Research Paper

FHFA’s Capital Rule Is a Step Backward

December 21, 2020

Authors Mark Zandi Jim Parrott Bob Ryan

Current Themes

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Overview

This white paper by Jim Parrott, Bob Ryan, and Mark Zandi critiques the Federal Housing Finance Agency's (FHFA) proposed capital rule for Fannie Mae and Freddie Mac. The rule aims to ensure the Government-Sponsored Enterprises (GSEs) remain viable post-conservatorship by adopting a capital framework similar to that required for banks. The authors argue that the rule misapplies the banking capital regime to the GSEs, leading to higher mortgage rates, riskier GSEs, and a less stable housing finance system.

Key Message

The FHFA’s proposed capital rule is poised to have significant repercussions on the housing finance system. The rule’s bank-like capital requirements would raise mortgage rates by 15-20 basis points while the GSEs are in conservatorship and by 30-35 basis points if they are privatized. This increase results from the higher capital costs and reduced capital relief from credit risk transfers (CRTs). Consequently, the GSEs would need to hold more capital, leading to decreased incentives to offload credit risk and potentially increasing their exposure to riskier loans.

The proposed rule also undermines the GSEs' role in providing market stability during economic stress, as evidenced during the COVID-19 pandemic. By increasing capital requirements and reducing CRT utilization, the rule may limit the GSEs’ ability to support the mortgage market effectively. The authors recommend adopting a more tailored capital framework that aligns with the GSEs' specific risk profiles and promotes a balanced and resilient housing finance system.