IV. PROTECTING TAXPAYERS AGAINST BAILOUTS CAPITAL AND LIQUIDITY REQUIREMENTS
1. Capital Requirements
Deficiencies in the GSEs’ regulatory capital framework were a root cause of the GSEs’ growth, risk taking, and near insolvency. As described in the Background section, the GSEs’ regulatory capital requirements were too low relative to their risks, which undermined market discipline and gave the GSEs a competitive advantage over banks and other market participants. In July 2018, the previous FHFA Director proposed a new framework to address these issues by increasing the
60
Given the GSEs and their potential successor guarantors’ central role in the housing finance system and the potential taxpayer exposure with respect to PSPA-backed or Government- guaranteed MBS, each GSE or guarantor should be subject to FHFA-prescribed regulatory capital requirements that require it to be appropriately capitalized by maintaining capital sufficient to remain viable as a going concern after a severe economic downturn and also to ensure that shareholders and unsecured creditors, rather than taxpayers, bear losses. To foster a level playing field with private sector competition, similar credit risks generally should have similar credit risk capital charges across market participants. To manage the limitations of risk- based capital requirements, the regulatory capital framework also should contemplate a simple, transparent, non-risk-based leverage restriction that is calibrated to act as a credible supplementary measure to the risk-based capital requirements.
60 Enterprise Capital Requirements, 83 Fed. Reg. 33,312 (proposed Jul. 17, 2018). FHFA has suspended the GSEs’ existing capital requirements since the beginning of the conservatorship, but according to the proposed rule, “while the [GSEs] are in conservatorship, FHFA will expect Fannie Mae and Freddie Mac to use assumptions about capital described in the rule’s risk-based capital requirements in making pricing and other business decisions.” Id.
GSEs’ regulatory capital requirements.
capital charges to different mortgage loans. It also would provide for separate capital requirements for market risk and operational risk, as well as a going concern buffer.
The proposed rule would assign specific credit ri It is unclear based on publicly available information whether FHFA’s proposed capital rule
61
On a related note, certain statutory definitions in the laws governing FHFA’s authority contain
specific definitions relating to the GSEs’ regulatory capital that are outdated or could otherwise
62
restrict FHFA’s discretion in prescribing regulatory capital requirements. Those statutory
definitions should be repealed and not incorporated into future legislation. Treasury recommends:
? Congress should repeal the existing statutory definitions relating to the GSEs’ regulatory capital that restrict FHFA’s discretion in prescribing regulatory capital requirements, and those definitions should not be incorporated into future legislation. (legislative)
? FHFA’s eventual regulatory capital requirements should require that each guarantor, or each GSE pending legislation, be appropriately capitalized by maintaining capital sufficient to remain viable as a going concern after a severe economic downturn and also to ensure that shareholders and unsecured creditors, rather than taxpayers, bear losses. FHFA’s eventual regulatory capital requirements also should include a simple, transparent leverage restriction that supplements the risk-based capital requirements. (administrative)
? In connection with the new FHFA Director’s ongoing re-assessment of the proposed capital rule, FHFA should disclose additional information on the calibration of the regulatory capital requirements. (administrative)
2. Credit Risk Transfers
In 2013, the GSEs began to develop programs to transfer credit risk on their acquisitions of single-family mortgage loans. These CRT programs have expanded significantly and have become a core part of the GSEs’ single-family businesses. Most of the GSEs’ CRT has been arranged through debt issuance structures – namely Fannie Mae’s Connecticut Avenue Securities (“CAS”) and Freddie Mac’s Structured Agency Credit Risk (“STACR”) securities – that track the performance of a reference pool of mortgage loans that have been securitized into the GSEs’
61 There is perhaps even some basis for doubt on that score. FHFA has projected that, had each GSE been in compliance with the proposed capital rule in the lead up to the financial crisis, Fannie Mae and Freddie Mac would have had only, respectively, $3 billion (10 basis points) and $12 billion (50 basis points) of regulatory capital remaining after the peak cumulative capital losses incurred during the crisis. Id. at 33,327 (presenting in Table 1 Fannie Mae’s capital requirement in comparison to peak capital losses), 33,328 (presenting in Table 3 the same information for Freddie Mac).
62 See FED. HOUS. FIN. AGENCY, ANNUAL REPORT TO CONGRESS 2018, cover letter. 29
satisfies these principles.
underway to re-assess the adequacy of the proposed capital rule. In addition, to ensure that the GSEs’ creditors and counterparties will have the requisite confidence in the final rule, FHFA should disclose additional detail with respect to the calibration of the risk-based capital requirements, including the underlying models, data, and assumptions.
The new FHFA Director should continue FHFA’s effort already
MBS. However, insurance and reinsurance transactions, as well as lender risk sharing and other front-end transactions, are also a growing share of these CRT.
The GSEs’ CRT programs enhance taxpayer protection and foster price discovery and market discipline, and in light of these features, FHFA should continue to support efforts to expand these programs. In particular, the reduction in retained credit risk that is achieved through CRT generally should be reflected in FHFA’s regulatory capital requirements. At the same time, each of the existing CRT structures has strengths and weaknesses, and it remains unclear how CRT will function over the long term. FHFA should therefore encourage the GSEs to continue to engage in a diverse mix of economically sensible CRT, including by increasing reliance on institution-level capital.
Treasury recommends:
? FHFA should, in prescribing regulatory capital requirements, provide for appropriate capital relief to the extent that a guarantor, or a GSE pending legislation, transfers mortgage credit risk through a diverse mix of approved forms of CRT. (administrative)
