GSE capital rule is hypothetical, but FHFA gets earful anyway

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WASHINGTON — A risk-based capital plan for Fannie Mae and Freddie Mac is only theoretical as long as the two mortgage giants remain under government control. But the Federal Housing Finance Agency proposal requiring the government-sponsored enterprises to prepare for future crises still elicits strong opinions.

The FHFA has mostly won praise for developing the plan, meant to smooth the transition if Fannie and Freddie are released from their conservatorships. But lenders and other stakeholders are still poking holes in the proposal, calling for a higher level of required capital, changes to risk factors to protect the GSEs in a downturn, and a revamp to the FHFA's rulemaking process.

Among the more than 70 comment letters received by the agency, several stakeholders also called for greater transparency about how the proposal was formulated.

The Housing Policy Council "urges FHFA to reconsider and rework several features of the proposed capital framework and to republish the proposal with the full set of models, data, and assumptions, embedded in the proposed capital framework," wrote Edward DeMarco, president of the group representing some of the largest lenders and a former acting FHFA director.

The proposal, issued in June, would assess the GSEs' credit risk for different mortgage categories and include market and operational risk components in measuring the firms' capital strength. The FHFA also asked for comment on two different options for establishing a minimum leverage ratio for the companies: one where capital is equal to 2.5% of assets and off-balance-sheet guarantees, or an option requiring capital equal to 1.5% of trust assets and 4% of nontrust assets.

But both big and smaller lenders saw room for improvement in the plan.

Smaller financial institutions encouraged the FHFA to require a bigger capital cushion than the agency originally proposed. Ron Haynie, senior vice president of mortgage finance policy at the Independent Community Bankers of America, said a more conservative approach would be to set minimum GSE capital levels at least equal to those for the Federal Home Loan banks.

"ICBA strongly believes that the GSEs’ capital requirements, at a minimum, should be similar to the capital requirements of the FHLBs. That would put the GSEs’ total capital at 4 percent with a 5 percent leverage ratio," Haynie wrote in a comment letter. "We, therefore, suggest that the FHFA implement the proposed framework but with a higher capital requirement that reflects consideration for both protecting the taxpayer and the optics surrounding the GSEs."

The Community Home Lenders Association, which represents smaller nonbank lenders, agreed that "a larger cushion is needed, even in the absence of full recapitalization, and therefore CHLA continues to urge FHFA to suspend dividends to reach a more reasonable cushion."

Others argued that the FHFA's proposed capital plan is too procyclical, which could leave the mortgage giants severely weakened in a crisis.

“[The proposed rule’s] minimum leverage ratios would not be consistent with requirements for global systemically important banks, given the de facto status of the GSEs as systematically important financial institutions,” wrote Edward Pinto and Lynn Fisher, co-directors of the American Enterprise Institute's Center on Housing Markets and Finance, and AEI adjunct fellow Patrick Lawler. “The result would be underpricing of risks and exacerbation of house price cycles.”

In its letter, the Mortgage Bankers Association noted that the proposal's use of mark-to-market loan-to-value ratios contributes to the plan's procyclical nature. Those ratios immediately go down in a housing boom when home values increase.

The effect would allow guarantors to “release capital during stronger markets, only to then require larger capital buffers in the midst of a downturn,” wrote MBA President and CEO Bob Broeksmit in the organization’s comment letter.

The Housing Policy Council agreed, and suggested that the procyclicality of the framework could be offset by a separate measure.

“An automatic, rules-based, adjustment could be applied consistently, in a timely manner and would not be subject to political pressures,” wrote DeMarco.

At the same time, consumer groups worry that a tougher capital framework imposed on the GSEs could result in higher mortgage costs for cash-strapped borrowers.

The Center for Responsible Lending, joined by the NAACP, National Community Reinvestment Coalition and other advocacy groups, claimed that the proposed distribution of capital would unfairly burden lower-income consumers and it should therefore be restructured.

“This capital is a buffer for a future systemic market failure above and beyond the credit risk capital that covers losses that occur throughout the business cycle,” CRL wrote in its joint letter. “The model would disproportionately place the cost of this systemic failure capital on lower wealth borrowers, by a factor of as much as ten to one.”

The Credit Union National Association pressed the FHFA for information on how the capital requirements would impact the primary mortgage market, citing a study that estimated that a 1% increase in capital minimums at a financial institution could trigger a five to 10 basis-point increase in lending rates.

“Consequently, there is a direct correlation between the FHFA’s efforts to ensure that Fannie Mae and Freddie Mac are adequately capitalized and the affordability of mortgage credit for consumers,” wrote Mitria Wilson, CUNA’s senior director of advocacy and counsel. “In releasing the notice of proposed rulemaking, however, the FHFA fails to adequately discuss any examination into how the new capital requirements will impact conventional mortgage rates.”

Still, virtually all of the commenters praised the aim of the proposal, saying that the need for a stronger capital framework for the new firms was made clear by the crisis.

"MBA strongly supports the development of revised capital requirements for the enterprises, which, though suspended while the enterprises remain in conservatorship, will help facilitate the eventual transition to a reformed secondary mortgage market,” wrote Broeksmit.

While the GSE capital plan is still somewhat academic, with policymakers struggling to develop a housing finance reform plan to move on from the conservatorships, CHLA said the proposal can help guide the reform discussion.

“Development of capital restoration plans would enable Congress, FHFA, Treasury and the public to make a more informed decision by demonstrating how Fannie and Freddie could be recapitalized and how long it would take,” the group wrote.

But many groups said the FHFA could still be more transparent about its capital methodology as the agency develops the rulemaking.

DeMarco said the agency used a prior framework to help write the proposal, the details of which have not been made public.

"As published, the framework is based upon an existing Conservatorship Capital Framework (“CCF”) that has never been disclosed, and it includes a set of models, data, and assumptions that FHFA has not revealed in the proposal," he wrote. "The omission of this critical information precludes HPC members and other interested parties from providing informed comment on key aspects of the proposed capital framework, prevents FHFA from receiving valuable insights and input, and inhibits HPC and other interested parties from understanding and validating significant provisions of the framework."

Broeksmit of the MBA urged the agency not to rush the rulemaking process. Although FHFA extended the comment period to a total of 90 days, that was still insufficient for the public to fully assess the intricacies of the proposal, he said.

“There is a clear need for more information from FHFA and the opportunity for additional public input,” wrote Broeksmit. “Despite the length and complexity of the proposed rule, there are numerous areas in which it will not be possible for stakeholders to submit more detailed feedback unless FHFA provides the rationale for certain features or the assumptions underlying certain calculations.”

Broeksmit suggested that the agency utilize a “multi-round set of notice-and-comment periods” to improve the framework in stages.

“Such a process would also allow stakeholders to submit more useful input and analysis, provided FHFA releases further details with respect to critical inputs and assumptions,” he said.

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GSE reform GSEs Minimum capital requirements Risk-based capital rule FHFA Fannie Mae Freddie Mac Mortgage Bankers Association