As their capital reserves dwindle thanks to the Net Worth Sweep, it looks as though Fannie Mae and Freddie Mac are directing more attention to the subject. In Freddie’s 2016 year-end 10-K filing and in both Fannie Mae and Freddie Mac’s 10-Qs for the second quarter of 2017, there is reference to the Conservatorship Capital Framework (CCF).

Freddie’s 10-Q for the second quarter of 2017 declares, “We and Fannie Mae have worked with FHFA to develop an overall risk measurement framework for evaluating Freddie Mac’s and Fannie Mae’s risk management and business decisions during conservatorship, known as the Conservatorship Capital Framework (“CCF”). We are now working with FHFA on the implementation of the CCF. We continue to expect this will result in limited change to our decision making.

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The reemergence of this “framework” raises more questions than it answers.  Coming nearly nine years into the conservatorship, even passing focus on the CCF in a statutorily required report could be a signal that change is in the works. It is possible that the Federal Housing Finance Agency (FHFA) is coming to grips with the fact that it is not sustainable to operate the government sponsored enterprises (GSEs) without adequate reserve capital and the time has come to address the situation. But until Fannie, Freddie and FHFA elucidate, this is mere speculation.

The CCF apparently originated by necessity at the start of the conservatorship when traditional capital classification at the GSEs was suspended and the Preferred Shares Purchase Agreements went into effect. FHFA used its statutory authority as conservator broadly in making the determination that capital regulatory requirements continued to be necessary and adopted an internal protocol for this. However, until this past year, the CCF has been given little if any attention in agency or GSE earnings reports. In Freddie’s year-end 10-k for 2016, a section on Economic Capital provided the most detail to date about the CCF:

“We use an internal economic capital framework as a component in our risk management process, which includes a risk-based measurement of capital adjusted for relevant interest rate and other market, credit, and operational risks. We assign economic capital internally to asset classes based on their respective risks. Economic capital is a factor we consider when we make economic decisions, establish risk limits, and measure profitability. We and Fannie Mae are working with FHFA to develop an overall risk measurement framework for evaluating Freddie Mac’s and Fannie Mae’s risk management and business decisions during conservatorship, known as the Conservator Capital Framework (“CCF”).  FHFA is finalizing key inputs to the CCF, and we expect to begin making risk management and business decisions using the CCF in 2017. We currently expect this will result in limited change to our decision making.”

Now that we are well into the third quarter of 2017, it would be useful for FHFA to provide more insight on how the painstaking process of “finalizing key inputs” will influence decisions – but maybe not that much, i.e. “limited.” For example, the GSEs derive income from guarantee, or g-fees, which, in addition to administrative costs, cover projected credit losses from borrower defaults, as well as the cost of holding capital to protect against projected credit losses. In essence, the most important factors the GSEs need to know in assessing g-fees are how much capital to charge for and the cost of that capital. This was discussed in more detail in a FHFA report on g-fees one year ago. At this point, FHFA will be engaging in a discussion about a capital framework where there will soon be no capital reserves. FHFA Director Mel Watt surely appreciates that the $5 trillion mortgage market cannot rest on assumptions akin to bitcoin transactions. The GSEs are major financial services firms and must hold real capital. If they lack capital to cover losses in 2018, taxpayers will be affected. Does the CCF address this possibility?

For well over a year, Director Watt warned of the need to prevent the GSEs’ capital reserves from disappearing altogether, but his hands have been tied politically when it comes to suspending dividend payments. It is possible that the time has come for Watt to exercise his authority.  Last week, when Fannie and Freddie announced their latest quarterly profits, accompanying statements placed conditions on whether the money would automatically be sent to Treasury.

In its story on the quarterly earnings, Market Watch also pointed out that Fannie and Freddie have been in the process of undertaking meaningful reforms even as Congress has remained at an impasse about the future of the GSEs. Fannie and Freddie have been shrinking investment portfolios, adopting tougher lending requirements and taking others steps that have helped them return to a more narrowly defined but critical function in home lending.

Capital remains a key part of reform. Until now, Fannie and Freddie’s capital has been commandeered for dubious purposes rather than deployed for responsible public policy that serves taxpayers and home buyers. The CCF discussion in Fannie and Freddie’s latest 10-Qs could mean FHFA is gearing up to take action to address the issue, thereby giving the process of ending the conservatorship and constructing a more sustainable secondary mortgage market a long overdue boost.