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OFHEO risk-based capital stress test for Fannie Mae and Freddie Mac : hearing before the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises of the Committee on Financial Services, U.S. House of Representatives, One Hundred and Seventh Congress, second session, July 23, 2002.
This report responds to a mandate in the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the act)1 that we study whether the Office of Federal Housing Enterprise Oversight (OFHEO) should incorporate new business assumptions into the stress test used to establish risk-based capital requirements. The stress test is designed to estimate, for a 10-year period, how much capital the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) would be required to hold to withstand potential economic shocks, such as sharp movements in interest rates or adverse credit conditions. Incorporating new business assumptions into the stress test would mean specifying details about the types and quality of new mortgages that would be acquired during the 10-year stress period, the types of funding that would be used to acquire such mortgages, and other operating and financial strategies that would be implemented by Fannie Mae's and Freddie Mac's (the enterprises) managements. Under the terms of the act, the current test assumes that the enterprises do not contract for any new business beyond what is on the books at the time of the test. OFHEO issued its risk-based capital rule on September 13, 2001." Four years after issuing its risk-based capital rule, OFHEO has the option to incorporate new business assumptions into the test. Our mandate is to provide, within the first year after the rule is issued, an opinion on the advisability of including new business after the initial 4-year period.
Stress testing has recently become a critical risk management and capital planning tool for large financial institutions and their supervisors around the world. However, the one prior U.S. experience tying stress test results to capital requirements was a spectacular failure: the Office of Federal Housing Enterprise Oversight's (OFHEO) risk-based capital stress test for Fannie Mae and Freddie Mac. We study a key component of OFHEO's model -- 30-year fixed-rate mortgage performance -- and find two key problems. First, OFHEO had left the model specification and associated parameters static for the entire time the rule was in force. Second, the house price stress scenario was insufficiently dire. We show how each problem resulted in a significant underprediction of mortgage credit losses and associated capital needs at Fannie Mae and Freddie Mac during the housing bust.
This report responds to a mandate in the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the act)1 that we study whether the Office of Federal Housing Enterprise Oversight (OFHEO) should incorporate new business assumptions into the stress test used to establish risk-based capital requirements. The stress test is designed to estimate, for a 10-year period, how much capital the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) would be required to hold to withstand potential economic shocks, such as sharp movements in interest rates or adverse credit conditions. Incorporating new business assumptions into the stress test would mean specifying details about the types and quality of new mortgages that would be acquired during the 10-year stress period, the types of funding that would be used to acquire such mortgages, and other operating and financial strategies that would be implemented by Fannie Mae's and Freddie Mac's (the enterprises) managements. Under the terms of the act, the current test assumes that the enterprises do not contract for any new business beyond what is on the books at the time of the test. OFHEO issued its risk-based capital rule on September 13, 2001." Four years after issuing its risk-based capital rule, OFHEO has the option to incorporate new business assumptions into the test. Our mandate is to provide, within the first year after the rule is issued, an opinion on the advisability of including new business after the initial 4-year period.
This report responds to a mandate in the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the act)1 that we study whether the Office of Federal Housing Enterprise Oversight (OFHEO) should incorporate new business assumptions into the stress test used to establish risk-based capital requirements. The stress test is designed to estimate, for a 10-year period, how much capital the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) would be required to hold to withstand potential economic shocks, such as sharp movements in interest rates or adverse credit conditions. Incorporating new business assumptions into the stress test would mean specifying details about the types and quality of new mortgages that would be acquired during the 10-year stress period, the types of funding that would be used to acquire such mortgages, and other operating and financial strategies that would be implemented by Fannie Mae's and Freddie Mac's (the enterprises) managements. Under the terms of the act, the current test assumes that the enterprises do not contract for any new business beyond what is on the books at the time of the test. OFHEO issued its risk-based capital rule on September 13, 2001." Four years after issuing its risk-based capital rule, OFHEO has the option to incorporate new business assumptions into the test. Our mandate is to provide, within the first year after the rule is issued, an opinion on the advisability of including new business after the initial 4-year period.

OFHEO Risk-based Capital Rule

United States. Congress. House. Committee on Financial Services. Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises

Published: 2001

Total Pages: 62


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