With its risk-based capital rule due to be completed by the end of the year -- six years late -- the federal agency which regulates the safety and soundness of Fannie Mae and Freddie Mac is gearing up to take a broader look at the dangers the two government sponsored housing enterprises pose to the entire financial system.

The Office of Federal Housing Enterprise Oversight will undertake a comprehensive study of the systemic risk posed by Fannie and Freddie as part of its regulatory responsibilities.

"We must understand not just the risks faced by the enterprises," OFHEO Director Armond Falcon said, "but also the risks they pose to the financial system."

Among other things, the agency will investigate the nature of the hazards Fannie Mae and Freddie Mac pose to the system, the ways in which their financial difficulties could cause other market participants to incur losses, and the likelihood such losses could cause others to either default or begat still further disruptions.

Also on the agenda is an analysis of the potential benefits and costs of options for limiting Fannie and Freddie's potential for systemic risk.

Fannie Mae and Freddie Mac are federally-chartered financial institutions which are charged with maintaining liquidity in the mortgage market. They do that by purchasing loans from local lenders and packaging them into securities that are sold to investors throughout the world or kept in their own portfolios.

Falcon said that the "rapid growth" of the GSEs' debt and mortgage securities "has increased concerns" about the effect their problems could inflict upon the rest of the financial industry.

"Systemic risks have the potential to cause widespread crisis in the financial system, a disturbance that severely impairs the flow of credit, payment, payments or the pricing of financing assets," he said.

Now beginning the second year of his five-year appoint as OFHEO's director, Falcon, a former member of the legal staff of the House Banking Committee, pointed out that the enterprises' debt and securities are now "widely held" by foreign and well as domestic investors, many of which are financial institutions.

Moreover, he added, the amount of Fannie-Freddie obligations they hold are "large relative to their capital.

"If either Fannie Mae or Freddie Mac got into financial trouble, their securities became illiquid or they defaulted on their obligations, the consequences for a significant number of investors might impair the functioning of financial markets."

On the long awaited risk-based capital rule, which was supposed to have been completed at the end of 1994, Falcon said his plan now is to send the final regulation to the Office of Management and Budget by the end of the year.

He expects OMB to complete its required review of the rule by early 2001, at which time it will take effect. And once it is in place, the GSEs will be required to hold sufficient capital to withstand "very stressful economic conditions."

Published: September 27, 2000

Use of this article without permission is a violation of federal copyright laws.