Oversight council warns of systemic threat from Fannie, Freddie

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WASHINGTON — The Financial Stability Oversight Council has acknowledged for the first time that any financial strain at Fannie Mae and Freddie Mac would threaten financial stability, and it said the companies may need more of a capital cushion than its regulator has proposed.

The FSOC — created by the Dodd-Frank Act to monitor the financial system for looming risks and currently chaired by Treasury Secretary Steven Mnuchin — came to that conclusion after conducting a review of the secondary mortgage market as part of its recent shift to an activities-based approach to identifying systemic dangers.

The announcement occurred Friday, weeks after the public comment period closed on the Federal Housing Finance Agency’s post-conservatorship capital framework for Fannie and Freddie. The FHFA proposal would require the government-sponsored enterprises to hold more than five times their current capital levels and align their capital standards more closely with those of banks.

The FHFA is aiming to finalize the proposed requirements by the end of this year so that Fannie and Freddie can begin the process of raising the capital needed to exit conservatorship in 2021.

The council's announcement came weeks after the public comment period closed on the Federal Housing Finance Agency’s post-conservatorship capital framework for Fannie Mae and Freddie Mac.
The council's announcement came weeks after the public comment period closed on the Federal Housing Finance Agency’s post-conservatorship capital framework for Fannie Mae and Freddie Mac.

In a statement approved during a council meeting, the FSOC said that capital requirements that are “materially less than those contemplated by the proposed rule” would likely not address the risk that Fannie and Freddie pose to financial stability.

“Moreover, it is possible that additional capital could be required for the enterprises to remain viable concerns in the event of a severely adverse stress, particularly if the enterprises’ asset quality were ever to deteriorate to levels comparable to the experience leading up to 2008 financial crisis,” Howard Adler, deputy assistant secretary for the council, said during a presentation at Friday’s meeting.

The working group that the FSOC set up during the summer — which included staff from Treasury, the FHFA and the Federal Reserve — also found that the proposed framework’s use of a stress capital buffer and a stability capital buffer could be risk-insensitive, because the buffers are based on total adjusted assets and not risk-weighted assets.

“For that reason, the statement encourages FHFA to consider the relative merits of alternative approaches for more dynamically calibrating the capital buffers,” Adler said.

However, the council stopped short of designating Fannie and Freddie as "systemically important financial institutions." But the FSOC also added that if it finds that FHFA’s final capital framework and other regulatory requirements, like stress testing and resolution planning, are inadequate, it would consider such a designation for either the GSEs or their activities.

That designation would accompany banklike supervision from the Federal Reserve and supplementary regulatory requirements that could include stress tests, higher capital standards and the need to submit “living wills.”

The FSOC finalized a new process in December that moved emphasis away from designating "systemically important" nonbanks for tougher regulation in favor of looking at potentially risky activities in a certain sector across multiple institutions, but the panel still has the authority to designate individual firms as SIFIs.

In a statement, FHFA Director Mark Calabria, who has a seat on the oversight council, applauded the FSOC for recognizing the risk Fannie and Freddie pose to the financial system, and said that the agency would consider the panel’s findings as it looks to finalize the capital rule “in the coming months.”

“As the council found, risk-based capital and leverage ratio requirements materially less than those in the proposed rule would likely not adequately mitigate the potential stability risk posed by the enterprises,” Calabria said. “Indeed, more capital might be necessary.”

Calabria had previously suggested designating Fannie and Freddie as SIFIs would make sense, and said it would be appropriate for the FSOC to at least consider the label.

Federal Reserve Chairman Jerome Powell added in a statement that the FHFA’s current proposal was an improvement on a previous proposed framework that the agency had put forward in 2018 under Calabria’s predecessor, Mel Watt.

“We welcome the sight of higher capital levels and less procyclicality,” Powell said. “Any capital rule for the GSEs should be sensitive to the risks that they're taking and should ensure that the GSEs retain enough capital to continue their critical role during times of economic stress or in the wake of a shock to the housing market.”

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FSOC Fannie Mae Freddie Mac FHFA Mark Calabria Jerome Powell Steven Mnuchin Capital requirements GSEs
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