WASHINGTON — 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 Tuesday 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.”

Fannie Mae building
The new proposal would target Fannie Mae and Freddie Mac's combined capital at $180.9 billion, assess credit risk for different mortgage categories, and include components for market risk and operational risk. Bloomberg News

Others saw the proposal as having a more substantive impact, both for 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 the companies’ capital profile.

“What’s nice about it really first and foremost 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,” he said. “It should be helpful going forward 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.”

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