Is GSE cap pro­posal an aca­demic ex­er­cise — or a whole lot more?

No plan will be im­ple­mented as long as Fan­nie and Fred­die re­main in con­ser­va­tor­ship, but a cap­i­tal frame­work could still have a ma­jor im­pact.

National Mortgage News - - Contents - By Han­nah Lang

As with any­thing in hous­ing fi­nance re­form, an­a­lyz­ing a pro­posed cap­i­tal frame­work for Fan­nie Mae and Fred­die Mac starts with these mas­sive caveats: the govern­ment-spon­sored en­ter­prises are still in con­ser­va­tor­ship, and long-term re­form is still way out of reach.

To some ob­servers, there­fore, the pro­posal re­leased by the Fed­eral Hous­ing Fi­nance Agency — out­lin­ing risk-based cap­i­tal and min­i­mum lever­age ra­tio re­quire­ments sim­i­lar to those im­posed on banks — was some­what of an aca­demic doc­u­ment. In­deed, the pro­posal states promi­nently that the cap­i­tal rules will not be im­ple­mented as long as Fan­nie and Fred­die are still con­trolled by the govern­ment.

“It seems like a rea­son­able com­pro­mise in terms of num­bers, but ob­vi­ously it’s the­o­ret­i­cal,” said Bose Ge­orge, a man­ag­ing di­rec­tor at Keefe, Bruyette & Woods. “It’s a frame­work peo­ple can use for the fu­ture.”

Oth­ers saw the pro­posal as hav­ing a more sub­stan­tive im­pact, both for the good or bad.

Jim Par­rott, a fel­low at the Ur­ban In­sti­tute, said the pro­posed cap­i­tal frame­work “is largely the one [the GSEs] use to­day” with re­gard to pric­ing and coun­ter­party risk man­age­ment. That will help pol­i­cy­mak­ers out­side the FHFA and the GSEs un­der­stand the com­pa­nies bet­ter the next time Con­gress tries to re­form them, he said.

“It re­ally does pro­vide a sort of blue­print for the kinds of things we ought to be think­ing about leg­isla­tively,” Par­rott said. “Even if we de­fer to the reg­u­la­tors ul­ti­mately, at least we see at the end of the day what a rich cap­i­tal regime should look like, and then we can de­cide then and our leg­is­la­tors can de­cide then what role they want to play in set­ting guardrails around what a reg­u­la­tor ought to do.”

But some said the pro­posal could have a less pos­i­tive ef­fect, since — in con­trast to the FHFA’s de­scrip­tion — the frame­work could point to dif­fer­ences in the cap­i­tal struc­tures between large banks and the GSEs that might give pol­i­cy­mak­ers pause.

“Although FHFA says its new ap­proach is ‘gen­er­ally’ like that gov­ern­ing large banks, it’s in fact strik­ingly dif­fer­ent, es­pe­cially in com­par­i­son to the largest U. S. banks,” said Karen Shaw Petrou, man­ag­ing part­ner of Fed­eral Fi­nan­cial An­a­lyt­ics. “As a re­sult, un­der these rules, Fan­nie and Fred­die will re­main the prime movers of U.S. mort­gage fi­nance. Their com­bi­na­tion of size and cap­i­tal ad­van­tage means that they’ll beat banks ev­ery time, ev­ery way, ev­ery day.”

While the FHFA has at­tempted to move the ball for­ward ad­min­is­tra­tively on GSE re­form, long-term hous­ing fi­nance re­form by Con­gress still ap­pears to be go­ing nowhere.

“There just seems to be a gen­eral con­sen­sus that [re­form] is not go­ing to hap­pen this year, and we think it might not hap­pen for longer,” said Brian Har­ris, se­nior vice pres­i­dent of Moody’s.

The new pro­posal would tar­get the GSEs’ com­bined cap­i­tal at $ 180.9 bil­lion, as­sess credit risk for dif­fer­ent mort­gage cat­e­gories, and in­clude com­po­nents for mar­ket risk and op­er­a­tional risk. The FHFA also asked for pub­lic com­ment on two dif­fer­ent min­i­mum lever­age ra­tio re­quire­ments for the GSEs. Un­der one pos­si­bil­ity, the GSEs would have to hold cap­i­tal equal to 2.5% of as­sets and off- bal­ance-sheet guar­an­tees. The sec­ond op­tion would re­quire Fan­nie and

Fred­die’s cap­i­tal to be equal to 1.5% of trust as­sets and 4% of non­trust as­sets.

“FHFA’s pro­posed rule is based on a cap­i­tal frame­work that is gen­er­ally con­sis­tent with the reg­u­la­tory cap­i­tal frame­work for large banks, but re­flects dif­fer­ences in the char­ters, busi­ness op­er­a­tions, and risk pro­files of the En­ter­prises,” the agency’s pro­posal said. The frame­work bor­rows con­cepts from the in­ter­na­tional Basel ac­cord used to mea­sure cap­i­tal for large banks, “with ap­pro­pri­ate mod­i­fi­ca­tions for the En­ter­prises,” the agency added.

The pub­lic will have 60 days to com­ment, but that struck some as too short a pe­riod given the com­plex­ity of the pro­posal.

Jaret Seiberg, an an­a­lyst for the Cowen Wash­ing­ton Re­search Group, wrote in a re­search note that that won’t give com­menters enough time to “fully ac­cess the ram­i­fi­ca­tions of the plan.”

“The ob­vi­ous con­clu­sion here is that FHFA Di­rec­tor Mel Watt wants to fi­nal­ize this cap­i­tal regime be­fore his term ends in Jan­uary,” Seiberg wrote.

While the pro­posed reg­u­la­tion may be hy­po­thet­i­cal, the FHFA ex­plained in a press re­lease that it be­lieves it is ap­pro­pri­ate to com­mu­ni­cate the agency’s views about cap­i­tal ad­e­quacy for the fu­ture. The FHFA ended reg­u­la­tory cap­i­tal re­quire­ments for Fan­nie and Fred­die in Septem­ber 2008 af­ter plac­ing the GSEs into con­ser­va­tor­ships, but a cap­i­tal frame­work had been in place un­der the FHFA’s pre- cri­sis pre­de­ces­sor, the Of­fice of Fed­eral Hous­ing Enterprise Over­sight.

“We are fol­low­ing a for­mat that is sim­i­lar to bank­ing cap­i­tal but these en­ter­prises are not banks and cap­i­tal is about pro­tect­ing against risk,” said Watt in con­gres­sional tes­ti­mony in May. “You have to re­ally as­sess the risks that are be­ing un­der­taken, com­pare them to risks banks have and there are some dif­fer­ences.”

But Petrou said the cap­i­tal frame­work may only serve a short-term process for when Fan­nie and Fred­die come out of con­ser­va­tor­ship, rather than es­tab­lish long-term cap­i­tal pro­to­cols that can sus­tain af­ter the sys­tem has been re­formed.

“This pro­posal is de­signed to shape cap­i­tal frame­work for GSE suc­ces­sors whether these are crafted by Con­gress or far more likely, the ad­min­is­tra­tion early next year,” she said. “While they have sig­nif­i­cant, im­me­di­ate im­pact on GSE op­er­a­tions in con­ser­va­tor­ship, the dif­fer­ences between FHFA’s con­struct and the cap­i­tal rules ap­plied to large U.S. banks will give both Con­gress and Trea­sury a lot of con­cern. I view this as a tran­si­tional cap­i­tal frame­work, not a ro­bust one that should ap­ply per­ma­nently to giant util­i­ties un­der­tak­ing a sys­tem-crit­i­cal func­tion like hous­ing fi­nance.”

Par­rott said the pro­posal is still use­ful in con­nect­ing ideas about how to re­form the com­pa­nies with real on-the-ground in­for­ma­tion about their cap­i­tal pro­file.

“What’s nice about it is for the first time it shows those who are not in FHFA or the GSEs ex­actly how the cap­i­tal­iza­tion frame­work that they use to­day works. It should be help­ful be­cause even if the next FHFA mi­grates off of this some­how, it is the doc­u­ment to which we’ll all turn to un­der­stand what we’re try­ing to ar­gue about, he said.”

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