Could capital plan for Fannie and Freddie stymie homeownership?

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WASHINGTON — A proposal for Fannie Mae and Freddie Mac's capital levels to grow by more than five times once the companies return to the private sector has drawn the ire of both the mortgage industry and consumer groups over concerns the plan could drive up housing costs.

The proposed rule unveiled in May by the Federal Housing Finance Agency would align capital requirements for the government-sponsored enterprises with those of the large banks and incorporate the spirit of several post-2008 crisis regulations. The plan would not go into effect until after Fannie and Freddie are released from conservatorship, whenever that is.

But in comment letters submitted to the FHFA, many industry groups and even the two companies themselves pushed back on the idea that the GSEs should be treated like banks.

“While the U.S. bank capital framework may provide a useful precedent, the Enterprises’ business models and risk profiles are substantially different from those of banks,” said Ricardo Anzaldua, executive vice president and general counsel at Freddie. “In contrast to banks, the Enterprises are pass-through, monoline businesses focused on a traditional, well understood and secured asset class.”

The plan would result in a colossal effort to strengthen the GSEs' balance sheets. For example, if the framework had been in effect in September 2019, the FHFA estimates that the companies would have been required to hold a combined $234 billion in capital, representing 3.85% of their total assets and 13.9% of risk-weighted assets. Currently, Fannie and Freddie's retained earnings are capped at $45 billion combined.

Ed DeMarco, the president of the Housing Policy Council and a former acting director of the FHFA, agreed that the GSEs are substantially different from banks. He suggested that the capital framework use insurance companies in addition to banks as a point of comparison for Fannie and Freddie.

“Banks do not engage principally in the mortgage credit guarantee business, which is the core business of the Enterprises,” he said in the group’s comment letter. “Moreover, unlike banks, the Enterprises do not rely upon deposits for funding, so they do not face the same liquidity and interest rate risk as banks.”

The Community Mortgage Lenders of America also urged the FHFA to treat Fannie and Freddie more like insurance companies and less like banks.

“We remain highly skeptical of arguments that the GSEs must mirror bank-like capital standards given that they have solidified their business models as insurance companies, with a ... regulator better able to keep them in this space relative to the old regulatory model,” the group said, referring to the FHFA.

Yet the proposal was not universally panned. Some noted that the new capital regime is not as tough as the supervisory standards imposed on the largest, most complex banks.

Sheila Bair, a former chair of the Federal Deposit Insurance Corp. and a member of Fannie's board, called the FHFA’s proposal a “highly credible framework” that would protect taxpayers from losses while at the same time assuring shareholders a return on investments. While the plan would go further than a 2018 proposal drafted by the FHFA's prior leadership, Bair said, it still strikes a middle ground.

“The rule FHFA has proposed seems to strike a good balance,” she wrote in a comment letter. “While much stronger than the 2018 proposal, it would still only require roughly half as much capital as would be required under rules applicable to globally systemic banks, which protect the FDIC from losses.”

But Fannie and Freddie both warned that a higher capital benchmark would require them to boost their earnings in order satisfy the requirements. That could require them to increase the fees they charge lenders to back mortgages, they said.

“To satisfy the requirements of the proposed rule while achieving a rate of return sufficient to attract loss-bearing, private-sector capital, increases to guaranty fees may be required,” said Celeste Brown, the chief financial officer at Fannie. “The final capital framework should take into account the potential impact of such guaranty fee increases on the borrowers Fannie Mae serves and housing affordability generally.”

Anzaldua estimated that the proposed capital framework could force Freddie to increase its guarantee fees by up to 35 basis points. If those fees increase, lenders would likely pass on the extra cost to consumers, he said.

“Certain negative effects on our business and in the markets may arise from this increase,” he said.

A joint comment letter from 14 consumer groups said the end result would be reduced mortgage credit availability, "with an acute impact on low- to moderate-income families and families of color."

“It would do this directly, by pricing out of the GSE channel many borrowers with lower credit scores and higher loan-to-value ratios, and indirectly, by pricing out higher credit score and lower LTV borrowers that generate much of the current system’s cross subsidy to make its loans more affordable,” said the groups, including the Center for Responsible Lending and the National Community Reinvestment Coalition.

But on the flip side, Bair also noted that strong capital requirements would reduce the likelihood of another taxpayer bailout of the GSEs.

“What we learned from the Great Financial Crisis is that weak capital requirements lead to financial instability and crisis and that the brunt of the damage caused by that instability falls disproportionately on LMI families, and African-American families in particular,” she said.

The Mortgage Bankers Association suggested that the proposed capital requirements were too strong, and also took issue with the framework’s use of a fixed leverage ratio requirement.

“The level of required capital implied by the framework is too high and may be determined too frequently by a leverage ratio rather than risk-based standards,” wrote Robert Broeksmit, the president and cheif executive of the MBA.

Broeksmit also argued that the capital framework was too complex.

“Taken together, these multiple, complex, overlapping constraints are likely to frustrate FHFA’s goals of providing a clear signal to the Enterprises — and to the broader market — regarding how much capital is required for the Enterprises to conduct their businesses safely and soundly, and how they might operate to reduce that requirement, or to more efficiently allocate that capital,” Broeksmit said.

The proposal suggests that Fannie and Freddie maintain a leverage capital buffer on top of the leverage ratio requirement, as well as a “prescribed capital conservation buffer amount” that would be comprised of a stress capital buffer, a countercyclical capital buffer and a stability capital buffer.

Fannie and Freddie would be required to hold excess regulatory capital in the amount of the prescribed capital conservation buffer, or would face limits on capital distributions and bonus payments, similar to the expectations for banks regulated by the Federal Reserve, FDIC and the Office of the Comptroller of the Currency.

The stability capital buffer in particular would go against the GSEs’ mission to provide liquidity to underserved communities in periods of stress, argued Vince Malta, the president of the National Association of Realtors.

“Specifically, the stability buffer, which grows in proportion to the Enterprises’ role in the market, would rise in a crisis, precisely when the GSEs should be taking a more supportive role that implies a larger market share,” he wrote.

Many commenters also expressed concern about the proposal’s treatment of credit risk transfers, which Fannie and Freddie currently take advantage of in order to offload some of their risk to third parties. However, the new proposal would boost capital requirements on the amount of exposure a GSE retains through a credit risk transfer, which some feel would disincentivize the use of the program altogether.

“The proposed rule’s treatment of credit risk transfer would discourage the use of credit risk transfer, treating it more like another risk to be managed rather than as a critical means to absorb credit losses,” DeMarco said. “The result will be … an increase in systemic risk.”

Freddie Mac also implored the FHFA to rethink the policy.

“The capital framework should recognize the risk-reducing nature of CRT and the historical policy support provided by FHFA and Treasury to develop the CRT program,” Anzaldua said.

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GSE reform Housing finance reform GSEs FHFA Fannie Mae Freddie Mac Capital requirements Risk-based capital