Research Paper

Analysis of the Proposed 2020 FHFA Rule on Enterprise Capital

December 21, 2020

Authors Laurie Goodman Edward Golding Jun Zhu

Current Themes

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Overview

This analysis by Edward Golding, Laurie Goodman, and Jun Zhu evaluates the Federal Housing Finance Agency’s (FHFA) 2020 proposed rule on capital requirements for Government-Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac. The authors assess the proposed capital framework, which includes Basel-like requirements, leverage ratios, and additional buffers. They critique the complexity and potential consequences of applying a banking capital regime to GSEs, which are fundamentally different in structure and risk profile.

Key Message

The FHFA’s 2020 proposed capital rule for GSEs introduces a complex framework that may not be well-suited to the unique nature of Fannie Mae and Freddie Mac. The analysis highlights several critical points:

•    Basel Framework Misapplication: The rule relies heavily on a banking model, which is overly complex and not entirely appropriate for the GSEs' monoline business focused on mortgage credit risk, not the broader banking risks.
•    Excessive Leverage Requirements: The high leverage ratio requirements could become the binding constraint, discouraging risk mitigation strategies like credit risk transfers (CRT) and potentially leading to higher mortgage rates.
•    Procyclicality and Market Stability: The stability buffer and other capital buffers create high marginal capital requirements that could exacerbate procyclicality, limiting the GSEs' ability to act countercyclically during market stress.
•    Inadequate CRT Credit: The proposed rule does not provide sufficient capital relief for CRT transactions, which are effective in offloading credit risk and enhancing market stability.
•    Capital Allocation Issues: The capital requirements disproportionately penalize low-risk loans and high-LTV purchase loans, potentially driving high-quality loans away from the GSEs and affecting their ability to support affordable housing.

The authors recommend a simpler, more tailored capital framework that better aligns with the GSEs' risk profiles and public mission. They suggest reducing the leverage ratio, revising the stability buffer, and providing adequate credit for CRT transactions to ensure the GSEs can continue to support a stable and affordable housing market.