Eakinomics: The
FSOC and the GSEs
Friday the Financial Stability Oversight Council (FSOC) released its review of the secondary mortgage
market activities of the housing government-sponsored enterprises (GSEs)
Fannie Mae and Freddie Mac. It was an important moment from a number of
perspectives. First, the review was conducted using the
"activities-based approach" described in the interpretive
guidance on nonbank financial company determinations issued by the Council
in December 2019. Critics of the FSOC have stressed that it should move
away from a simple examination of entities as the route to designating
systemically important financial institutions (SIFIs). This was usually
just a “big is bad” sentiment in action; the activities-based approach
forces the FSOC to spell out exactly how systemic risk is generated.
Second, the FSOC concluded that the GSEs activities – namely purchasing
mortgages for securitization and sale as guaranteed mortgage-backed
securities – are a potential source of systemic risk. "The 2008
financial crisis demonstrated that financial stress at the Enterprises
could limit their ability to provide reliable liquidity to the secondary
market or perform their guarantee and other obligations on their MBS and other
liabilities, with significant implications for the national housing finance
markets, financial stability, and the broader economy. The Enterprises
continue to play a central role in the national housing finance
markets—acquiring nearly 50% of newly originated mortgages in both
single-family and multifamily markets—and are two of the largest U.S.
financial institutions. The Enterprises’ provision of secondary market
liquidity generates significant interconnectedness among the Enterprises,
banks, non-bank financial institutions, and other counterparties. Moreover,
given their similar business models, risks at the Enterprises are highly
correlated; if one Enterprise experiences financial distress, the other may
as well. If the Enterprises were unable to provide liquidity to the
secondary market, other market participants may be unable in the near- or
medium-term to provide liquidity at the scale and pricing needed to ensure
smooth market functioning and financial intermediation. As a result, any
distress at the Enterprises that affected their secondary mortgage market
activities, including their ability to perform their guarantee and other
obligations on their MBS and other liabilities, could pose a risk to
financial stability, if risks are not properly mitigated."
The key phrase at the end – "if risks are not properly mitigated"
– leads to the third important aspect. The FSOC concluded that the recently
proposed GSE capital rule from the Federal
Housing Finance Agency (FHFA) was sufficient to mitigate those risks, but a
less stringent capital rule was not. This is tantamount to buy-in
to the capital rule by other financial regulators and makes is very
unlikely that the rule will be revised substantially.
The final aspect of the FSOC decision is that it is wind at the back of
those in favor of ending the conservatorship. There is still enough
unfinished work – finalizing the capital rule, reworking the GSEs agreement
with Treasury, actually raising capital, and so forth – that it does not
appear imminent, but the FSOC decision is a step in that direction.
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