goals for Fannie Mae and Freddie Mac, the two large government-sponsored enterprises that provide a secondary market for home mortgages. The legislation directed HUD to set and enforce percentage-of-business targets for the two companies' purchases of mortgages on affordable housing and housing in underserved geographical areas. Since they were established, these goals have stimulated Fannie Mae and Freddie Mac to finance mortgages that have enabled hundreds of thousands of additional low-and moderate-income borrowers and borrowers in targeted neighborhoods to purchase their homes.

The articles in this issue provide perspectives on how Fannie Mae and Freddie Mac responded to the housing goals during the first few years that they were in effect. The topics reflect the broad range of interests and analytical expertise among the authors, from the case studies of individual markets by Williams, McClure, and Boxall and Silver, to MacDonald's and Pearce's statistical analyses of mortgage market patterns nationwide. The articles are a product of small research grants that were made by HUD's Office of Policy Development and Research in 1997. A subsequent Cityscape volume will contain additional studies stemming from this grant program.

Fannie Mae and Freddie Mac and HUD's Regulatory Mandate
Fannie Mae and Freddie Mac, government-sponsored enterprises (GSEs) in the secondary mortgage market, play an instrumental role in the American housing finance system. They are the two largest sources of housing finance in the United States, funding a total of $564 billion in mortgages during 1999.The GSEs fund these mortgages by purchasing loans directly from primary market mortgage originators, including mortgage bankers and depository institutions, and holding these loans in portfolio or by acting as a conduit and issuing mortgage-backed securities (MBS), which are then sold in the capital markets to investors. HUD has estimated that 11.7 million single-family and multifamily dwelling units were financed by conventional conforming mortgages in 1998 and that the GSEs provided financing for 55 percent of these units.

As GSEs, Fannie Mae and Freddie Mac receive certain benefits from the government, and in return Congress has established public purposes for the GSEs, as spelled out in their charter acts. The explicit benefits received by the GSEs include exemption from all State and local taxes except property taxes, exemption from 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. But 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 financial markets perceive an implicit Federal guarantee of GSE securities.

The public purposes of the GSEs, established by Congress and stated in their Federal charter acts, are to increase the liquidity of mortgage investments and improve the distribution of investment capital available for residential mortgage financing in order to:

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (FHEFSSA) established the current regulatory structure for the GSEs. This legislation gave the Secretary of HUD general regulatory authority over Fannie Mae and Freddie Mac in all areas other than the GSEs' financial safety and soundness. The Secretary's authority includes the establishment of affordable housing goals, monitoring compliance with fair lending principles, and review of the GSEs' proposals for new programs to determine if such programs are consistent with their charter acts and are in the public interest. In particular, FHEFSSA called for the Secretary of HUD to establish three affordable housing goals for each of the GSEs:

Congress expressed concern in the early 1990s about the "disturbing lack of empirical information" regarding the GSEs' activities, and it anticipated that the FHEFSSA would alleviate this information vacuum by mandating the creation of "modern, state-of-the-art data systems at both enterprises."¹ In response to this concern, HUD requires the GSEs to provide loan-level data on all of the mortgages they purchase, and the Department has created and distributed an extract from the loan-level data in the form of a nonproprietary, public use database (PUDB).

HUD has taken additional steps to alleviate the information vacuum regarding the GSEs' activities. The Department has published analyses of many aspects of the GSEs' activities in conjunction with its establishment of the affordable housing goals for the enterprises.² The Office of Policy Development and Research (PD&R) initiated a series of in-house studies titled "Working Papers in Housing Finance" and has published a number of papers in this series to date. It has funded studies by outside researchers on various topics, including issues related to proposals for privatizing the GSEs and to the GSEs' underwriting guidelines. In 1997 PD&R funded 11 research grants on various aspects of the GSEs' activities. Five of the studies funded in 1997 are contained in this volume; four others will be published in a second volume of Cityscape.³

Studies in This Issue of Cityscape
The articles in this issue of Cityscape analyze various aspects of the GSEs' mortgage purchase activities. They involve a wide range of analytical approaches, from broad analyses of the GSEs' role across a number of local mortgage markets to local case studies that focus on the enterprises ' impact in specific metropolitan areas. Some of the analyses combine the GSE data with data from other mortgage market databases, such as Home Mortgage Disclosure Act (HMDA) data, and with programmatic information available from the GSEs and other mortgage market participants. 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.&sup4;

Richard Williams, Eileen McConnell, and Reynold Nesiba in "The Effects of GSEs, CRA, and Institutional Characteristics on Home Mortgage Lending to Underserved Markets," look at mortgage lending in underserved markets in the primary and secondary mortgage markets for metropolitan areas in Indiana. An extensive analysis is provided for South Bend/St. Joseph County, Indiana, that examines GSE purchases in underserved markets by type of primary market lender in both 1992 and 1996.As in a number of studies of the GSEs' mortgage purchases, the authors compare the goal-qualifying shares of the GSEs' purchases with the corresponding shares for conventional conforming mortgages originated in the primary mortgage market. For example, if the low-and moderate-income share of a GSE 's purchases is less than the corresponding share of mortgage originations for the mortgage market as a whole, or for a particular type of lender, the GSE is said to lag behind the market, or to lag behind the lenders in this segment of the mortgage market. If such a share of a GSE 's purchases exceeds the corresponding share of originations for the market, the GSE is said to lead the market.

Williams, McConnell, and Nesiba compare the performance in underserved markets of the GSEs and financial institutions (banks and thrifts)subject to the Community Reinvestment Act (CRA)between 1992 and 1995.The authors conclude that although the GSEs continued to lag behind primary market CRA lenders, they narrowed the gap over this period. Across all Indiana metropolitan statistical areas (MSAs) the GSEs did appear to mirror the performance of mortgage companies. They also find that Fannie Mae's underserved market performance was slightly better than Freddie Mac's performance in this period.

Williams, McConnell, and Nesiba look at the impact of size and location of lenders on lender activity in the home mortgage market. Large lenders were found to be more likely to finance mortgages for very low-income and African American borrowers than smaller lenders. Lenders headquartered in Indiana were more likely to purchase mortgages in underserved areas than lenders who only had branches or no apparent physical presence in Indiana.

Kirk McClure, in "The Twin Mandates Given to the GSEs: Which Works Best, Helping Low-Income Homebuyers or Helping Underserved Areas?" examines the twin mandates of FHEFSSA: to direct mortgage credit to neighborhoods that have been underserved by mortgage lenders, and to direct mortgage credit to low-income and minority households.

Using the Kansas City metropolitan area as a case study, mortgages purchased by the GSEs in 1993-96 are compared with mortgages held by portfolio lenders in order to characterize the performance of the GSEs in serving these two objectives. Kansas City provides a useful case study area for this analysis because it includes a range of weak and strong housing market areas.

McClure finds that borrowers are better served if credit is directed to them independent of location. Very low-income and minority borrowers fare better, in terms of the housing and employment opportunities of the neighborhoods in which they are located, than borrowers in underserved neighborhoods, suggesting that directing credit to low-income and minority households has the desired effect of helping these households purchase homes in areas where they can find good homes and good employment prospects. According to McClure, HUD's 1996-99 housing goals defined underserved tracts so broadly that nearly one-half of the tracts in the Kansas City area are categorized as underserved. Because the definition is so broad, directing credit to these tracts means including many areas with stable housing stocks and viable job markets.

McClure finds that directing credit to underserved areas is helpful only insofar as it helps direct credit to neighborhoods with slightly lower household income levels and higher incidence of minorities than found elsewhere in the metropolitan area. McClure believes that neighborhoods that receive very low levels of mortgage credit seem to provide insufficient housing or employment opportunities to justify the effort that would be required to direct additional mortgage credit to them.

McClure concludes that, relative to each of the mandates, the GSEs did not perform as well as primary credit lenders in the Kansas City metropolitan area in 1993-96.In terms of helping underserved areas, the GSEs lagged behind the industry in the proportion of loans found in these areas. In terms of helping low-income and minority borrowers, the GSEs also lagged behind the primary market in Kansas City.

Patrick Boxall and Joshua Silver, in "Performance of the GSEs at the Metropolitan Level," examine differences in the GSEs' purchases as shares of single-family loans originated in metropolitan areas across the country, with a particular focus on the extent of institutional relationships between the GSEs and other mortgage market participants. A prominent example of such relationships is the network of partnership offices established by Fannie Mae in various metropolitan areas during the 1990s.Freddie Mac has also established targeted relationships with local governments and nonprofit institutions to increase mortgage access for underserved borrowers. The specific objective of the research is to determine whether differences in the extent of relationships between the GSEs and lending institutions, government agencies, and nonprofit community-based organizations explain differences between MSAs in the GSEs' purchases of loans made to traditionally underserved populations, including lower income families and minorities. A related objective is to determine whether the affordable housing goals, which apply to the GSEs' nationwide mortgage purchase activity, could be extended into a system of metropolitan-level goals as a means of stimulating the GSEs' purchases of loans made to underserved populations.

Boxall and Silver provide a review of the national context for considering GSE performance at the metropolitan level. The authors demonstrate that across all MSAs, the GSEs' purchases of single-family loans satisfying the affordable housing goals are related to local economic and demographic characteristics. In particular, the percentage of GSE loan purchases that qualify for the housing goals is greatest in markets where median income levels are relatively high. Although the study finds that economic and demographic factors affect the amount of business conducted by both GSEs and lenders, the shares of primary mortgage market originations for underserved populations across all MSAs generally exceeded the corresponding shares of the GSEs' purchases in 1996.

The authors conduct detailed analyses of the contribution of institutional relationships to GSE purchases of loans made to minority and low-and moderate-income populations in four metropolitan areas for 1995-96:Washington,D.C., where both GSEs purchased relatively high percentages of loans that qualified under the goals; Houston, Texas, where Fannie Mae's performance under the affordable housing goals exceeded its performance elsewhere; Columbus, Ohio, where Freddie Mac's performance under the goals exceeded its performance elsewhere; and Pittsburgh, Pennsylvania, where both GSEs purchased relatively low percentages of loans that qualified under the goals. Each case study analyzes HMDA data on primary and secondary market activity and provides insights gleaned from interviews with local affordable housing institutions, including the GSEs, lenders, government, developers, and nonprofits.

From these case studies, Boxall and Silver conclude that the GSEs purchase higher percentages of loans made to underserved populations in case study MSAs where there are strong linkages between the GSEs and the local affordable housing system. In their opinion, institutional relationships can bolster the GSEs' efforts to serve minority and lower income populations.

Boxall and Silver conclude that it would not be feasible to establish metropolitan-level goals, since the GSEs often negotiate with lenders on a regional or national level. How- ever, while metropolitan-level goals are not recommended, the authors suggest that local Consolidated Plans and Analyses of Impediments required by HUD include discussions of GSE activity. They believe that this could aid in the design and implementation of affordable housing programs that build on the GSEs' institutional linkages with local affordable housing systems.

Heather MacDonald, in "Fannie Mae and Freddie Mac in Nonmetropolitan Housing Markets: Does Space Matter?" investigates variations in GSE market share among a sample of counties. Due to the lack of reliable data on mortgage lending in nonmetropolitan areas, MacDonald creates a database for 426 nonmetropolitan counties in eight census divisions. Specifically, she estimates conventional conforming mortgage originations from residential sales data, adjusted to exclude government-insured and nonconforming loans.

MacDonald then investigates whether GSE market shares differ significantly by location after controlling for the economic, demographic, housing stock, and credit market differences among counties that could affect use of the secondary markets. The study also investigates whether there are significant differences between the nonmetropolitan borrowers served by Fannie Mae and those served by Freddie Mac.

MacDonald finds that proximity to metropolitan areas contributes significantly to explaining variations in GSE market shares among nonmetropolitan counties, but its effects are quite specific. One remote region-nonadjacent West North Central counties-had significantly lower GSE market shares than all others. The study also finds that there are significant disparities between the income levels of the borrowers served by each agency, with Freddie Mac buying loans from borrowers with higher incomes than the incomes of borrowers served by Fannie Mae. Due to the unavailability of complete data on nonmetropolitan mortgage originations (such as the data compiled under HMDA within metropolitan areas), more precise conclusions about the extent to which the GSEs mirror primary mortgage originations in these areas cannot be reached.

James Pearce, in "Fannie Mae and Freddie Mac Mortgage Purchases in Low-Income and High-Minority Neighborhoods:1994-96," analyzes mortgage lending and GSE purchases in 10 large metropolitan areas from 1994 to 1996,focusing on the underserved areas goal established by HUD for the GSEs, and subdividing these areas between those with high and low housing costs (based on the median cost of owner-occupied housing)in order to test whether or not the GSEs' goal performance depends on housing affordability in an area. UD defines underserved tracts in metropolitan areas based on low median incomes (relative to the MSA median)or high minority concentrations, based on the association of these proxies with low mortgage origination rates and high mortgage denial rates.

Pearce's case studies provide an indication of whether, and to what extent, service by the primary mortgage market is relatively low (based on lending volumes)in the census tracts designated as underserved by HUD. He finds that, although low income and high minority representation are, on average, indicators of low levels of mortgage activity, they may not identify neighborhoods with relatively low lending volumes in all 10 metropolitan areas.

Pearce examines whether the primary market serves high-cost and low-cost areas equally well. He finds that homeownership is more difficult for lower income households in areas where homes are more expensive relative to area median income.

The author finds that mortgage-lending activity in low-income tracts is below the level in middle-income tracts in some, but not all, of the MSAs studied. Specifically, he concludes that lending in low-income tracts is relatively low more often in the low-cost MSAs than in the high-cost MSAs. Three of the low-cost MSAs exhibited shortfalls, even after controlling for factors that arguably could yield lower origination rates in low-cost census tracts.

Pearce also considers whether, and to what extent, loan purchases by Fannie Mae and Freddie Mac are concentrated within or outside of these underserved census tracts. He finds that GSE purchase rates from low-income tracts were often, but not always, lower than the rates from middle-income tracts. Shortfalls were smaller for Fannie Mae than for Freddie Mac, particularly for home purchase loans. Purchase rates in high-minority, middle-income tracts were much closer to parity with purchase rates for other middle- income tracts, with Fannie Mae purchase rates at or exceeding parity in most MSAs, and Freddie Mac purchase rates at or near parity in most cases in 1994-96.Both GSEs had shortfalls in purchase rates in the three low-cost MSAs that exhibited low origination rates in low-income tracts. Pearce discusses constraints that face the enterprises, such as the GSEs' conforming loan limits, charter-based underwriting standards, and competition from government-backed lending programs and special affordable lending programs by banks and thrifts, that may differentially impact GSE purchases across MSAs.

Paul Manchester, in a Note, "Mortgage Lending on the Pine Ridge Indian Reservation," analyzes a variety of data sources to estimate the volume of mortgage lending and secondary mortgage market activity on the Oglala Sioux (Pine Ridge)Indian Reservation in South Dakota. Some published reports have cast doubt about the viability of such lending on this reservation, one of the poorest in the United States, and one of the areas targeted by the HUD-Treasury One-Stop Mortgage Center Initiative. While Manchester finds a shortage of lending relative to needs on the Pine Ridge Indian Reservation, he concludes that such activity is taking place to a greater extent than generally recognized.

Background for These Studies
These studies were funded through research grants competitively awarded by PD&R 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.&sup5; One purpose of the grants was to demonstrate research uses of the Department'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 post-2000 period on October 31, 2000.

Conclusion
The articles in this issue of Cityscape demonstrate both the recent progress in extending mortgage credit to lower income borrowers and underserved neighborhoods and the challenges that remain. Anyone interested in mortgage markets and the role of Fannie Mae and Freddie Mac will find rich insights in these articles.

Authors&sup6;
John Gardner received a Ph.D. in economics from the University of Minnesota, after which he held positions as research associate in the Center for Urban Studies, University of Chicago, and visiting assistant professor of economics at Roosevelt University in Chicago. He joined the U.S. Department of Housing and Urban Development as a staff economist in 1975 and is director of the Financial Institutions Regulation Division in HUD's Office of Policy Development and Research. 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 serves as an economist in the Financial Institutions Regulations Division of HUD's Office of Policy Development and Research, where his work has focused on a wide variety of topics related to the Department's regulation of Fannie Mae and Freddie Mac. He previously taught economics at Mary Washington College and The Catholic University of America. Manchester worked as a senior economist with the Joint Economic Committee of Congress and the Office of Thrift Supervision. He has a Ph.D. in economics from the University of Minnesota.

Susan M. Wachter is professor of real estate and finance at the Wharton School of the University of Pennsylvania and former Assistant Secretary for Policy Development and Research at the U.S. Department of Housing and Urban Development.

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

2. The most recent such analyses are contained in the Federal Register, Vol.65, No. 211, October 31, 2000.

3. The four articles to be published in the second volume are "Spatial Variation in GSE Mortgage Purchase Activity" by Bradford Case and Kevin Gillen; "Mitigating Information Externalities in Mortgage Markets: The Role of Government-Sponsored Enterprises" by David Harrison, David Ling, Marc Smith, and Wayne Archer; "Government-Sponsored Enterprise Secondary Market Decisions: Their Effects on Racial Disparities in Loan Rejection Rates" by Samuel Myers, Jr.; and "The Patterns of GSE Participation in Minority and Racially Changing Markets Reviewed From the Context of Levels of Distress Associated With High Levels of FHA Lending "by Calvin Bradford. 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 Secondary Mortgage Market Purchases Made in Support of Affordable Housing" by Joseph Gyourko and Dapeng Hu, March 2000, is available from the Director of the Financial Institutions Regulation Division, Office of Policy Development and Research.

4. The views expressed in these studies are those of the authors and do not necessarily reflect the views of the U.S. Department of Housing and Urban Development.

5. 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 notes at the end of each article.

6. We wish to thank Theresa DiVenti, an economist in the Financial Institutions Regulation Division, for helping us to bring these studies to fruition.