Fannie Mae/Freddie Mac uniform mortgage instruments: the forgotten benefit to homeowners.

• Author: Forrester, Julia Patterson
• Position: Symposium: A Festschrift in Honor of Dale A. Whitman

1. INTRODUCTION

   Fannie Mae and Freddie Mac are the giants of the home mortgage industry. Today they own or guarantee about forty percent of outstanding home mortgage debt in the United States. (1) In addition, their uniform mortgage instruments document the great majority of home mortgage loans. (2)

   Dale Whitman is a giant in the arena of real estate and property law. The substance and quality as well as the volume of his work make him a giant. Dale's treatises and casebooks are well-regarded and well-known. I teach from his Real Estate Transactions casebook, (3) and I consult and cite his treatises regularly. (4) His work as reporter for the Restatement (Third) of Property: Mortgages is also renowned and deservedly well-regarded.

   Less known is his background in electrical engineering, a background that I happen to share. Also less known is the time he spent in government service. In 1971, after teaching at the University of North Carolina and UCLA, Dale was a Deputy Director of the Federal Home Loan Bank Board where he worked on promoting minority ownership of savings and loans and loans to minority borrowers. He later served as a senior analyst for the Department of Housing and Urban Development where he drafted the HUD-1 closing statement in substantially the same form it stands today. Subsequently, he taught on the law faculties of Brigham Young University, the University of Washington, and the University of Missouri-Columbia, where he also served as dean for six years. This symposium honors him.

   Dale's work at FHLBB and HUD in the early 1970s occurred during a fascinating time in the development of the secondary market for conventional home mortgage loans (5) by Fannie Mae and Freddie Mac. FHLBB supervised Freddie Mac at the time of its creation in 1970, (6) and HUD has regulated Fannie Mae and Freddie Mac for many years. (7) This time period also saw the birth of the Fannie Mae/Freddie Mac uniform mortgage instruments which are the subject of this Article.

   In recent years economists and lawmakers have debated the public costs and benefits of the two housing government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac. (8) Some critics of the GSEs have even proposed making the GSEs fully private entities. (9) Some parties involved in the debate have concluded that the costs of the GSEs outweigh their benefits, while others assert the converse. (10) In terms of benefits, both sides consider the GSEs' contributions to lowering interest rates and encouraging affordable housing. (11) Forgotten, however, is a difficult to quantify but important benefit that the GSEs create for homeowners--the uniform mortgage instruments that evidence the vast majority of home mortgage loans. As this article will demonstrate, the Fannie Mae/Freddie Mac instruments are extraordinarily balanced and fair compared to other documents consumers must sign. The benefit that Fannie Mae/Freddie Mac uniform instruments provide to homeowners is a factor that weighs against privatization of the GSEs.

   As an attorney, I usually cringe when I have to sign standard form documents. Apartment leases, rental car agreements, credit card agreements, and many other form contracts that consumers must enter into are contracts of adhesion. (12) These contracts are drafted to give a minimum of rights to consumers, and negotiation is not an option.

   The story is different, however, for the largest transaction in the lives of most Americans: financing the purchase of a home. When a home purchaser signs loan documents, the legal terms are usually more favorable for the borrower than the terms that sophisticated real estate developers can negotiate in commercial mortgage loans. The reason for the difference is the huge dominance in the home mortgage market of Fannie Mac/Freddie Mac uniform mortgage instruments--standardized loan documents that are extraordinarily fair to consumers. (13)

   Part II of this Article discusses Fannie Mac and Freddie Mac, their creation and evolution, their current role in the secondary market, and the development and current use of the Fannie Mac/Freddie Mac standardized forms. Part III looks at these uniform mortgage instruments in detail, and compares them to other residential loan documents and to commercial mortgage loan documents. Part III also considers typical terms of other consumer transactions that are not so balanced and explores how the problems that consumers face in choosing consumer credit make loan documents with fair terms particularly beneficial to consumers. Part IV discusses current criticisms of Fannie Mac and Freddie Mac, proposed regulatory reform, and the debate over privatization of the GSEs. Part IV also explores what role the standardization of mortgage documents by the GSEs should play in the debate. The purpose of the Article is not to weigh in on who should win the privatization debate or on where the balance of the costs and benefits of the GSEs should fall. The Article concludes, however, that the benefits of Fannie Mac/Freddie Mac standardization are a factor that must be considered in the ongoing debate over Fannie Mac and Freddie Mac.

2. FANNIE MAE AND FREDDIE MAC

   Fannie Mae and Freddie Mac are government-sponsored enterprises privately owned corporations operating under federal charters that impose restrictions on their activities and grant benefits that other private corporations do not enjoy. The President appoints five of the eighteen directors of each GSE, (14) while the rest are elected by shareholders. Fannie Mae and Freddie Mac are currently regulated by the Office of Federal Housing Enterprise Oversight (OFHEO) and the U.S. Department of Housing and Urban Development (HUD). (15) The benefits they receive as GSEs include exemption from state taxes (except for real property taxes), (16) exemption from federal securities laws, (17) a line of credit from the U.S. Treasury, (18) and the ability to issue securities through the Federal Reserve electronic book-entry system. (19) Since Fannie Mae and Freddie Mac are not government agencies, their guarantees are not backed by the full faith and credit of the federal government; however, a perception exists that the federal government would honor their obligations in the event of financial trouble. (20) This perception provides a substantial benefit because it means that Fannie Mae and Freddie Mac can raise capital at a lower cost than purely private actors in the mortgage market. (21)

   1. Creation and Evolution

      Fannie Mae was created in response to the Great Depression under the New Deal leadership of President Franklin D. Roosevelt. Because of widespread foreclosures during the Depression and wide variation in interest rates and availability of mortgages, President Roosevelt's National Emergency Council recommended the establishment of a program for long-term, federally-insured mortgages and the creation of national mortgage associations to purchase these mortgages. (22) Congress responded by creating the Federal Housing Administration (FHA) to insure home mortgage loans and by authorizing the charter of mortgage associations to purchase the insured mortgages. (23) In 1938 Congress chartered the Federal National Mortgage Association (now called Fannie Mae). (24) Fannie Mae was initially a government agency that issued bonds to raise funds for the purchase of FHA-insured mortgages and, beginning in 1948, Veteran's Administration (VA)-guaranteed mortgages. (25) In 1968 Congress divided the functions of Fannie Mac between two entities--Fannie Mae, which became a GSE and was allocated the secondary market operations of the former entity, and the Government National Mortgage Association (Ginnie Mac), which remained a division of HUD. (26)

      In 1970 the Emergency Home Finance Act authorized Fannie Mae to purchase conventional mortgages for the first time (27) and also created the Federal Home Loan Mortgage Corporation (Freddie Mac) to purchase conventional mortgages. (28) Freddie Mac was initially under the supervision of the Federal Home Loan Bank Board, and its stock was owned by the twelve Federal Home Loan Banks. (29) Freddie Mac was expected to purchase mortgages from savings and loan associations, while Fannie Mae was expected to purchase primarily from commercial banks and mortgage banks. (30)

      In addition to issuing bonds and using the proceeds to purchase loans, in 1971 Freddie Mac began selling pass-through mortgage backed securities (MBS) backed by conventional mortgage loans. (31) With pass-through MBS, "the investor purchases a fractional undivided interest in a pool of mortgage loans, and is entitled to share in the interest income and principal payments generated by the underlying mortgages." (32) In 1983 Freddie Mac issued the first Collateralized Mortgage Obligation (CMO), which created multiple classes of bonds all backed by the same mortgage pool but with each class paid sequentially as principal payments were received from the underlying mortgages. (33) Fannie Mae began securitizing mortgage loans in the 1980s. (34) When the GSEs issue MBS they "guarantee that investors will receive timely principal and interest payments regardless of what happens to the underlying mortgages." (35) Today Fannie Mae and Freddie Mac are almost identical in their charters and functions. They both purchase home loans to hold in their portfolios but securitize even more loans.

      Through their purchases and securitization of residential mortgage loans, Fannie Mac and Freddie Mac together provide the largest source of home mortgage financing in the nation. In 2004 nearly thirty-five percent of outstanding home mortgage debt was in the GSEs' MBS, and they held over twenty percent of home mortgage debt in their combined portfolios. (36) At the end of 2005, they had securitized or were holding in their portfolios forty-four percent of outstanding home mortgage debt. (37) More recently, they own in portfolio or guarantee through their MBS...