In 2000, the MBA convened a blue ribbon panel of mortgage industry leaders to examine the limits of secondary market activity relative to Fannie Mae and Freddie Mac which are Government Sponsored Enterprises ("GSEs"). Over a period of months, the panel met to analyze and review the spectrum of real estate finance activities engaged in by the GSEs and the primary market. The panel established guiding principles and definitions to assist in interpreting the scope and limits of the GSE charters. The work of the panel was shared with Fannie Mae and Freddie Mac. Both companies provided extensive comments that were considered by the panel. The report of the panel is provided below.

I. Background

The American home finance system owes much of its vitality to a robust and competitive primary mortgage market. Competition in this sector is the key to the development of innovative products that expand consumer choice and lower the costs of homeownership and rental housing.

The GSEs also play an enormously important role in this system by assuring that the country has a stable and adequate supply of affordable mortgage credit. The MBA has a strong commitment to the present mortgage finance system, in which the GSEs, operating to provide liquidity in the secondary market, team with primary market mortgage lenders to provide the American public with a uniquely successful residential mortgage delivery system.

The GSEs enjoy significant legal and financial advantages conferred upon them by the federal government to ensure that the GSEs meet their critical function of secondary market stability and liquidity. The stability of the mortgage lending system would be threatened if the GSEs use these benefits to expand their activities beyond the mandate intended by Congress and into the sphere of the primary market residential, multifamily and commercial finance system, where the GSEs' competitive advantage could permit them to dominate.

By expanding beyond the intended boundaries of their charters, the GSEs could upset the equilibrium between the primary and secondary mortgage markets upon which the continued success of the American system of home finance depends. The immediate casualties might be existing lenders and other primary market participants in the real estate industry, but consumers would be the ultimate losers. Less competition means higher borrowing costs for consumers and fewer financing options. It means less responsiveness to consumer needs, especially for non-traditional borrowers.

Many believe that, in recent years, the GSEs have begun to insert themselves into the primary market by attaching conditions on the deployment of their technologies, building brand identity, investing in non-lender primary market participants, and working directly with owners of multifamily properties. For example, in recent years, the GSEs have been advertising intensively to consumers, ending a long-term practice of avoiding consumer contacts. The GSEs also have become owners of significant interests in a broad range of primary market companies ranging from homestore.com to a property disposition company to a company selling loan level risk-based pricing and other technologies. The GSEs also have worked to boost their respective market shares by enforcing loan delivery standards that favor the use of their proprietary technologies for primary market activities (automated underwriting, automated property appraisals, loan origination systems) to the detriment-and often the demise-- of private market technology providers.

The MBA believes that strong independent regulation of the GSEs is necessary to maintain the delicate balance designed by Congress. The MBA also believes that oversight must be structured so as not to interfere with the smooth operation and efficiency of today's mortgage markets.

In its 1999 policy statement, the MBA called for maintaining a "clear distinction" between primary and secondary market activities, supported by strong, well funded federal oversight of the GSEs. The statutory mandate of the GSEs is to operate in the "secondary market for residential mortgages". But what are the boundaries of the secondary market? Current law provides little guidance, and this void has left the GSEs vulnerable to critics who argue that the existing regulatory system is unable to adequately provide oversight of the GSEs' mission. The MBA believes that clear definition, combined with intelligent and independent regulatory authority, would provide predictability for the GSEs and the regulators, and eliminate the uncertainty that characterizes the current oversight system. In short, ambiguity should be replaced with clarity.

II. Summary of Primary and Secondary Market Functions

The essential roles of the primary and secondary market provide a straightforward foundation for establishing clear boundaries for secondary market activity.

A. Fundamental Functions of the Primary Market

Primary market participants work directly with consumers and borrowers to:
- solicit and maintain consumer and borrower contact;
- process, underwrite, obtain ancillary closing services, close and fund residential loans to borrowers;
- service residential mortgages and maintain borrower contact;
- serve as intermediaries (wholesalers or conduits) between the GSEs and correspondent lenders; and
- develop and market systems and technologies in support of these functions.

These brief descriptions of activities establish a broad sphere of potential contacts and transactions between lenders and other primary market participants and consumers that together establish the "primary market." This sphere should be regarded as very fluid as the manner of contacts and the types of transactions will evolve over time. In interpreting what activities fall within the sphere of the primary market, we believe there should be a presumption that an activity is a primary market activity if it is performed by a primary market participant and it is not "investment-related" (see below). The statutory prohibition against a GSE's originating a mortgage should be broadly construed to encompass the full sphere of potential contacts and transactions between lenders and other primary market participants and consumers/property owners and not just the limited act of funding a loan at closing.

B. Fundamental Functions of the Secondary Market

The GSEs, in furtherance of their secondary market purposes, are intended to promote the liquidity of residential mortgages through various secondary market transactions. The GSEs:

- replenish funds used to originate mortgages through whole loan purchases from primary market lenders of "residential mortgages", as defined in the GSEs' Charter Acts;
replenish lender capital by facilitating the securitization of residential mortgages;
- provide predictable access to future capital by pricing whole loans for "forward" as well as "spot" delivery;
- purchase or securitize whole loans from Wall Street or other conduits; and
- conduct these activities in a manner which supports the attainment of affordable housing goals.

Activities such as the sale of mortgages, MBS or REMICs from the GSEs' portfolios are necessary to the efficient management of the GSEs' secondary market function. Hedging and other risk management and cash management activities for their own accounts are incidental to these functions.

In general, secondary market activities may best be characterized as "investment related" - those activities involving the mortgage after it has been originated or aggregated. Consumer and borrower contact is outside the scope of secondary market activities.

III. Standards and Criteria for Determining Whether an Activity is Outside the Boundaries of the Secondary Market

With the preceding principles of primary and secondary functions in mind, a series of definitional touch points emerge that signal whether an activity is properly within the sphere of GSE authority.

A. Inside the Box: Secondary Market Transactions

The GSEs are chartered to operate only in the "secondary market for residential mortgages." The MBA believes that the secondary market involves transactions constituted by the following types of activities:

- Purchase by the GSEs of ownership rights in an existing residential mortgage from a lender or third party investor;
- Issuance and guarantee by the GSEs of securities backed by residential mortgages;
- Issuance by the GSEs of multiclass securities backed by purchased residential mortgages or purchased mortgage-backed securities backed by residential mortgages;
- Sale by the GSEs of acquired residential mortgages or single or multi-class mortgage backed securities issued by the GSEs;
- Purchase by the GSEs of their own MBS or those of others to support liquidity and the price of MBS in times of market stress, to "incubate" new products so that the market can judge over time how the products will perform, and to otherwise make or support a market in a type of security; and
- Support for open technology standards, including standards for e-mortgages, through the Mortgage Industry Standards Maintenance Organization and related bodies.

B. Outside the Box: Activities Involving Borrower Contact And Other Primary Market Functions

Activities which carry no legitimate secondary market purpose are clearly outside the scope of the GSEs' charters. A secondary market transaction by its nature excludes contact with borrowers, borrowers' agents or representatives, or potential borrowers. The MBA believes that activities excluded from the definition of the secondary market include both loan origination and loan servicing functions, described as follows:

1. Loan Origination Functions Excluded From GSE Activity:

- identifying potential borrowers;
- soliciting and contacting borrowers;
- advising, prequalifying and counseling borrowers;
- negotiating loan terms and options;
- taking loan applications; obtaining third-party reports, such as appraisals; and handling all other elements of loan processing;
- making decisions to extend credit which may include use of an automated underwriting system;
- providing or obtaining a credit enhancement necessary for the sale of a mortgage to the GSEs, including by not limited to mortgage insurance (but excluding guarantees provided by the GSEs pursuant to its secondary market operations);
- document preparation;
- obtaining or providing other settlement services, including those related to loan closing or funding; and
- encouraging contacts with mortgage brokers and real estate agents who are the customers of mortgage lenders, or dealing directly with them as links to borrowers.

The GSEs' statutory obligation to meet specific affordable housing goals does not alter the scope of their mission. It is very clear that Congress did not intend the introduction of the affordable housing goals to accomplish a wholesale re-write of the GSEs' charters. Merely asserting a link between GSE activity and attainment of the goals is insufficient justification for a GSE initiative that is otherwise outside the GSEs' secondary market authority. Every GSE initiative must meet the test of promoting liquidity in the secondary market for residential mortgages. Otherwise, a GSE could justify purchasing or entering into the business of a homebuilding company, realtor business, settlement service provider or virtually any other entity with some housing connection if it could argue that its management of the company would make housing more affordable.

A particular area of concern has been the GSEs' outreach efforts to consumers through advertising that serves to diminish the role of the lender in the mortgage transaction. The MBA has no objection to the GSEs engaging in consumer education activity or advertising, so long as there is a valid secondary market purpose, or the advertising or consumer education activity is done in conjunction with a lender or group of lenders.

2. Loan Servicing Functions Excluded From GSE Activity

- Setting up loan files
- Collecting and recording mortgage payments
- Responding to borrowers' post closing inquiries
- Administering escrow accounts
- Providing other services to borrowers such as discussing or proposing refinancing options
- Handling delinquencies, foreclosures and investor accounting processes
- Handling the disposition of real estate owned by third parties after foreclosures

The only situation in which the GSEs properly have authority to exercise loan servicing functions is on a temporary, emergency basis after terminating a lenders servicing rights for cause, pending a transfer of the servicing rights to a substitute servicer.

IV. Assessing GSE Activity Against These Definitions

Measured against these definitions, the GSEs during the past few years have entered into a variety of ventures which appear to run afoul of their secondary market charter. Examples of these activities include:

- GSE agreement with McDonalds to provide electronic kiosks for consumer mortgage information;
- GSE commercial loan to Lending Tree electronic broker;
- A variety of GSE internet sites and toll free numbers targeted at consumers;
- GSE development of proprietary technologies as a separate for-profit business line rather than also developing or approving third-party standards for risk management and other functions;
- Deployment of automated valuation models which crowd out competing systems that compute appraised value;
- Direct contacts with mortgage brokers and real estate agents, the lender's customers; and
- Advertising and other promotional activities directed to consumers by the GSEs' charitable foundations which appear to promote the GSEs' corporate "brands" to the detriment of the lender's image. It is frequently very difficult to discern the line between corporate activity and foundation activity.

The Mortgage Bankers Association will continue to monitor GSE activity against the framework described in this issues paper, and keep its members informed about those activities which may violate the principles of the GSEs' charters. The MBA will also work with the regulatory bodies that provide oversight of GSE activities. This issue paper will be shared with legislators, regulators, industry participants and the GSEs themselves to provide guidance regarding GSE activities.