CUNA Regulatory Comment Call
November 6, 2000
Study of Possible Systemic Risk Posed by Freddie Mac and Fannie Mae
EXECUTIVE SUMMARY
The Office of Federal Housing Enterprise Oversight (OFHEO) is requesting comments for a study on the risks that the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae) may pose to the financial system and to housing finance markets. OFHEO regulates the activities of Freddie Mac and Fannie Mae.
The study will examine the nature and magnitude of any risks posed by these government-sponsored enterprises (GSEs), whether and to what extent these GSEs contribute or mitigate systemic risks, and actions that OFHEO and others may take to limit these possible risks.
Comments on the study are due by January 29, 2001. Please submit your comments to CUNA by January 22, 2001. Please feel free to fax your responses to CUNA at 202-371-8240; e-mail them to Associate General Counsel Mary Dunn at mdunn@cuna.com or to Assistant General Counsel Jeffrey Bloch at jbloch@cuna.com; or mail them to Mary or Jeff in c/o CUNA’s Regulatory Advocacy Department, 805 15th Street, NW, Suite 300, Washington, DC 20005. You may also contact us if you would like a copy of the request for comment or you may access it on the Internet at the following address:
http://www.ofheo.gov/docs/press/PRsystemicrisk.PDF
BACKGROUND
Congress created OFHEO in 1992 as an independent office within the Department of Housing and Urban Development to ensure that these GSEs are adequately capitalized and operating safely. In fulfilling this mission, OFHEO imposes capital requirements on Freddie Mac and Fannie Mae, conducts an examination of each of these GSEs, and engages in broad research programs. Up until now, OFHEO has consistently classified these GSEs as adequately capitalized pursuant to the minimum capital requirements, and OFHEO’s examinations have found these GSEs to be financially sound and well managed.
DESCRIPTION OF THE REQUEST FOR COMMENT
OFHEO is now requesting comments for a study on the risks that Freddie Mac and Fannie Mae may pose to the financial system and to housing finance markets. The study will examine the nature and magnitude of any risks posed by these GSEs, whether and to what extent these GSEs contribute or mitigate systemic risks, and actions that OFHEO and others may take to limit these possible risks.
The concern is that unexpected future economic shocks, management failures, or other factors could at some point cause either of these GSEs to fail to meet OFHEO’s safety and soundness standards. Because of their fast rate of growth and their increasingly central role in the mortgage and financial markets, significant financial distress or failure of either of these GSEs could disrupt the U.S. financial system and housing finance markets to such an extent that the U.S. and international economies would be adversely affected.
The study will focus on systemic risk. OFHEO generally defines systemic risk as the possibility that the direct or indirect effects of the failure of a large financial firm would cause disruptions in the financial system significant enough to have a substantial effect on real output and employment. An event that caused changes in asset values, even substantial losses in values, would not rise to a systemic threat if it were not expected to induce a loss in employment or economic output.
As part of the study, OFHEO is currently seeking comment on a number of specific research questions that the study may address, in addition to other topics that commenters believe should be addressed by the study. OFHEO is encouraging commenters to provide specific analysis and to suggest research methodologies that would be applicable to some or all of the questions.
QUESTIONS TO CONSIDER REGARDING THE REQUEST FOR COMMENT
(The following are the specific research questions, listed under three broad categories)- Do Fannie Mae and Freddie Mac pose systemic risk, as defined above, to the U.S. and international financial systems? If so, how? How does any systemic risk posed by the GSEs compare, in magnitude and character, to that posed by other large financial firms such as large, complex banking organizations?
- Do the activities of Fannie Mae and Freddie Mac reduce the systemic risk of the U.S. and international financial systems? If so, how?
- Can the risks the GSEs pose to the financial system in general and U.S. housing finance markets in particular, and any systemic risk they may pose, be quantified meaningfully? If so, how?
- If Fannie Mae or Freddie Mac defaulted, how severe would losses on that GSE's obligations have to be to render other financial firms undercapitalized or insolvent? How many firms could experience such solvency problems? How does the risk of solvency problems vary for different types of firms (for example, federally insured depository institutions, securities firms, major derivatives dealers, other GSEs, and pension and retirement funds)? How does that risk vary for firms of different size? How severe might such solvency problems be? How might such problems affect the functioning of the financial system?
- If Fannie Mae or Freddie Mac experienced severe financial distress or failed, how many other financial firms could experience liquidity problems? How would such liquidity problems differ for different types of firms (for example, federally insured depository institutions, securities firms, major derivatives dealers, other GSEs, and pension and retirement funds)? How does that risk vary for firms of different size? How severe might such liquidity problems be? How might such problems affect the functioning of the financial system?
- If Fannie Mae or Freddie Mac failed or significantly curtailed its activities, how would liquidity in U.S. mortgage markets be affected? Would the other GSE or the rest of the industry be able to effectively fill the void? What would be the likely effects on the supply and price of mortgage credit? What would be the likely effects on economic activity in the housing sector? How might prospective homebuyers be affected?
- What is the risk that solvency or liquidity problems at financial firms caused by severe financial distress at, or default by, either GSE could be serious enough to reduce employment or economic output or hamper the achievement of the goals of federal housing policy?
- Fannie Mae and Freddie Mac are major participants in national and international systems for clearing and settling financial transactions. What risks do the GSEs pose to such systems?
- The outstanding debt of Fannie Mae and Freddie Mac has grown at an annual average rate of nearly 24 percent since year-end 1992. If debt issued by the GSEs continued to grow substantially faster than most other types of credit market instruments, how would any risks that Fannie Mae and Freddie Mac pose to the financial system as a whole, and U.S. housing finance markets in particular, be affected? How would those risks be affected if debt issued by Fannie Mae, Freddie Mac, and other GSEs replaced Treasury securities as a benchmark in financial markets?
- How independent are the risks posed by Fannie Mae and Freddie Mac?
- What are the implications for the risks Fannie Mae and Freddie Mac pose to the financial system in general, and U.S. housing finance markets in particular, of the fact that investors in the GSEs' obligations believe the federal government would act to protect them in the event either GSE failed?
- Is there uncertainty about the actions the federal government would take in the event either GSE experienced severe financial distress? Does any such uncertainty affect the risks posed by Fannie Mae or Freddie Mac?
- How does current federal regulation of Fannie Mae and Freddie Mac affect any systemic risk posed by the GSEs?
- What steps could be taken to reduce the risk that a default by Fannie Mae or Freddie Mac would cause other financial firms to experience solvency or liquidity problems? What are the potential costs and benefits of those options?
- What steps could be taken to reduce the risk of the GSEs developing liquidity problems if either of them experienced severe financial distress? What are the potential costs and benefits of those options?
- In addition to OFHEO's capital regulation and examinations of Fannie Mae and Freddie Mac, what steps can OFHEO or other appropriate entities take to reduce any risks the GSEs may pose to clearing and settlement systems? What are the potential costs and benefits of those options?
- In what areas could increased transparency and public disclosure by Fannie Mae and Freddie Mac reduce the risks they pose to the financial system in general and U.S. housing finance markets in particular? What specific information would be most valuable to market participants?
- Could increased market discipline of Fannie Mae and Freddie Mac reduce the risks they pose to the financial system in general and U.S. housing finance markets in particular? If so, how? What specific actions could be taken to increase market discipline of the GSEs? Could increased market discipline increase the risks that Fannie Mae and Freddie Mac pose?
- Should OFHEO's statutory authority and OFHEO’s approach to regulating the GSEs be adapted to reflect the risks Fannie Mae and Freddie Mac pose to the financial system in general and U.S. housing finance markets in particular? If so, how?
Whether and to What Extent Fannie Mae and Freddie Mac Pose Risks to the Financial System and U.S. Housing Finance Markets
The Effect of Federal Sponsorship and Regulation on the Risks Posed by the GSEs
Actions to Reduce Risks Posed by Fannie Mae and Freddie Mac
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Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com Mary Mitchell Dunn • SVP & Associate General Counsel • (202) 508-6736 • mdunn@cuna.com Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com Catherine Orr • Senior Regulatory Counsel • (202) 508-6743 • corr@cuna.com |
