Positive Results of Fannie/Freddie Stress Tests, from Gary Hindes
Sun, Aug 13 at 1:18 PM
Hello all:
FHFA published the Fannie Mae and Freddie Mac 2023 stress tests on Friday and as one publication put it, the two companies “aced” them (see attachment).
The stress tests indicate that the GSEs would earn $9.9 billion under the “Severely Adverse” scenario. I noticed, however, that for whatever reason, FHFA decided to crank up the draconian assumptions vs the 2022 stress tests. As an example, the 2023 stress tests now assume an across-the-board decline in residential housing prices of 38 percent (yikes!) vs 29 percent for 2022 (as well as commercial real estate declining 40 percent vs 35 percent; an 8 percent decline in GDP, and unemployment at 10! percent). Those are extremely conservative assumptions when you consider that the largest residential housing price decline in the country’s history was during the 2008 financial crisis (down 27½ percent according to the S&P/Case-Shiller U.S. National Home Price Index).
Imagine that. A 38 percent drop in housing prices – and even under that scenario, Fannie and Freddie remain profitable ($9.9 billion between the two) and neither would need a dime of government support. This according to the government’s own stress tests.
In the meantime, here’s Tim Howard’s take:
“For Fannie and Freddie both to now be able to survive a stylized 38 percent decline in nationwide home prices without the need for ANY initial capital (let alone the 4 percent-plus mandated by the Calabria capital standard) should be a headline finding. But FHFA said nothing about it; it just published the result without commentary, as if ignoring this important reality would make it go away, leaving the fiction of grossly undercapitalized companies needing to be kept in indefinite conservatorship as the only story worth telling.”
As for the Calabria 4 percent capital requirement, I suspect Ms. Thompson is giving some thought to reducing it to something more like 2½-3 percent. These stress tests definitely give her the backup she needs to justify the change. And last week, the Urban Institute weighed in, calling the 4 percent requirement “beyond what is reasonable”. The UI team directly takes on Calabria’s decision to impose the Basel III bank capital framework on two companies that have no business in common with banks. “The framework is a misguided approach to managing the risk the GSEs pose”. Banks assume interest rate risk, credit risk, and funding risk on mortgages, not to mention the many other lines of business in which they operate (i.e., auto loans, personal and commercial loans, credit cards, etc.). The GSEs, on the other hand, primarily assume only mortgage credit risk. And they assume that risk on millions of loans over several years, making returns relatively stable and predictable. “The [Basel III] capital framework . . . is thus unnecessary for the GSEs. And it comes at a significant cost, forcing the GSEs to hold more capital than their risk warrants.”
So I will be watching for an announcement that the capital requirements are under review. That is a crucial step towards releasing the GSEs. And as I have been saying for some time now, there is no legitimate reason for keeping them in conservatorship. The stress tests released on Friday prove it.
GH
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