After reading the recent report from the Federal Housing Finance Agency on the performance of Fannie Mae and Freddie Mac’s credit risk transfer programs, anyone unfamiliar with the purposes of CRT might understandably conclude that the GSEs vastly overpaid capital market investors and insurance providers to transfer credit risk off their books. After all, the FHFA reported that since 2013, the GSEs had paid approximately $15 billion in interest and premiums for their CRT coverage while receiving just $50 million in write downs or reimbursements.
I can’t take issue with the statistics reported by FHFA, but they don’t tell the full story.
Let me offer an analogy. Suppose you had a home in the heart of Oklahoma’s tornado alley and you regularly pay your homeowner’s insurance. So far, though, your home has been spared any wind damage and you have made no claim against your insurance coverage. Does that mean you have paid too much in insurance premiums? Or that you might be better off canceling your home’s insurance protection altogether?
It would be fiscally irresponsible for the Oklahoma homeowner to come to that conclusion. The same is true for the GSEs’ CRT programs. The premium cost compared to the losses recovered that underpins FHFA’s recent report oversimplifies why the GSEs transfer credit risk and undervalues the extraordinary potential to protect taxpayers against unexpected losses during periods of economic turmoil.
After all, Freddie and Fannie have been consistently profitable over the eight years since their CRT programs were first introduced. If the most important determination of CRT’s efficacy was a narrow comparison between the cost and recovery when the housing market is strong, then one could similarly conclude both their guarantee fees – premiums in essence the GSEs collect for providing a credit guarantee – and the nearly $300 billion in capital the FHFA calls for in its recently published Enterprise Capital Rule, are excessive.
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G-fees and the Enterprise Capital requirement are set, in part, to account for expected and unexpected losses. CRT transactions, on the other hand, are typically designed to cover only unexpected losses. Simply put, we’ve not seen unexpected losses between 2013 and the first quarter of 2021.
The benefits of CRT are numerous.
A January 2020 white paper for the Harvard Joint Center for Housing Studies cites five challenges the GSEs are trying to solve by transferring credit risk to private investors:
- To reduce systemic risk in U.S. housing finance;
- To reduce taxpayer exposure to Fannie Mae and Freddie Mac;
- To provide the GSEs with real-time feedback on the credit risks GSEs are undertaking and introduce market discipline to their business practices;
- To reduce the cost of GSE capital; and
- To reduce the level of g-fees charged by Fannie and Freddie.
The first thing to note from reading this list is there is no mention of comparing the amount of premium and interest paid by the GSEs to the corresponding write-downs and reimbursements. It was simply not a goal of CRT. The second conclusion is that CRT has affirmatively proven it can solve four of the five challenges. The only item not yet resolved is the lowering of g-fees, the status of which remains uncertain in large part due to the recently finalized Enterprise Regulatory Capital Framework Rule.
CRT serves as a lower cost source of alternative capital for the GSEs. In fact, given that — up until recently — GSE capital has been near zero, CRT was the only thing standing in front of taxpayers. Between July 2013 and February 2021, reports FHFA, about $126 billion of risk in force (RIF) had been placed through securities issuance and insurance/reinsurance transactions. As of February 2021, $72 billion of the RIF remained in force. Today, that $72 billion still stands between the GSEs and taxpayer exposure on future unexpected losses.
What does the FHFA report say about this benefit? It is silent. In fact, in a footnote it acknowledges that “the net cost to the GSEs does not account for relief from capital requirements, imputed capital constraints, imputed or actual costs of capital.”
Again, the FHFA report doesn’t provide a full accounting of CRT’s benefits.
The COVID-19 pandemic was a timely reminder that disastrous economic events can happen without warning. The housing market was largely spared by the federal government’s forbearance and foreclosure relief, enhanced unemployment insurance benefits and stimulus programs. Next time this may not be the case.
Beyond the pandemic, FHFA’s capital rule significantly reduced the capital credit for CRT and prompted Fannie Mae to cease its CRT program. The largest participant in the conventional U.S. mortgage market is again accumulating risk without any protection. Fannie Mae’s decision is akin to the Oklahoma homeowner cancelling his insurance coverage.
This business model proved ineffective just over a decade ago when the GSEs last experienced unexpected loss activity. It is a dangerous development and re-establishing systematic risk transfer programs at the GSEs should be a top priority of all housing policymakers.
Is there room for improvement in the structure and design of CRT going forward? Absolutely. We’ve already seen changes, such as the elimination of fixed-severity transactions that existed in CRT’s early deals, and we welcome the opportunity to explore additional improvements. But make no mistake: CRT is working and together we can make it even better.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
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