Financial Markets and Institutions:

The Cooperative Model as a Potential Component of Structural Reform Options for Fannie Mae and Freddie Mac

GAO-11-33R: Published: Nov 15, 2010. Publicly Released: Nov 15, 2010.

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William B. Shear
(202) 512-4325


Office of Public Affairs
(202) 512-4800

On September 6, 2008, the Federal Housing Finance Agency (FHFA) placed the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) into conservatorships. FHFA took this step after concern developed that the deteriorating financial condition of the two government-sponsored enterprises (GSE), which had about $5.4 trillion in combined financial obligations, threatened the stability of financial markets. Since then, the Department of the Treasury (Treasury) has provided financial support to Fannie Mae and Freddie Mac (the enterprises) to help stabilize their financial condition and help ensure their ability to continue to support housing finance. As of September 2010, Treasury had provided about $150 billion in capital contributions to support the enterprises, and the Congressional Budget Office has estimated that the total cost to taxpayers could be nearly $400 billion over a 10-year period. In recent months, Congress and the administration have been considering a variety of proposals to reform the enterprises in order to help ensure their safety and soundness and the effectiveness of the U.S. housing finance system. We issued a report under the Comptroller General's authority on structural reform options for the enterprises in September 2009 and, on the basis of subsequent congressional interest, we conducted this work as a follow-up effort, also under the Comptroller General's authority. This letter summarizes briefings that we provided to the staffs of the Senate Committee on Banking, Housing, and Urban Affairs and the House Financial Services Committee. Our objectives were to (1) identify the key characteristics of the cooperative model, (2) discuss the cooperative model's potential role as part of any long-term structural reform option for the enterprises, (3) discuss some likely advantages and disadvantages of the cooperative model as a potential reform option for the enterprises, and (4) identify some of the key decisions that Congress and the administration would have to make to initiate overall structural reform for the enterprises and design an effective transition process.

A cooperative is generally defined as an entity that is jointly owned and controlled by the members that use its services. The members--such as businesses--finance and operate the cooperative for their mutual benefit and, by working together, can potentially reach an objective that would be unattainable if acting alone. Cooperatives often involve participants in a single industry that have common economic interests and goals and that undertake joint activities such as marketing, purchasing supplies and equipment, and providing certain services. Typically, cooperatives are governed by a board of directors that is elected by the members. Cooperatives may acquire capital through membership fees or members' stock purchases, withholdings from members' net earnings, assessments on the members' sales or purchases, or a combination of these. As indicated in our September 2009 report, the cooperative model is generally viewed as a component of the three larger reform options (government corporation or agency, reconstituted GSE, or privatization or termination) rather than an option by itself. While the cooperative model could conceivably fall under any of the options, it is generally seen as most closely associated with the reconstituted GSE option. Under this option, the enterprises could be established as privately owned entities that would generally focus on purchasing qualifying mortgages from lenders and issuing MBS, which would benefit from explicit federal financial guarantees. These private entities could be structured as cooperatives owned by mortgage lenders, shareholder-owned corporations as is the case today, or possibly as nonprofits. In contrast, the cooperative model is generally not viewed as integral to establishing a government corporation or agency to replace the enterprises. As a public entity, a government corporation or agency would not likely be capitalized by lenders, nor would they likely have a role in its governance or operations. And while lenders may choose to form cooperatives if the enterprises are privatized or terminated, this decision would likely depend on whether they decide that doing so is in their economic interests. One potential benefit of the cooperative model, as cited by proponents, is that it would encourage safer and sounder mortgage underwriting practices. For example, as the owners of the cooperatives, lenders might have financial incentives to help ensure that the mortgages sold to the cooperatives were properly underwritten in order to minimize potential losses that would adversely affect their capital investments. However, a cooperative model does not necessarily guarantee safe and sound operations. Reforming the enterprises' long-term structure requires Congress and the administration to make key decisions on the appropriate reform option, the mission of the entity or entities, and the oversight framework. If the new structure includes the cooperative model, a number of decisions would also have to be made on the number of cooperatives that would be formed and their membership requirements, governance and capital structures, and permitted business activities. Key transition issues would also include (1) ensuring that the entity or entities replacing the enterprises have sufficient resources, staffing, and technology to carry out their responsibilities; and (2) if applicable, determining the best means and time frames for lenders to establish cooperatives.

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