Credit risk transfers earn bipartisan praise

• Key insight: Republicans and Democrats alike touted the ability of credit risk transfers to spread risk around the financial system during a hearing Wednesday, with lawmakers especially supporting the tool's utility in housing finance and for Fannie Mae and Freddie Mac. 
• Forward look: No specific legislation was under consideration during the hearing, but lawmakers' discussions suggest that Democrats are unlikely to make the instruments a top priority for scrutiny if they retake either chamber of Congress in the 2026 midterms. 
• What's at stake: Banks use credit risk transfers to move risk off their books while retaining underlying assets. 

WASHINGTON — Credit risk transfers, a financial instrument banks use to move risk off their balance sheets, received broad bipartisan support in a public hearing despite some concerns that the instruments could spread financial contagion. 

At a House Financial Services Committee meeting, both Republican and Democratic lawmakers touted the benefits of credit risk transfers and reinsurance in the housing market, particularly as a tool at Fannie Mae and Freddie Mac. 

"CRT, if used properly, will help redistribute some of the risk on the GSEs' books to other financial actors, lessening the burden on the Enterprises themselves," said Rep. Mike Flood, R-Neb., chair of the subcommittee on housing and insurance. "For those of us that are interested in lessening the taxpayers' potential liability from Fannie Mae and Freddie Mac, CRT is a tool that can help meet that goal."

While the hearing was primarily about the instruments' use in the housing market, the lack of partisan gridlock was nonetheless notable, suggesting that reining in the instruments may not be a top priority for Democratic lawmakers if they retake either the House or Senate in this year's midterm elections.

"CRT's, can offer benefits to our housing finance system," said Rep. Maxine Waters, D-Calif., the ranking member of the full House Financial Services Committee. "They can provide insight about market perceptions of the default risk of the housing portfolios of Fannie Mae and Freddie Mac, and may allow private capital to help absorb losses. But to be clear, CRTs will never replace the role of the federal government in housing finance." 

Credit risk transfers, sometimes known as synthetic risk transfers, are used by banks to push risk off their books without removing the underlying assets. They've come under some pressure from some corners of Washington — notably from Sen. Jack Reed, D-R.I. — but have nonetheless slid mostly under the radar. 

That broad bipartisan support is a good sign for banks, because the tools have become increasingly common and could represent a political liability if they were more controversial.  

Banks have for years used credit risk transfers, but they became especially popular in the U.S. in 2023 when it looked like regulators would boost capital requirements. While that concern is waning, banks still use the instruments for loans under heightened supervisory scrutiny under the regulatory microscope, such as commercial real estate loans. Fannie and Freddie use credit risk transfers to shift a portion of the mortgage default risk on single-family loans from their balance sheets to private investors. 

Many market watchers, however, aren't happy with the way that credit risk transfers have become more popular. 

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"The eventual credit cycle turn is likely to show again that weaker banks' CRT use merely transformed but did not eliminate risk," said Jill Cetina, a finance professor at Texas A&M University, in an American Banker op-ed. 

Sheila Bair, a former chair of the Federal Deposit Insurance Corp, has also taken aim at the instruments. 

"This issue takes on heightened urgency as so much credit intermediation has migrated to the nonbank sector," she wrote in 2023. "Should we have a recession next year — a real possibility — escalating credit losses here could seriously disrupt the flow of credit to the real economy. And again, if regulated banks have lowered their capital through credit risk transfer, they will be in a weakened position to take up the slack."