Board of Administrators warns of systemic menace from Fannie, Freddie

WASHINGTON – The Financial Stability Oversight Council has recognized for the first time that a financial burden on Fannie Mae and Freddie Mac would jeopardize financial stability, and it said companies may need more capital buffers than their regulators suggested.

The FSOC, created by the Dodd-Frank Act to monitor the financial system for impending risk and currently led by Treasury Secretary Steven Mnuchin, came to this conclusion after conducting a review of the secondary mortgage market as part of its recent move to activity . based approach to the identification of systemic hazards.

The announcement came on Friday, weeks after the public comment deadline on the Federal Housing Finance Agency's capital envelope for Fannie and Freddie after the Conservatory. The FHFA proposal would require government-sponsored companies to hold more than five times their current capital levels and align their capital standards more closely with those of banks.

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

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

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In a statement approved during a council meeting, the FSOC said capital requirements "significantly lower than those provided for in the proposed rule" are unlikely to take into account the risk Fannie and Freddie pose to financial stability.

In addition, it is possible that additional capital may be required for companies to have viable concerns in the event of severe encumbrance, especially if the quality of companies' assets ever deteriorates to levels comparable to pre-2008 experience is crisis, "said Howard Adler, deputy assistant secretary of the council, during a presentation at the meeting on Friday.

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

"For this reason, the statement encourages the FHFA to review the relative merits of alternative approaches to calibrating capital buffers more dynamically," said Adler.

However, the Council has stopped calling Fannie and Freddie "systemically important financial institutions". However, the FSOC added that it would consider using such a label for the GSEs or their activities if it found that the FHFA's final capital framework and other regulatory requirements such as stress testing and resolution planning were inadequate.

This designation would come with bank-like oversight from the Federal Reserve and additional regulatory requirements that could include stress testing, higher capital standards, and the need to produce "living wills".

In December, the FSOC completed a new process in which the focus is no longer on naming "systemically important" non-banks for stricter regulation, but on examining potentially risky activities in a certain sector across several institutions. However, the body still has the power to designate individual companies as SIFIs.

In a statement, FHFA Director Mark Calabria, who has a seat on the board of directors, applauded the FSOC for recognizing the risk that Fannie and Freddie pose to the financial system, saying the agency used the panel's findings in finalizing the issue will take into account the capital rule "in the coming months".

"As the Council noted, risk-based capital and leverage ratio requirements that are significantly lower than the proposed rule would likely not adequately mitigate the potential stability risk for businesses," Calabria said. "Indeed, more capital might be needed."

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

Federal Reserve Chairman Jerome Powell added in a statement that the FHFA's current proposal is an improvement on an earlier framework proposal proposed by the agency in 2018 under Calabrian predecessor Mel Watt.

"We welcome the sight of higher capital levels and less procyclicality," said Powell. "Any capital rule for the GSEs should be sensitive to the risks they are taking and ensure that the GSEs have sufficient capital to continue their critical role during times of economic stress or after a shock to the property market."

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